A mezz cure priced right and still unaffordable is a case worth studying closely

What was the actual trap trigger, senior-only DSCR or combined? I've seen both and the combined ones spring about six months earlier than sponsors model them.

The gap between having a cure right and being able to fund it is the structural feature of mezzanine that borrowers and junior lenders both tend to underestimate, and @hannah_west29 described it accurately.

Mezzanine debt sits between the first mortgage and common equity. It is usually secured by a pledge of the ownership interests in the entity that owns the property rather than by a lien on the property itself, so enforcement runs through Article 9 of the UCC as adopted in the relevant state rather than through a mortgage foreclosure. That is why the remedy is a sale of the equity interests. Whoever buys those interests owns a company that still owes the senior loan on its existing terms, assuming the intercreditor and senior loan documents permit the transfer at all. The economics of exercising therefore include the outstanding senior balance, any arrears and reserve shortfalls the intercreditor requires you to cure, and whatever capital the asset needs to reach the value that justified the position in the first place.

Two mechanics compound this. Interest that converts from current pay to accrual increases the balance without producing cash, so the position gets larger while the borrower's ability to service it gets smaller. And a senior cash management trap can route all property cash to the senior lender before any junior payment is made, which is a common structure and one you should read in the specific documents rather than assume.

Pricing at 10 to 15 percent reflects the subordinate position and the risk that comes with it. It does not by itself fund the cost of control. Sizing a reserve against that cost is a modeling decision, and how the intercreditor and the state's UCC provisions apply to any particular structure is a question for counsel on that deal.

Two questions before drawing any lesson from this. What level was the DSCR test set at, and was it tested on trailing three or trailing twelve? The trailing period is worth as much as the level, because a trailing three test on a lease up asset can trip on a single soft quarter, and almost nobody puts a number on that when they sign.

$14/sf of TI on a 1980s suburban office at 62% leased was never going to be enough. Second generation office space in a building that age wants demo, ceiling grid, and HVAC boxes that have not run in years, and by the time a full floor tenant is built out the number sits at $45 to $70/sf in most markets before commissions. Whatever the cash trap did, the business plan was underfunded from day one and the mezz was funding a gap that would have reopened even with full occupancy.

What does PIK mean here? I gather you stopped getting paid but the number kept going up.

What did the legal cost across the whole thing? Original docs plus the workout. I ask because when I model my own deals I put a flat number for legal and I suspect flat is the wrong shape.

The part worth sitting with is the 61%. Buying a minority piece of a tranche means the decision that determines the outcome gets made by someone else's investment committee. That reads as though the actual purchase was a vote the buyer didn't have, and the coupon was just the price paid for it.

I've hit a smaller version of this on the borrower side. My mezz lender had a cure right they didn't want to use either, and for about four months nobody was willing to be the one who spent money. The asset just sat there getting worse while two sets of lawyers wrote letters.

Every time a story like this surfaces it is a reminder of why straightforward ownership with a fixed rate is worth the lower ceiling.

What was the exit assumption on the office? If it was a cap rate on stabilized NOI in a market that was already giving back space, I'd want to know what your downside case looked like at close, not in month 11.

@hannah_west29 to put a number on that point, take a 190,000 sf building going from 62 to 82 percent leased, that's roughly 38,000 sf. At 50 a foot of TI plus commissions at say 5 percent of a ten year lease, the cost is north of 2.4 million before touching the base building. A 14 a foot line only works when renewing sitting tenants who don't move a wall.

@hannah_west29 the reserve idea is what I want to steal. How would you have sized it in practice? Full senior balance is obviously absurd for a minority participant. Something like arrears plus twelve months of senior debt service plus the leasing capital, expressed as a multiple of your check, so you either hold it or you know at close you're a seller in trouble?

Who else was in the tranche and how did you find out? When I look at participations the sponsor of the paper is happy to tell me the coupon and much less happy to tell me the names on the other 60%, and I've started treating that reluctance as the answer.

The cause here sits somewhere different from the TI number. The TI allowance was thin and the leasing trap was aggressive, but neither of those cost the recovery on its own. The participation agreement did. A 61 percent holder with the right to direct enforcement and to sell the strip effectively held every other right in the intercreditor agreement, and the smaller holder held none of them in practice. What gets bought in that structure is an economic interest described as a lending position, not control over the outcome. The two things worth reading first in any participation agreement are who directs remedies, and whether a non-controlling holder has any purchase option when the controlling holder decides to sell.

Sorry for the basic one. When the tranche sold the strip at 22 cents, who buys that? Is there a standing market for distressed mezz paper, or is it a phone call to four people who all know each other?

@wendy_park48 most of that holds up. When one holder controls 61 percent, that holder decides the outcome regardless of what the governing document technically allows anyone else to sign. Control alone would not necessarily change the result, though. Take a mezz position needing $3.1m of cure plus leasing capital against a $2.5m position: the fund simply does not have it. Control without capital gets a slower version of the same result. @stephen_ok9 that formulation is close to a useful standard. Arrears plus twelve months of senior debt service plus the remaining business plan capital, divided by the check size, is a reasonable stress ratio to compute before writing a position. A ratio near 2.8x should give any investor pause before committing. @joe_delgado5 senior-only, tested trailing three, set at 1.20x is a common structure, and trailing three is typically what makes a covenant spring quickly. @aliyah_b legal and workout costs on a position like this commonly run around $190k across the life of the deal, with roughly two thirds of that in the workout rather than the closing.

On the collateral question, mezz is not a second mortgage under a different name. A pledge of the equity in the property owner, rather than a lien on the dirt, changes the path to control: taking the equity does not automatically extinguish the senior debt or other claims against the entity, and enforcing an equity pledge runs through different mechanics than a foreclosure on real property.

@raj_mehta14 it matters a lot. A second mortgage is a lien on the real property and gets foreclosed under that state's real property procedure, which in judicial states can run a long time. Mezz is a pledge of the membership or partnership interests in the entity that owns the property. It gets foreclosed under Article 9 as adopted in the governing state, which is generally a commercially reasonable sale after notice and moves faster. What comes out the other end is the company, and the company still owes the senior loan. So the debt is inherited rather than wiped out. Whether that transfer is even permitted usually depends on transfer conditions in the senior loan and the intercreditor, which is a document question for a lawyer on the specific deal.

@hannah_west29 thanks for the 2.8x. That single ratio is more useful than the rest of the thread, and it can be computed from a term sheet before asking anyone for anything.

@sonia_alvarez that lands. So the recorded document at the county isn't the mezz at all?

@raj_mehta14 right. The mortgage or deed of trust for the senior gets recorded in the county land records. The mezz pledge is typically perfected by a UCC-1 filed with a state office, usually the secretary of state of the state where the borrower entity is organized, and the exact filing office and practice vary by state. Someone pulling only the county records on a property can miss the mezz entirely. That is one reason mezz balances are harder to see from the outside than mortgage balances, and in a dozen or so states the sale price isn't even publicly visible to begin with.

@gregpowell66 is right about the TI and I'd add the part that always gets me, timing. Even if the $14/sf had been $50/sf, second gen office fitouts run six to nine months from lease signature to rent commencement once you're through permits. So your cash trap sprang while the money you did spend was sitting in half-built suites producing nothing. The trap tests don't care that the rent is coming.

On price, 13 percent all-in for a subordinate pledge behind a floating senior on a 62 percent leased office repositioning reads thin for the risk actually present, whatever the general range for these positions runs. The coupon has to cover the chance of needing multiples of the original check to protect it. If the reserve math described by @hannah_west29 comes out at 2.8x, that is information about pricing, not only about sizing.

How does someone even see one of these? I've never been shown a mezz anything and I'm not sure whether that's because I'm new or because they don't circulate.

A useful test before pricing any coupon is break-even occupancy at combined debt service, using the senior's stressed rate rather than the current one, and using in-place rents rather than the sponsor's mark to market. On the shape @hannah_west29 described, break-even likely sat somewhere in the mid 70s while the building was at 62 and falling. If the trap trigger sits above break-even occupancy, the trap isn't a warning system, it's a schedule. That timing is knowable the day the deal closes.

@hannah_west29 did the intercreditor let the cure payments count against the senior balance, or were they gone? Drafts go both ways on this and the difference changes the whole calculus of whether a mezz holder cures at all. Some versions treat mezz cure advances as an add-on to the mezz loan against the borrower, which is worth something if the equity ever comes back, and some treat them as payments to the senior with no credit to the mezz position anywhere.

Adding two lines to my checklist from this. Ask for the participation agreement before the intercreditor, and ask for the ratio @hannah_west29 described in writing from whoever is offering me the piece. If they can't produce arrears plus twelve months of senior service plus remaining business plan capital over my check size, they haven't done the work, and I'd rather find that out over email than in month 31.