Senior lenders, as we all have noticed, have become increasingly cautious in the past few months, worried about what’s to come, yet those very same bankers have been opening their doors to non-traditional alternatives to fill the void in capital stack for qualified borrowers with well-positioned assets. It seems the stars have aligned for mezzanine lenders. A rapid increase in development in and around the boroughs, as well as a steady increase month-over-month in investment sales and produced a concrete outlook for both the residential and commercial markets in the months to come. Borrowers are on the lookout for both conventional and alternative sources of capital to fill their capital stack and take out loans made five or seven years ago with high LTVs.
Rates have come down significantly on mezz loans, reflecting a more stable market and increased competition among lenders, both public and private. Money is abundant, and although the first position lenders are becoming a bit more alert as to the uptick in rates over the next 6-12 months, mezz lenders are mitigating their risk with airtight loan agreements and fair intercreditor arrangements.
The swelling number of borrowers on the prowl for these alternative loans has driven lenders to hop on the bandwagon. Traditional lenders, funds, REITs, and individuals themselves have instituted mezzanine lending programs that they may not have had in the past, and surely were not at the forefront of their agendas.
Structuring a mezzanine loan does have its share of complex legal issues though, as both the senior and junior lenders must work out the aforementioned intercreditor agreement to the satisfaction of all parties. The creditors will outline the various terms, conditions, and rights that each lender expects, which details the relationship between the creditors and the borrower. Since the junior position gets paid only after the senior debt is satisfied, the risk must be carefully mitigated. Typically, the second lien lender will have the option to acquire the senior debt position at par in the event of bankruptcy or borrower default as a way to protect its invested capital.
Lee Silpe is the senior analyst at Berko & Associates, New York, N.Y.