There’s a lot of reasons to structure a large loan destined for securitization as a mortgage in part and a mezzanine loan in part. Sometimes it’s simply that the borrower is needy while the capital markets are charry. In that case, the lender whacks up the credit into a mortgage loan for SASB execution and assumes (hopes) there’s someone out there with sufficient acumen, optimism or naivete to buy the mezzanine loan. But sometimes, there are other reasons to divide a loan into a mortgage and mezz.
The Dechert team just recently closed a SASB securitization of a stapled mortgage and mezz as a REMIC and as far as we could tell, it had not been done before (other than a single mezz which was REMIC’d a few years ago which, rather like a tree falling in the forest that no one hears, didn’t seem to impact our markets much).
To dive a bit into the weeds, if you’re in the SASB market, you know that these deals are often done as REMICs. That’s what investors expect.
A question has always lurked in the shadows as to whether you can REMIC a mezzanine loan. Many in the tiny coterie of expert REMIC tax lawyers have thought that a mezz loan was a good REMIC asset. This view has been buttressed by favorable IRS positions as to the treatment of mezz loans in analogous cases, albeit in another context. The problem, of course, is that there has been nothing on all fours and that can make a tax lawyer twitchy. Due to a certain lack of bandwidth to think about it in the hurly-burly of trying to get things done, some lingering anxiety amongst the tax bar and the iron-bound conservatism of the securitization marketplace, no one has tried to do it in a regular SASB way.
In the case at hand, we were confronted with a borrower that could harvest material savings by transmogrifying a portion of the mortgage into a mezz. We also had a client with the innovative bent of mind and the audacity to try something new, and so we did. And it worked. After some back and forth with underwriter’s tax counsel and a lot of collegial brainstorming, we agreed that the mezz was a good REMIC asset and the transaction could go forward on that basis. So, the tax lawyers went off to get the plumbing right, but nothing is easy and that was only the first step in getting this transaction done. The next problem was convincing the ratings agencies that a stapled mortgage and mezz was not credit negative and then, of course, convincing the bankers who had to move the iron and assuring investors that investing was okay.
To get ahead of the anxieties we anticipated we’d encounter, we structured the securitization with the mortgage and mezz firmly stapled together. Each financial asset had the same interest rate, the same amortization schedule (in this case none), the same interest accrual mechanics and the same maturity. The securitization was tranched as if it was one whole mortgage loan without separately treating a tranche as tied to the mezz. In fact, in some circumstances, repayments would be applied to the mezzanine loan before the mortgage, and frankly, I think that is a really good idea as it would cause an increasing portion of the overall loan to be secured by a lien of a mortgage. (This would work as long as the mezzanine loan did not become unduly small, for a number of very technical legal concerns). Generally, payments were applied pro rata and the mortgage could not be paid off before the mezz. This ameliorated concern that the mortgage would for some reason pay off early leaving the bonds only secured be the mezzanine loan.
We argued, ultimately persuasively, that everything else being equal, it is a terrific lender enforcement mechanic to have a portion of the loan structured as a mezz and have access, or at least potential access, to the more rapid foreclosure mechanics of a UCC foreclosure. This could be particularly useful in jurisdictions that provide a balky, unwieldy or unamiable foreclosure experience.
After a bit of hard thinking about these issues and other hoary legal issues from the time of the mort gaige in Ol’ England, we convinced ratings agencies, bankers and ultimately investors that the structure was indeed not only okay, but in fact a good idea.
From after action debriefings with the bankers, it seemed pretty clear that the transaction did not take any sort of a hit in the investor marketplace because of its structure.
I’m convinced that if the benefits of this structure are more broadly disseminated and investors could become more aware and comfortable with the structure, a pickup might also be achievable from this.
So, the market should think about this some. This should not be a “tree falling in the forest where no one hears it” type of thing. It is certainly a viable alternative where there are compelling business reasons to structure a portion of the loan as a mezz loan, and there also might be good reasons to use this structure more generally to acquire the enhanced remedies of potential mezz foreclosure in connection with these large loans.
We may be conservative as an industry, but we’re not moribund and when a good idea is validated, we should embrace it. We’ll be here to cheer it on. Not so much a shotgun marriage, is it?