Structuring and Enforcing Real Estate Mezzanine Intercreditor and B - PowerPoint PPT Presentation

Presenting a live 90-minute webinar with interactive Q&A Structuring and Enforcing Real Estate Mezzanine Intercreditor and B Note Agreements: Latest Developments Lessons for Lenders from Past Workouts and Real Estate Bankruptcies on Enforceability and Remedies THURS DAY, APRIL 24, 2014 1pm East ern | 12pm Cent ral | 11am Mount ain | 10am Pacific Today’s faculty features: Mark S . Fawer, Partner, Arent Fox , New Y ork Jerry L. Hall, Counsel, Pillsbury Winthrop Shaw Pittman , Washington, D.C. Robert (Robin) Childress Jones, Jr., Retired Partner, Pillsbury Winthrop Shaw Pittman , Washington, D.C. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .

Outline of Presentation  Description and Analysis of the Architecture of Real Estate Mezzanine Lending  Background of Mezzanine Financing and Mezzanine B-Note Structures  Interrelationship of the Parties in a Mezzanine or B-Note Structure  Intercreditor Agreement Structure and Key ICA Issues  Sponsor Recourse Liability  Overview of Bankruptcy Issues and Case Study of Georgian Voluntary Bankruptcy/365 Sale  Lessons from CMBS 1.0 for CMBS 2.0  Advanced Topics  Subordination of Sponsor Recourse Claims and Cure Payments  Release of Sponsor Claims Against Foreclosed Entities  Non-Foreclosure Takeover of Pledged Equity [Colony v Gramercy]  Warehouse financing Page | 2

What is Mezzanine Financing?  Financing that is between equity Equity and the mortgage lender in terms of risk, return and security.  Not a second mortgage loan (i.e., not secured by the same assets as mortgage lender) Mezzanine Financing Mortgage Lender Page | 3

What is Mezzanine Financing?  Many forms ranging from loan to Equity preferred equity.  Contractual subordination: second lender agrees to subordinate its payment or security [primary mechanism for corporate sub debt]. Mezzanine  Structural subordination: second Financing lender subordinate via borrower structure [typical real estate/CMBS structure]. Mortgage Lender Page | 4

Traditional Real Estate Second Mortgage Financing  1st Mortgage Lender is secured by lien on borrower’s assets.  1st Mortgage Lender’s loan-to-value restriction limits size of 1st mortgage loan.  2nd Mortgage Lender could interfere with 1st Mortgage foreclosure, so 1st Mortgage Lender prohibits 2nd Mortgage. Equity $ Loan Property Owner, LLC Mortgage Lender Mortgage Page | 5

Typical Real Estate Mezz Loan  Mezz and Mortgage Lender have parallel loan documents.  Key Difference: separate borrower and separate collateral. Equity $ Loan Mezz Lender Mezz Borrower, LLC Pledge of LLC Interests $ Loan Property Owner, LLC Mortgage Lender Mortgage Page | 6

Bankruptcy Remoteness  Each of the property owner and its parent are “special purpose entities” designed (and contractually required) to be “bankruptcy remote.”  The property owner is thus insulated against bankruptcy of its parent/mezz borrower.  Each entity in the chain has as its only business the ownership of the property (in the case of the mortgage borrower) or of the equity in the property owner (in the case of the mezz borrower).  These SPEs are not authorized to incur other debt, have other activities, etc. Page | 7

Mezz Lender is Structurally Subordinate  Mezz Lender is not a creditor of the property owner.  Mezz Lender has no lien against the underlying property.  If the property owner files for bankruptcy, the Mezz Lender has no “seat at the table.”  If Mezz Lender forecloses, it owns the property owner, subject to the Mortgage and any other obligations of the property owner . Page | 8

If the Mortgage Lender forecloses… The “structure” of the borrower chain Equity subordinates the Mezz Lender to the Mortgage Lender – i.e, “structural subordination.” Mezz Borrower, LLC $ Loan Mezz Lender Pledge of LLC Property Owner, LLC Interests x Mortgage Lender Real Estate Page | 9

If the Mezz Lender forecloses… Equity Mezz Lender Mezz Borrower, LLC x Mtge Loan Property Owner, LLC Mortgage Lender Mortgage Real Estate Page | 10

Sample Spreads Lenders add a risk prem ium Lender Loan Rate   LIBOR + 100 bps Mortgage   LIBOR + 250 bps 1st Mezz   LIBOR + 620 bps 2nd Mezz   LIBOR + 925 bps 3rd Mezz Page | 11

Key Loan Documents Mortgage Loan Mezz Loan   Senior Loan Agreement Mezz Loan Agreement   Senior Promissory Note Mezz Promissory Note   Mortgage, ALR & Security Agreement Pledge Agreement   Assignment of Management Agreement Subordination of Management Fee   Senior Recourse Guaranty Mezz Recourse Guaranty Page | 12

Other Key Documents – Interest Rate Cap and Title Insurance Document Purpose   Interest Rate Cap Agreement Protects a borrower with a variable rate loan against the rate exceeding the cap   Assignment of Interest Rate Cap Assigns payments to the lender Agreement   Title Insurance Conventional property title insurance for mortgage loan  ”Eagle 9” UCC insurance for mezz loan Page | 13

Other Key Documents – Lockbox Document Purpose   Clearing Account Agreement Receives directly all property cash (principally rents) and sends to Deposit Bank   Cash Management Agreement Receives cash from Clearing Account and disburses per cash “waterfall” agreement of lenders and borrowers Page | 14

Participation Agreements and B-Notes/Co-Lender Agreements  What is a “B-Note”? Either a junior participation in a mortgage loan secured by the property or a junior note from the property owner, secured by the same mortgage which secures the more senior notes.  The term “B-Note” is also used to refer generally to multiple junior notes – there may be a C-Note, D-Note, etc. – each junior to the prior.  Relationship between holders of A-Note and B-Note: governed by a Participation Agreement or Co-Lender Agreement.  Administration of Whole Loan: typically by a servicer acting pursuant to a servicing agreement or pooling agreement  Control of Servicer/Whole Loan: junior-most B-Note with 25% of loan value (after actual/appraisal value losses) has right to approve major servicer actions Page | 15

Major Distinctions Between Senior/Mezz Relationship and A-Note/B-Note Relationship MEZZ B-NOTE   Mezz Lender has direct access to its Mezz B-Note holder must act through a Borrower under its own mezz loan servicer administering the whole documents; within ICA limitations, does not mortgage loan; if not “controlling need consent or approval of anyone else holder”, may have no approval of to take action. servicer actions.   Upon default, Mezz Lender may take over Servicer can foreclose mortgage if all equity with credit bid at UCC auction, but noteholders then have undivided takes title to equity subject any interest in REO (now-owned real indebtedness/liens of property owner. estate).   Mezz Lender may be “primed” by B-Note holder has benefit and priority intervening liens/senior borrower debt. of mortgage securing the whole loan in which B-Note participates.   Mezz Lender has refinancing risk when As part of whole loan in which B-Note mortgage loan matures – can be wiped out participates, B-Note holder must be if mortgage cannot be refinanced. refinanced at mortgage loan maturity. Page | 16

Major Terms of B-Note/Co-Lender Agreement  Controlling B-Note holder may replace special servicer (with or without cause) and has major decision consent rights until a “Control Appraisal Event.”  “Control Appraisal Event”  Generally occurs following a bankruptcy of property owner, 60 days after mortgage default, commencement of a mortgage foreclosure or other major credit event.  Appraisal then ordered by servicer.  Appraisal calculation starts with 90% of appraised value, subtracts unpaid taxes, servicer advances, etc., and adds back reserves, etc.  Net appraised value then measured against outstanding loan stack with any shortfall allocated successively to most junior B-Notes.  Reduction in value of B-Note to less than 25% of face results in a shift in control to next more senior holder (if there is no more senior B-Note, then to A-Note holder).  In some deals, B-Note holder has right to avoid losing control by pledging cash collateral in an amount necessary to compensate for drop in value. Page | 17