WORKOUTS OF MEZZANINE FINANCING
By: Stuart M. Saft
Mezzanine financing is a form of subordinate financing that fills the gap between the debt on the real property, that is secured by a mortgage (the "senior debt") and the equity in the project. It is a form of junior debt that is not secured by a lien on the real estate but rather, an assignment of the borrower’s interest in the single purpose entity that owns the property. Mezzanine financing has become particularly popular since the advent of securitized financing where the underlying debt is sold pursuant to a commercial mortgage backed security (CMBS) and the senior mortgage lenders forbid subordinate financing on the property. However, mezzanine debt and securitized mortgage debt are not dependent on each other to exist, because a property and its owners can be encumbered by either, both or none. It is the flexibility that is offered by mezzanine debt that made it so appealing to property owners and investors.
Mezzanine debt provides the owner with the ability to improve the loan-to-value ratio of the property without placing a subordinate mortgage on the property, which provides an added level of protection to the holder of the mortgage on the property. Moreover, because the mezzanine debt would be eliminated in a foreclosure of the senior debt or a bankruptcy filing by the property owner, there is an incentive for the mezzanine lenders to assist in solving any problems the property or the borrower might have. As a result of this increased risk, mezzanine loans usually have a higher interest rate and frequently a participation in the appreciation of the underlying property. The added complexity of mezzanine debt workouts arises from the fact that there are different tranches of mezzanine debt and the further down a tranche is, the higher the interest rate, but the less likely it is that the holder of that tranche of mezzanine debt will ultimately be paid which is, of course, the reason for...