The mezz attachment point is what's stopping me from sizing this

Two commitments due by the end of the quarter and I've only got $400,000 to split.

Fund A, residential bridge, first lien. Coupons 10.5 to 11.5, average loan $480,000, roughly 900 loans across 20 states, sized at 68 percent of as-is value with rehab held back in draws. Fees are 1.25 and no promote under an 8 percent hurdle. Net target is 9 and change. Reported loss rate 34 basis points cumulative since 2019.

Fund B, CRE mezzanine behind bank seniors. Coupons 13.5 average, 34 positions, average $6.8 million, attaching between 65 and 82 percent of appraised value. 71 percent of the book is multifamily originated in 2021 and 2022. Net target is 11.5.

My problem with B is arithmetic. If the value on a 2021-basis multifamily deal is down 15 percent from the appraisal that set the attachment point, everything above 65 percent is already impaired and the mezz position is where that lands first, before the senior feels anything. The manager's answer is that the seniors are all fixed rate to 2029 and the properties are cash flowing at 1.15 debt service coverage, so nothing forces a sale. That's true and it's also a story about time rather than about value.

My problem with A is that I cannot verify 900 loans. I'm trusting a process and a servicer I've never met, and 34 basis points of loss over a period when house prices only went up tells me nothing about the servicer's competence in a workout.

Current plan is 300 to A and 100 to B, or all 400 to A and pass on B until the 2021 vintage clears. What would make B worth the 200 basis points?

Answer

2stephen_ok9CO2CPRO6

Concentration alone answers a chunk of it. 34 positions at $6.8 million means one total loss is close to 3 percent of the book, and mezz doesn't lose 20 percent, it loses most of it or nothing. So the 200 basis points of extra yield buys you a return distribution with a fat left tail, and you'd want to see the manager's assumed recovery on a mezz position that goes bad. If they say 40 percent, ask which of their own workouts produced that, and if the answer is none, the 40 is a spreadsheet input.

The 1.15 coverage figure is the one I'd push on. Is that on the senior alone or senior plus mezz current pay? Those are different properties. If the mezz accrues rather than pays cash, your distribution is coming from somewhere other than property cash flow.

On Fund A, the thing you can actually verify is process at the exit. Ask for every loan that went past maturity in the last two years and what happened to it, month by month. Foreclosure timelines and whether the process is judicial or non-judicial vary a lot by state, and a fund spread over 20 states owns that variation, so ask which states hold the most principal and what their last completed foreclosure in each cost and took. A servicer who has never run one at scale in a slow-timeline state is the risk you are underwriting, more than the 68 percent.

2 replies

2jordan_ellis2ActivePRO6

I've been on the borrower side of quotes from bridge lenders like your Fund A, and the draw process is where the discipline shows. Ask how many inspections per draw, who does them, and whether the lender ever releases a draw on photos. The sloppy ones fund ahead of the work and their as-is cushion is fiction by month four.