MEET THE NEW MEZZ, not the same as the old mezz.
In early 2008, when the credit crisis was in full bloom, several capital sources shelved their bridge and mezzanine loan programs. And who could blame them for that flight to safety? Stabilized assets could find well-priced debt, sure, but transitional assets were another story. After all, the idea of doing a value-added rehab and raising rents was—and remains—a hard sell.
But some capital sources are now reintroducing these executions for different purposes. Instead of offensive plays—helping developers to build—these lenders are positioning their programs for defensive refis. With values down up to 40 percent from their 2007 peak, an “equity gap” continues to dog owners seeking to refinance.
In April, Fannie Mae and Freddie Mac re-introduced their mezz loan programs, aimed at plugging the gap in the capital stack of overleveraged borrowers. Meanwhile, Prudential Mortgage Capital Co. (PMCC) decided to dust off its variablerate bridge loan program to help newly constructed assets achieve stabilization.
“When the credit market tightened in late 2008, the viability of these programs, particularly with respect to rehabilitation loans, became strained,” says Manny Menendez, vice president of product development at Washington, D.C.-based Fannie Mae. “For all intents and purposes, we stopped doing mezzanine financing. But now we see an opportunity.”
Fannie, Freddie Bring Mezz Back
In the space of a week in early April, both government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac re-introduced their mezz programs. (Although as of late April, Freddie's program was delayed “due to unforeseen circumstances,” according to the company.)
While the programs are similar, there are some key differences. Freddie's initiative will marry a senior loan with a mezzanine piece provided by a third-party to allow up to 90 percent combined loan-tovalue (LTV). Fannie's program, meanwhile, only goes up to 80 percent LTV. That 10 percent difference is significant, especially given that leverage is the defining factor behind these programs. Still, most Freddie lenders believe the average leverage level will be closer to 80 percent than 90 percent this year.
Another major difference is the GSEs' partners in crime. The mezz providers working with Freddie Mac are all large multifamily owners, operators, or investors, enabling lenders to get multiple quotes, fueling competition, and ultimately driving down the interest rate on the mezz piece. Fannie Mae, meanwhile, is partnering with the original mezz provider for its programs, RCG Longview—one of the industry's most prolific mezz lenders with more than $500 million left in a $600 million debt fund closed last year.
For Freddie, the choice of mezz partners speaks to the most important difference between this program and the company's previous High Leverage program, which focused on acquisition/rehab deals. Today's mezz program is aimed at borrowers who are in danger of losing their properties. So by partnering with large players, the GSE has the comfort of knowing that, should the borrower go under, the mezz provider could stand in as owner.
The mezz initiative is aimed at refis from within or outside of Freddie's portfolio, take-outs of existing construction loans, and acquisitions. A minimum of 10 percent cash equity in the property is required, and the mezz portion is backed by that borrower's equity. The blended debt service coverage ratio (DSCR) is 1.05x, though the Freddie first mortgage will not go below 1.25x. The Freddie loan can be either a Capital Markets Execution (CME) or portfolio execution, and the mezz piece can be either fixed- or floating-rate.
For its part, Fannie Mae revived its DUS Plus and CI Mezz-Mod Rehab programs, which combine a standard mortgage with mezz financing to achieve up to 80 percent leverage. The GSE has updated the programs' terms so they align with today's DUS underwriting parameters. Before the credit crisis, DUS Plus provided a maximum 85 percent LTV, and the CI Mezz-Mod Rehab program maxed out at 95 percent LTV. Now, 80 percent LTV is the max for both programs. The minimum DSCR is 1.10x combined, though Fannie said it may go down to 1.05x in some cases.
While Fannie hadn't closed such a loan as of early May, it is starting to build a pipeline of deals. “There are a lot of situations where borrowers essentially need to re-margin the loan,” says Tom Eberhardt, director of credit risk management for mezzanine debt at Fannie Mae. “So the borrower is putting in fresh equity and looking for mezz to help bridge the gap. Those are the kind of deals we're seeking.”
But both GSEs believe that defensive refis are only one part of the rationale behind the re-introduction. “We're not just re-introducing this because of defensive opportunities; that's just one potential use,” Menendez says. “We have to keep the options that we offer current so that when markets shift, we have the right products and parameters to take advantage.”
Bridging the Gap
Fresh on the heels of the GSEs' announcements, PMCC re-started its floating-rate bridge loan program, targeting deals in the $5 million to $25 million range.
Dubbed the “Agency Gateway” program, the loan works as a sort of “feeder” for the company's Fannie Mae, Freddie Mac, and FHA platforms, helping to buy some time for transitional assets until they are eligible for an agency permanent loan.
“This is purely for that newly constructed property that's at 80 percent occupancy and needs to get up to 92 percent,” says David Durning, senior managing director of Newark, N.J.-based PMCC. “If the borrower really wants an agency loan, then we'd use this program, which is targeted toward that kind of an exit.”
Durning believes the timing is perfect for such a program, given the slower absorption rates in many markets. But another dynamic is at play. “Banks are starting to force outcomes with regards to their portfolios,” Durning says. “As the banks move some of their paper, people buying it will need financing.”
That jibes with what bridge lender BRT Realty Trust has seen so far this year. The company provides short-term, first-position loans, offering LTVs between 75 percent and 80 percent and generally charging around 12 percent rates.
“We are seeing an awful lot of stabilized properties that are overleveraged and have the opportunity to pay off their loans at substantial discounts,” says Mitch Gould, executive vice president of Great Neck, N.Y.-based BRT. “And we've closed two loans this year for people who have purchased third-party notes.”