SASB: The (shotgun?) The marriage of the mortgage and the mezz | Dechert srl
There are many reasons to structure a large securitization loan partly mortgage and partly mezzanine loan. Sometimes it’s just that the borrower is in dire need while the financial markets are depressed. In this case, the lender turns the credit into a mortgage loan for the performance of the SASB and assumes (hopes) that there is someone with enough insight, optimism, or naivety to purchase the mezzanine loan. But sometimes there are other reasons to split a mortgage loan and mezz.
The Dechert team just completed a SASB securitization of a stapled mortgage and a mezz as a REMIC and as far as we can tell this had not been done before (apart from a single mezz which was REMIC a few years ago which, rather like a tree falling in the forest that no one hears, didn’t seem to have much of an impact on our markets).
To dive into the weeds a bit, if you’re in the SASB market, you know that these transactions are often done in the form of REMICs. This is what investors expect.
A question has always hovered in the shadows of whether you can REMIC a mezzanine loan. Many in the small coterie of expert REMIC tax lawyers thought that a mezz loan was a good REMIC asset. This view has been reinforced by the favorable positions of the IRS regarding the treatment of mezz loans in analogous cases, albeit in a different context. The problem, of course, is that there was nothing on all fours and that can make a tax lawyer tremble. Due to a certain lack of bandwidth to think about in the hustle and bustle of trying to get things done, some lingering anxiety among the tax bar, and the uncompromising conservatism of the securitization market, no one tried to do it in a usual SASB way.
In this case, we were faced with a borrower who could reap material savings by turning part of the mortgage into a mezz. We also had a client with the spirit of innovation and the audacity to try something new, and we did. And it worked. After some discussions with the subscriber’s tax advisor and many collegial reflections, we agreed that the mezz was a good REMIC asset and that the transaction could continue on this basis. So the tax lawyers went to do the plumbing, but nothing is easy and it was only the first step in completing this transaction. The next problem was convincing the rating agencies that a stapled mortgage and a mezz weren’t negative in terms of credit, and then, of course, convincing the bankers who needed to shake things up and reassuring investors that to invest. was acceptable.
To anticipate the anxieties that we anticipated encountering, we structured the securitization with the mortgage and the mezz firmly stapled together. Each financial asset had the same interest rate, the same amortization schedule (in this case none), the same mechanism for accumulating interest and the same maturity. The securitization was split as if it were an entire mortgage loan without separately treating a tranche as related to the mezz. In fact, in some circumstances the repayments would be applied to the mezzanine loan before the mortgage, and frankly I think this is a very good idea as it would cause an increasing portion of the overall loan to be secured by a lien on a mortgage. . (This would work as long as the mezzanine loan didn’t get too small, for a number of very technical legal issues). Usually the payments were applied on a pro rata basis and the mortgage could not be repaid until the mezz. This fear mitigated the fact that the mortgage would, for some reason, be paid off sooner, leaving the obligations only secured by the mezzanine loan.
We argued, ultimately convincingly, that all things being equal, it is a terrific execution mechanism for lenders to have part of the loan structured like a mezz and have access, or at least a potential access, to the faster foreclosure mechanisms of a UCC foreclosure. This could be especially helpful in jurisdictions that offer a difficult, unwieldy, or unfriendly foreclosure experience.
After reflecting at length on these and other hackneyed legal issues of the days of the gaige death at Ol ‘England we convinced the rating agencies, the bankers and ultimately the investors that the structure was indeed not only correct, but in fact a good idea.
After the action debriefings with the bankers, it seemed pretty clear that the deal had not been impacted by the investor market due to its structure.
I am convinced that if the benefits of this structure are more widely disseminated and investors could become more aware and comfortable with the structure, a recovery could also be achievable from it.
So the market should think about it. It shouldn’t be a “falling tree in the forest where no one hears” kind of thing. This is certainly a viable alternative where there are compelling business reasons to structure part of the loan as a mezz loan, and there could also be good reasons to use this structure more generally to acquire the enhanced foreclosure remedies. potential of mezz in relation to these large loans.
We may be conservative as an industry, but we are not dying and when a good idea is validated, we have to adopt it. We will be there to encourage it. Not so much a forced marriage, is it?