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New to Mezz Loans

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  • New to Mezz Loans

    New to syndications and mezz loans in general but i'm looking into a particular feeder fund that is investing in a mezz loan and would like to know what I need to look out for when evaluating whether or not to invest in this fund. Any advice would be greatly appreciated!

    Some things I've gathered is that there are some downsides to mezz loans, mainly being that if the borrower defaults, mezz loans typically have pretty low priority and much higher risk to lose your entire principal.

    Some basic information the syndication has provided is as follows:
    • The Mezz Loan basis is 70.5% LTV and 30% below replacement cost
    • 3 Year term with 8.6% projected average cash on cash return
    • Borrower has invested $11.8 million in property
    • Interest reserve in place to cover 27 months of payments

    More details on the mezz loan itself is provided below:

    An investment group provided a $10.5 million Mezz Loan Initial Funding at a 13.65% interest rate spread above 1-month Libor (“Libor”), subject to a Libor floor of 0.35% (effective rate of 14.00%) with all interest payments paid current. The loan term is three years and has no extension options.
    Capitalization Overview:

    Senior Loan: An investment group has provided a $27.0 million senior loan at a 6.50% interest rate spread above 1-month Libor (effective rate of 6.85%) with all interest payments paid current.

    The following highlights detail key components of the loan structure:

    •In-Place Cash Management / Distributions Waterfall / Cash Flow Sweep: In-place cash management was structured to ensure payment in the following order: 1) taxes and insurance; 2) Senior Loan debt service; 3) operating expenses; and 4) Mezz Loan debt service payments. Any excess cash flow is swept to replenish the interest and shortfall reserve.

    •Interest and Shortfall Reserve: $5,100,000 interest and expense shortfall reserve funded at closing is projected to cover combined (Senior Loan plus Mezz Loan) debt service payments through Month 27, equating to 75% of the loan term.

    •Minimum Interest: The loan structure stipulates that a minimum of 18 months of interest payments are to be paid by the Mezz Borrower. The minimum interest requirement also applies to the Senior Loan.

    •Intercreditor Agreement: Among other things, the intercreditor agreement provides for the following:
    1. The subordination of the claims of the Mezz Loan to the senior loan;
    2. Rights of the Mezz Lender to cure a Senior Loan default in the event the Mortgage Borrower defaults on the Senior Loan, thereby preventing an immediate foreclosure of the underlying property by the Senior Lender; and
    3. Steps that must be taken by a Mezz Lender related to the foreclosure of its collateral (such as providing a new creditworthy entity to act as a replacement guarantor for any guaranteed obligations under the Senior Loan).

    Ongoing Net Worth & Liquidity Requirement: Mortgage Borrower is required to maintain a minimum of $30,000,000 in net worth in addition to $1,500,000 in liquid assets.