Mezzanine investment

[kkent]

So I'm in the final round of interviews with an investment bank. I've been given a 62 page case study that deals with the analysis of a mezzanine investment for a commercial property. One of the questions I have to answer is, what is a mezzanine investment.

My research has gotten me many dispirate answers, and my final definition comes down to this:

"Mezzanine investment is often a late stage investment of both debt and equity; the equity gives the mezzanine lender some upside potential while the debt offers fixed, steady income. Mezzanine debt is senior to that of common stock and is secured by stock rather than property, making foreclosure far quicker."

My question is, is this correct? By that I mean, are all of these parts correct all of the time, most of the time, or only sometimes? Can someone else give a more concise and more "correct" definition? Thanks.

 

[DeadCat]

I've followed a stock for a few years that does mezzanine finance and - frankly - i've never quite been able to 'get it'. As you say the precise definition seems to change depending on the source.

I concluded that its an elastic concept that refers to any specialist funding that combines debt with an equity kicker. By nature the deals are bespoke, so I suspect that's why the precise definition keeps changing.

If you go here there are some useful guides, etc: http://www.icgplc.co.uk/default.aspx

 

[Mr.Good.Guy]

Its not a secure as senior and more secure than second lien and its pretty expensive.

What is it?

Mezzanine Financing!!!!!!!!

 

[skiloa]

It's like a CMO. You break the obligation into 3 tranches: senior, mezz and subordinate.

The senior tranches get paid first and get hit with losses last. The sub tranches get paid last, yet get hit with losses first. The mezz piece is in the middle.

Have you been to the opera? the Mezz seating is in the middle.

 

[Randall]

Mezz financing sits below subordinated debt on the capital structure. The only thing it's typically senior to is equity (common or preferred). There's usually a debt and equity component to it so your definition is pretty good.

It's certainly not more secure than a second lien.

 

[Saks]

Free money.

 

[kkent]

DeadCat, that site was actually really helpful. Thanks. Thinking of it like a CMO helps, too. Thanks, guys.

 

[Super I]

Think of where the word comes from. It refers to a floor level that is found in some stores above the first floor, but below the second and higher floors. Now apply that to a cap structure with equity as the first floor, and the other numbered floors the more routine types of senior debt.

In most cases that I've across (banking world) mezz debt is either regular sub debt, or junior subordinated debt. It comes into place to make a cap structure "work". Limited dilution to the shareholders, and ratios that work for senior lenders (ie level of capital underneath them).



Edited 1 time(s). Last edit at Wednesday, May 16, 2007 at 12:18PM by Super I.

 

[kkent]

Super, what's the difference between regular subordinated debt and junior subordinated debt? Is jr. sub debt just a step below sub debt?

 

[Super I]

kkent Wrote:
-------------------------------------------------------
> Super, what's the difference between regular
> subordinated debt and junior subordinated debt?
> Is jr. sub debt just a step below sub debt?



Yes, so in liquidation the (senior) sub gets paid before the junior sub. Because of the additional risk the junior sub will typically carry a higher coupon.

 

[1moreQ]

Mezz pieces as others said are never in 1st lien position. They may actually be way down the cash waterfall depending on upside/risk. The security is usually a simple high interest debt with entrance/exit fees and is subject to automatic equity conversion in event of default or some other trigger. Some lenders or investors specifically want an equity investment to be able to participate in profit sharing. Do keep in mind that there are small diff between real estate mezz loans and mezz loans for business purposes i.e. startups/expansion loans etc.

 

[1moreQ]

In any deal you will have a primary investor/lender who will have the 1st lien position. Anything under that (2nd or 3rd loan/mortgage) is referred to as subordinate loan. A mezz loan can be in the 2nd, 3rd, 4th, or lower position and even behind other mezz loans. Of course the lower the rank the higher the interest rate charged. It goes without saying that the number of loans and $ involved must be reasonably supported by said deal.

Another useful thing to know is that many lenders have restrictive covenant that make them the last man on the todempole. They require that borrowers seek their approval before borrowing any additional monies that result in liens on the asset. My company dis this to prevent sneaky or incompetent borrowers from piling on more debt (in some cases cashout their equity) and walk away from project leaving someone else holding the bag.