Andrew Foster: Mezzanine Market Musings
(Andrew Foster is MBA Director of Commercial/Multifamily Policy; he can be reached at afoster@mba.org or 202/557-2740.)
The commercial real estate mezzanine loan market is ripe with interesting market developments this year.
New York State Budget Does Not Include Proposed Mezzanine Debt
In April, Governor Andrew Cuomo, D-N.Y., announced New York had adopted a 2020-2021 budget–a budget that did not include a mezzanine tax provision. The Mortgage Bankers Association had advocated against such a tax and sent a letter to Cuomo and leaders of the state legislature in opposition to Senate Bill 7231 and Assembly Bill 9041. The bills would amend New York Real Property Law to require mezzanine debt (not secured by land) be recorded in county land records along with any related mortgage and require the payment of a recording tax on the mezzanine debt.
The letter, also signed by the New York Mortgage Bankers Association and the Commercial Real Estate Finance Council, said the organizations “oppose passage of these bills because the proposed new tax would increase costs to New York renters and small businesses (effectively a tax on renters) during an existing affordability crisis that has been exacerbated by the economic impact of the outbreak of the coronavirus (COVID-19).”
This is important because a tax on mezzanine debt would increase the cost of borrowing and potentially harm lending demand in New York. It is still possible the New York legislature could consider the mezzanine tax bill later in 2020. MBA will continue to advocate against it with CREF Policy Advisor Grant Carlson leading efforts on this state issue.
New York Court Allows Mezzanine Foreclosure to Move Forward
The Real Deal recently published a story highlighting a ruling that allows a mezzanine foreclosure to move forward in New York.
AmTrust Title Insurance Co. General Counsel Joseph Philip Forte said the judge ruled that while the Executive Order prohibits foreclosure of any commercial property for 90 days without limitation to mortgages, “that provision addresses enforcement of a judicially ordered foreclosure. The proposed mezzanine foreclosure as a sale under the UCC [Uniform Commercial Code] is a non-judicial proceeding and therefore not covered by the prohibition. As to the damages resulting from the sale are merely speculative and no irreparable harm would result from the UCC sale, the judge vacated his prior TRO because the mezzanine borrower could seek monetary damages later. He did not address whether the UCC sale could later be challenged as not being a commercially reasonable public sale in the context of the pandemic.”
The market for new mezzanine lending is challenged in the current economic environment not unlike some other commercial real estate lending strategies due to challenges during the price discovery process. As far as existing mezzanine loans, these may experience trouble more quickly than or in lockstep with senior mortgage loans given their place in the capital stack. The mezzanine finance market for commercial real estate lacks a ready source of data approximating its size as it is not tracked by any industry group or government body but given its continued prominent role as a source of funding for real estate projects, there is an expectation that the some loans will attract market attention as difficulties arise in property performance in the coming months.
How intercreditor agreements have been drafted and are interpreted by the courts for loans in various real estate projects will play an important role in how these situations evolve. The senior lender and the mezzanine lender negotiate the intercreditor agreement, which provides for communication between the two parties and gives certain rights to the mezzanine lender in default events.
Thompson & Knight Partner Mark Weibel, a member of MBA’s Commercial Board of Governors who represents special servicers of CMBS REMIC trusts in loan workouts and restructures, said working through issues created when a borrower’s business plan or property fails to meet expectations “may require, among other things, an appreciation of the complexity that an extra participant like a mezzanine lender adds to the workout or restructure. For example, in some workouts the unique nature of a mezzanine lender’s collateral and remedies may require the mezzanine lender to negotiate an issue that would normally not be a consideration for a CMBS trust,” he said. “Also, the intercreditor agreement between a CMBS trust and a mezzanine lender often conditions a workout or restructure on the mezzanine lender’s receipt of various notices, the expiration of time periods provided in the notices, a waiver (or deemed waiver) of certain rights held by the mezzanine lender, etc.”
Fitch Ratings Studies How Subordinate Debt Affects U.S. CMBS Loans
Fitch Ratings released a report showing senior commercial mortgage-backed securities loans with unsecured subordinate debt such as mezzanine debt show significantly lower default rates than senior loans with secured subordinate debt, such as B-note mortgage debt, at comparable leverage point. The report examines the difference in performance between types of subordinate debt–namely secured (e.g. B-note, C-note) versus unsecured (e.g. mezzanine, preferred equity).
Fitch evaluated 1,001 senior CMBS conduit loans with subordinate debt in place that were issued between 2003 and 2008. At leverage levels most commonly found in recent CMBS transactions, the default rate for senior loans with unsecured subordinate debt is significantly lower than for loans with secured subordinate debt, Fitch Senior Director Ryan Frank said. “For loans with mid-range leverage, the default rate for senior loans with unsecured subordinate debt is 25 percent lower than for loans with secured subordinate debt,” he said.
Similarly, total realized loss rates for senior loans with unsecured subordinate debt were lower at each leverage category than for loans with secured subordinate debt. For mid-range leverage loans (70 percent to 80 percent total debt issuer LTV), realized losses on senior loans with unsecured subordinate debt totaled 1.8 percent compared with 6.1 percent for loans with secured subordinate debt.
