Don't Shoot the Mezzenger - Key High-Level Differences Between CRE Loan-on-Loan Facilities And CRE Mezzanine Facilities


This article highlights key high-level differences between warehouse facilities in the European commercial real estate (CRE) lending market (CRE loan-on-loan facilities) and European commercial real estate mezzanine facilities (CRE mezzanine facilities) (based on the Loan Market Association (LMA) documentation). These comparisons are worthy of discussion given that each type of facility involves (directly or indirectly) an interest in CRE, with the providers of the respective types of financings sitting in a structure which involves other creditors also facing the underlying CRE or CRE loan.

For the purposes of this article CRE loan-on-loan facilities are English law revolving credit facilities which are lines of credit provided by banks to real estate debt funds or real estate investment trusts (REITs) that invest in commercial real estate debt, to lower their cost of funds and boost returns through the use of leverage. They are typically advanced on the basis of a maximum advance rate or maximum percentage of the value of the value of the underlying loan(s) and related rights, including the underlying real estate (the collateral assets), which form the collateral for the financing provided. The real estate debt fund or REIT will use the CRE loan-on-loan facility to originate, acquire and/or refinance a participation in collateral assets, which are usually first ranking mortgage loans secured on European CRE. CRE mezzanine facilities on the other hand are usually provided to sponsors to finance their CRE developments and acquisitions, filling a gap in the financial structure between the senior debt and common equity. CRE mezzanine facilities are subordinated to the senior debt but take priority over the sponsor’s equity and generate returns that are higher than the senior debt but generally lower than the total return that accrues to an equity position.

Although no two transactions are the same, certain high-level key differences are as follows:


CRE mezzanine facility CRE loan-on-loan facility
Borrower will be an SPV and, if the facility is structurally subordinated to the senior debt, it will be a holding company (HoldCo) of the property-owning SPV (the PropCo) (which will be the entity incurring the senior debt). If the mezzanine debt is contractually subordinated to the senior debt, the borrower will also be the PropCo. Borrower will also typically be an SPV but is the entity which advances the underlying CRE loan (i.e. the loan-on-loan lender lends to the underlying loan lender).

Security and guarantee package:

CRE mezzanine facility CRE loan-on-loan facility
In a CRE mezzanine facility involving structural subordination, the mezzanine lender will usually benefit from common asset security over the underlying property, the bank accounts, certain contractual rights and the shares in the PropCo, which security is shared with the senior lender (with the proceeds of that security being ranked in the intercreditor agreement and applied first to the senior debt and second to the mezzanine debt), or alternatively the senior lender will benefit from first ranking asset security over the underlying property, bank accounts and certain contractual rights and the shares in the PropCo with the mezzanine lender benefitting from its own equivalent second ranking security over the same assets. In either case, it is typical for the mezzanine lender also to have its own first ranking share security over the shares in the HoldCo (the mezzanine borrower). Day 1 security: there is a “day 1” security package over: the shares in the loan-on-loan borrower (the lender of the underlying CRE loan), any intercompany receivable owed by the loan-on-loan borrower to its parent, the bank accounts of the loan-on-loan borrower (including the collection account into which cashflows from the underlying loan are collected) and any rights arising under the underlying loan and the rights related thereto.

In addition, in order to provide for effective and perfected security to the loan-on-loan lender, each time a new underlying loan is financed by the CRE loan-on-loan facility, additional security may be taken by the loan-on-loan lender in respect of the rights in respect of that underlying loan. Typically this depends on the jurisdictions where the underlying real estate is situated and the governing law of the underlying loan, but where the underlying loan to be financed is English law where there is an English law security trust in place in the underlying loan, this additional security typically takes the form of a transfer certificate (using the form taken from the back of the underlying loan agreement) which is signed by the loan-on-loan borrower and held by the loan-on-loan lender to be completed in the event of an event of default on the CRE loan-on-loan facility (i.e. so the loan-on-loan lender could be entitled to appoint itself lender in respect of the underlying loan as an enforcement mechanism and thereby get the benefit of the security over the underlying real estate and other assets via the operation of the English law security trust which is for the benefit of the creditors from time to time).

Typically there is a negotiation to be had when agreeing CRE loan-on-loan facilities to ensure that (from the borrower’s perspective) the loan-on-loan lender only takes security over the underlying loan which is commercially reasonable as opposed to legally possible (for example there are certain types of sub-security over real estate that could be taken in certain jurisdictions which might result in costs for which the borrower is liable (e.g. stamp duty) which are disproportionate to the benefit that such security gives to the loan-on-loan lender.

A CRE loan-on-loan facility will also typically involve a parent fund guarantee (typically between 20% and 50% of the total amount of the outstanding debt under the financing, with the ability to ratchet down in certain circumstances) whereas in a CRE mezzanine facility the obligors of the debt guarantee each other’s obligations with no separate recourse to the fund.

Consent rights/amendments and waivers:

CRE mezzanine facility CRE loan-on-loan facility
The intercreditor agreement will set out a suite of restrictions on amendments and waivers (which are essentially basic terms modifications to key economic terms) of the senior finance documents that may not be undertaken without the consent of the mezzanine creditors, and in addition it will set out a suite of restrictions on amendments and waivers of the mezzanine finance documents (again, which are essentially basic terms modifications to key economic terms) that may not be undertaken without the consent of the senior creditors. There will be a negotiated set of “material decisions” or “material modifications” in respect of the underlying loan that the loan-on-loan borrower may not take without the consent of the loan-on-loan lender, with any amendments to the terms of the CRE loan-on-loan facility itself being a matter for the borrower of the CRE loan-on-loan facility and the loan-on-loan lender itself to agree.

Enforcement rights in respect of the underlying loan:

CRE mezzanine facility CRE loan-on-loan facility
Typically restricts the rights of the mezzanine lender to take enforcement action unless: the senior lender has accelerated under the senior debt, after the expiry of a standstill period or to prove in the insolvency of an obligor. Notwithstanding these restrictions, the intercreditor arrangements in respect of a CRE mezzanine facility may allow the mezzanine lenders to effect an acquisition of the shares in HoldCo under the separate HoldCo share security the mezzanine lenders benefit from subject to certain conditions (such as KYC and the remedying of the underlying senior default). Loan-on-loan borrower will typically insist on retaining the right to accelerate and/or enforce on the underlying loan, but will usually grant to the loan-on-loan lender the right to waive an event of default in respect of the underlying loan. This is because the loan-on-loan borrower is in the first loss position relating to the collateral asset, so the decision to accelerate and/or enforce will be matters that directly affect its entitlement to the proceeds of enforcement.

Application of ordinary cashflows:

CRE mezzanine facility CRE loan-on-loan facility
Facility is usually not revolving or amortising, with restrictions on repayment of the mezzanine debt while the senior debt is outstanding contained in the intercreditor arrangements. In addition, in respect of a CRE mezzanine facility, ordinary cashflows such as rent are applied in accordance with one or more waterfalls: a waterfall in the senior facility that permits payments required to service the mezzanine debt at the bottom of the waterfall prior to returning any surplus to equity, with any such amounts paid to service the mezzanine debt being applied in accordance with its own waterfall. Facility is usually revolving and the cashflows from the underlying loans are applied to a pre-ordained waterfall of payments and are used to pay down the loan in accordance with a repayment schedule referable to each underlying loan with any excess being returned at the bottom of that waterfall to the loan-on-loan borrower.

Disposals and the application of extraordinary cashflows:

CRE mezzanine facility CRE loan-on-loan facility
In a CRE mezzanine facility which is secured e.g. on a single piece of real estate, the disposal proceeds of that real estate must be equal to or more than the aggregate of the senior debt and the mezzanine debt plus any prepayment fee and are applied in prepayment of such amounts. The disposal provisions envisage two separate circumstances: disposals of the underlying loan during the availability period (where 100% of the amount borrowed against an underlying loan has to be repaid from the disposal proceeds) and disposals after the availability period has ended (where an accelerated pay down applies, with e.g. 110% of the amount borrowed against an underlying loan being taken from the disposal proceeds and applied first in repayment of the loan borrowed against that underlying loan, with any surplus being applied second in repayment of other loans outstanding under the loan-on-loan facility).

Financial covenants:

CRE mezzanine facility CRE loan-on-loan facility
Will typically include financial covenants which are set at different levels to the senior debt, including, among other things, an LTV test and an interest cover test. There may also be separate cash trap ratios that apply, with the mezzanine facility having its own, stricter (compared to the senior debt) cash trap ratios. There may be financial covenants relating to the fund guarantor (e.g. a tangible net worth test, a maximum indebtedness test, a minimum cash liquidity test and/or a fixed charge coverage ratio test), breach of which would constitute an event of default under the CRE loan-on-loan facility, but aside from that, the only LTV provisions that apply relate to the amount that the loan-on-loan borrower can borrow, i.e. up to lower of (i) x% of the principal amount of the loan, (ii) a “look through LTV” based on x% of the value of the real estate backing the loan, or (iii) the loan-on-loan lender’s (objective and commercially reasonable) determination of market value. In the event that such LTV provisions are breached in a CRE loan-on-loan facility (for example due to a redetermination of value by the loan-on-loan lender), a margin call payment is required to be made by the loan-on-loan borrower to rebalance the facility (e.g. by way of repayment).

Cure rights:

CRE mezzanine facility CRE loan-on-loan facility
Usually allows, in the intercreditor arrangements, for the mezzanine lender to cure certain senior events of default to keep the senior current and thereby remove the risk that the senior lender enforces and takes the assets via an enforcement of the senior security. Usually the fund parent is allowed to make as many equity cures of defaults in respect of the loan-on-loan facility by the loan-on-loan borrower as it wishes in the form of subordinated debt or equity injections (which it is clearly incentivised to do to hold on to its CRE loan portfolio). Such cure rights are in addition to the limited standalone fund guarantee discussed above.

About us:

Orrick is a globally integrated law firm serving clients in the financial services sector. We work with 250+ financial services clients across 12 countries from over 25 offices worldwide. Our market-leading structured finance and securitisation capability across Europe and the United States is complemented by our experience advising real estate debt funds and REITs on numerous CRE financings, mortgage/mezzanine originations, loan-on-loan financings, CRE repos and CRE CLOs for 20+ years.

Rick Hanson is a finance partner at Orrick in London. He has experience with funding structures backed directly and indirectly by commercial real estate, private debt and other asset classes. He advises on fund leverage matters including warehouse lines, loan-on-loan and repo financing, as well as loan portfolios (performing and non-performing) acquired or disposed of using securitisation and structured lending techniques.