Patent Publication Number: US-2005144119-A1

Title: Financing structure

Description:
BACKGROUND  
      This application is a continuation-in-part of International Application Ser. No. PCT\U.S.2004/008361, filed Mar. 19, 2004 and U.S. Provisional Application Ser. No. 60/455,754, filed Mar. 19, 2003, both of which are incorporated herein by reference.  
      This invention relates to financial structures for commercial loans and leases.  
      Financial assets, including loans, originate and trade at prices that are negotiated between buyer and seller based on various analyses and intuitions. One important factor in this price may include a “rating” by one or more the three principal credit rating agencies, Standard &amp; Poor&#39;s, Moody&#39;s Investors Service, or Fitch Ratings Inc. The rating agencies assess the “timely and ultimate repayment of principal and interest.” Generally, before it issues a rating, a rating agency will require that ultimate repayment of principal be established with certainty. A credit rating allows buyers and sellers to compare the asset in question with other similarly-rated assets. In contrast, for unrated assets, there is seldom any common and objective standard for assessing and communicating value, and the perceived value may vary greatly from buyer to buyer. The price a buyer will be willing to pay for an unrated asset will almost always be lower (and thus, the interest rate will be higher), because of the uncertainty associated with the valuation process—the buyer must factor in the risk that, if/when the asset is sold, other buyers may assign a lower value.  
      In secondary loans on owner-occupied residential real estate (e.g., “home equity loans” or “secondary mortgages”), the secondary lender obtains a right to foreclose on the real estate, subject to a senior lender&#39;s right to first payment out of the proceeds of any foreclosure.  
      In contrast, secondary or subordinate lending to owners of commercial real estate is relatively rare. Subordinate loans (also known as “mezzanine loans” or “junior loans”) typically require a complex inter-creditor agreement between the senior lender, the junior lender, the lessor, and the tenant. A typical inter-creditor agreement reduces the senior lender&#39;s right to foreclose and take over the property until the mezzanine lender has had the opportunity to cure a default by the tenant, or may either allow or obligate the mezzanine lender to operate the property. If any one of these parties finds that his position is worsened by the proposed agreement, he has the power to block the entire deal. Similarly, an inter-creditor agreement may leave the junior lender with too many obligations or an insufficient collateral position. For example, in order to lend, a junior lender might require a lien on the property. In this case, the senior lender typically observes that the lien reduces his collateral position, and he blocks the deal. Where junior lenders cannot secure high certainty of repayment, junior lenders charge high interest rates.  
      Consequently, owners of commercial real estate have had limited ability to borrow against their real estate or the equity that they may have in the real estate. Generally, mezzanine lending rates range from 12-13% where the aggregate capitalization is below 80% to more than 20% where these levels exceed 90%.  
     SUMMARY  
      In general, in a first aspect, the invention features a financing structure. An owner of commercial real estate obtains a senior financing from a senior lender, and a junior loan from a junior lender. Ownership of the real estate and of a lease of the real estate are arranged in one or more special-purpose entities bankruptcy remote from obligations unrelated to the real estate. The junior loan is independent of the senior financing. The owner surrenders over to a lockbox arrangement the right to rents paid by a tenant under the lease. The lockbox is obligated to make a senior payment to the senior lender and a junior payment to the junior lender before the owner receives any residual of the lease payments. The lockbox is structured to isolate payment risk to the credit of the tenant, and a pricing of the junior loan is based on the credit of the tenant.  
      In general, in a second aspect, the invention features a financing structure. A loan is made by a lender to an owner of an asset, such as commercial real estate. The asset is under lease from the owner to a tenant. The principal of the loan is guaranteed by a credit default swap or other financial derivative arranged to cover default of the tenant on rents under the lease.  
      In general, in third aspect, the invention features a financing structure. A lender lends funds to create a junior loan from a lender to an owner of real estate, the real estate being under lease from the owner to a tenant. The junior loan is subordinate to a senior loan owed by the owner. An interest rate of the junior loan is based on the credit of the tenant.  
      In general, in fourth aspect, the invention features a financing structure. An owner of an asset, such as commercial real estate, obtains a senior financing from a senior lender, and a junior loan from a junior lender. The junior loan is secured by payments under a lease of the asset, either the lease providing a bond-type guarantee of payment of rents under the lease, or the lease being enhanced with a bond-equivalent financial guarantee of payment. Ownership of the asset and of the lease are arranged in one or more special-purpose entities (SPE&#39;s) bankruptcy remote from obligations unrelated to the asset. A term of the junior loan is no longer than the term of the lease and no longer than the term of a senior financing of the asset. The owner SPE surrenders over to a lockbox arrangement the right to rents paid by a lessee under the lease. The lockbox is obligated to make a senior payment to the senior lender and a junior payment to the junior lender before the owner SPE receives any residual of the lease payments.  
      In general, in a fifth aspect, the invention features a financing structure. A junior loan and senior loan are made to an owner of commercial real estate. The junior loan is independent of the senior loan. The junior loan is collateralized at least in part by a junior assignment of rents under the lease in lieu of a mortgage foreclosable by the junior lender against the real estate. The junior assignment of rents is junior to any senior mortgage or assignment of rents to the senior lender.  
      In general, in a sixth aspect, the invention features a financing structure. A junior loan is made by a junior lender to an owner of commercial real estate. The owner of the real estate and of a lease of the real estate surrender over to a cash management (“lockbox”) arrangement the right to rents paid under the lease. The servicer is obligated to make a senior payment to a senior lender and a junior payment to the junior lender from the lockbox before the owner receives any residual of the lease payments. The junior loan is collateralized by a pledge to the lender of rent cash flows generated by a lease of the real estate, and neither a pledge nor a lien over the real estate nor against any ownership interest in any entity with an ownership interest in the real estate, except at most in the event of bad boy acts and force majeur events.  
      In general, in a seventh aspect, the invention features a financing structure. A junior loan from a lender to an owner of an interest in real estate is subordinate to a senior financing of the real estate. The junior loan is collateralized by a pledge to the lender of rent cash flows generated by a lease of the partnership interest in the entity that owns the real estate. The terms of the junior loan are non-recourse against the real estate, the lessor of the lease, or a tenant of the real estate, except at most in the event of bad boy acts and force majeur events.  
      In general, in an eighth aspect, the invention features a financing structure. A junior loan from a junior lender to an owner of an interest in real estate has a payment priority that is senior to all other obligations of the owner except a senior loan. The junior loan is collateralized by a pledge to the junior lender of rent cash flows generated by a lease of the real estate. The junior loan is non-recourse against the real estate, the owner, or a tenant of the real estate except at most bad boy acts and force majeur events.  
      Embodiments of the invention may include one or more of the following features. At least one step of originating, managing or servicing the loan may be performed with the assistance of a computer. Under the terms of the junior loan, in the event of default by the tenant, the owner may covenant to surrender rents under any replacement lease to the lockbox arrangement. The cash management arrangement may include two different servicers or custodians of different depository accounts for servicing the junior and senior loans, respectively. Alternatively, a single servicer may make the payments to the senior and junior lenders from a single depository account. The lockbox arrangement may be under control of a cash management special purpose entity with powers to collect rent and distribute proceeds to the senior and junior lenders. The lockbox arrangement may make a payment for operating expenses or taxes before the owner receives any residual of the lease payments. The independence of the junior loan from the senior financing being due, at least in part, to independence of the junior lender from the senior lender, or due to origination of the junior loan underneath a pre-existing senior financing, with at most minimal reformation of the terms of or re-underwriting of the senior financing. The junior loan may be entered under an existing senior loan, or may be entered contemporaneously with the senior loan. Terms of the junior loan may have the effect of imposing requirements on the tenant in event the tenant enters bankruptcy and reaffirms the lease. The lease may be a bond-type lease, a triple-net lease, a double-net lease, a single-net lease, or a gross lease. A bond-type lease may obligate the tenant to continue to pay rent in the case of at least a partial condemnation taking. Terms of the loan may provide recovery to the junior lender against any recovery by tenant or landlord for the condemnation. A net lease or gross lease may be supplemented with one or more financial products to cover any uncertainty in timely payment of rents by the tenant, to provide the junior lender with certainty of payment equivalent to that provided by a bond-type lease. For example, tenant default may be covered by a put, short, credit default swap, insurance, or other protection. Conditions that may relieve the tenant of an obligation to pay rent may be covered by insurance, or a covenant by a third party to advance expenses required to relieve the condition, which may in turn secured by a cash reserve. The cash reserve may be funded by a premium on the interest rate paid by the landlord, and may be the property of the junior lender, to revert to the junior lender on full repayment of the junior loan. At least part of the junior payment may be reserved in an over-collateralization account for the protection of the obligations. The lease may be a single-tenant lease, or a lease of a multi-tenant property. In cases involving a multi-tenant property, the owner may surrender over to the lockbox arrangement the right to rents paid by several tenants of the real estate. The junior lender may issue obligations backed by the payments from the lockbox arrangement. The obligations may include a private placement participating or syndicating the loan. The obligations may include a publicly-issued security.  
      The above advantages and features are of representative embodiments only. It should be understood that they are not to be considered limitations on the invention as defined by the claims. Additional features and advantages of the invention will become apparent in the following description, from the drawings, and from the claims. 
    
    
     BRIEF DESCRIPTION OF THE DRAWINGS  
       FIG. 1  is an entity cash-flow diagram.  
       FIG. 2 , comprising  FIGS. 2   a - 2   e,  is a term sheet for an example Mezzanine Loan.  
       FIG. 3  is a table comparing properties of two capitalization structures.  
       FIG. 4  is a graph plotting cash flows against time.  
       FIG. 5  is a flow chart. 
    
    
     TABLE OF CONTENTS  
      I. Overview  
      II. Mezzanine Loan Structure  
      II.A. Legal Structure—Overview  
      II.B. Senior Loan  112   
      II.C. The Lease 
          II.C.1. “Hell or High Water” Payment Guarantee 
            II.C.1(a) Bond-Type Lease     II.C.1(b) Synthesizing a Bond-Type Lease Using Hedging Structures or Lease Enhancement Insurance     II.C.1(c) Condemnation     II.C.1(d) Casualty     II.C.1(e) Lease Enhancement Insurance    
            II.C.2. Loan Tenor        

      II.D. Parties 
          II.D.1. Borrower/Landlord  130  
            II.D.2. Cash Management Lockbox    
               

      II.E. Agreements  
      II.F. Collateral  
      II.G. Rating  
      II.H. Pricing and Fee Structures  
      III. Alternatives  
      III.A. Interest-Only Variant  
      III.B. Bonding, Syndicating, or Securitizing the Loan to Investors  
      III.C. Mating Mezzanine Financing to Senior Financing  
      III.D. Multi-Tenant Leases  
      III.E. Financing Secured by Leases of Other Assets  
      IV. Further Reducing Risk to Investors  
      IV.A. Hedging Strategies 
          IV.A.1. Credit Default Swaps     IV.A.2. Hedging Using Other Derivatives        

      IV.B. Over-Collateralization Account  
      IV.C. Borrower&#39;s Liability Survives Default or Bankruptcy of Tenant  
      IV.D. Obligations of Tenant on Reaffirmation of Lease in Bankruptcy  
      IV.E. Full Recourse Due and Payable in Some Events  
      IV.F. Limitation on Borrower Incurring Debt or Disposing of the Property  
      IV.G. Required Reserves  
      V. Reaffirmation Database  
      VI. Increased Opportunities for Structuring Financing  
      VII. Investor Valuation of Mezzanine Bonds  
      VII.A. Loan Pricing Arbitrage  
      VII.B. Valuation of Bonds Issued by a Mezzanine Structure  
      VII.C. Subordinate, But Really Pari-Passu  
      VII.D. Evaluating Credit Default Risk 
          VII.D.1. Reaffirmation of Leases in Event of Bankruptcy     VII.D.2. Re-Letting Vacated Space     VII.D.3. Default     VII.D.4. Loss Severity     VII.D.5. Recovery 
 
 VIII. Uses 
 
 IX. Computer Implementation 
       

     DESCRIPTION  
      I. Overview  
      Referring to  FIGS. 1 and 2 , Mezzanine Loan  100  may be a mezzanine loan made to Owner/Landlord/Borrower  130 ,  132 ,  134  of commercial real estate leased to Tenant  104 . Mezzanine Loan  100  may be rated by one or more of the three principal U.S. rating agencies at or near the credit rating of Tenant  104 . For example, Mezzanine Loan structure  100  may be rated where it is structured to isolate risks relating to the borrower&#39;s credit and the real estate itself, and confine repayment risk to the credit of Tenant  104 . Especially when it is rated, Mezzanine Loan  100  may will bear an interest rate below the rate for a traditional, unrated mezzanine loan at or near the interest rate of the Tenant&#39;s corporate borrowings, and may have enhanced liquidity in the secondary market, and attractive to investors.  
      The parties to a Mezzanine Loan  100  structure may include Landlord/Borrower  130 , Tenant  104 , a cash management special purpose entity (CM-SPE)  136 , Senior Lender  110 , Mezzanine Lender  102 , and one or more servicers  142 ,  152 . Ownership of the property may be lodged in one or more special purpose entities  130 ,  134  that may be created for the sole purpose of owning and managing the property and being obligors on various loans, bankruptcy remote from Principal Owner  132 . Principal Owner  132 , in turn, is typically a partnership or other entity that has beneficial ownership of the real estate. Landlord/Borrower  130  receives the proceeds of the Loan  100 , and assumes the repayment obligation on both Senior Loan  112  and the junior Mezzanine Loan  100 . Landlord/Borrower  130  and Principal Owner  132  may irrevocably instruct Tenant  104  to make payment of rent to Senior Depository Account  144 . CM-SPE  136  and/or, or with the assistance of, Servicer  142 ,  152  maintains one or more Depository Accounts  144 ,  154 , and agrees with Senior Lender  110  and Mezzanine Lender  102  to pay Senior Lender  110  first, then Mezzanine Lender  102 , in some alternatives, all operating expenses, and then—only out of the residual—Landlord/Borrower  130 . The payments flow through the structure in a waterfall of priorities, with each party being paid in order of its priority claim, and the cash flows are isolated from any other interested party except to the extent each party is entitled. The position of Mezzanine Lender  102  may be secured by an assignment  138  of all rents  108  from the leases (typically junior to a first assignment to Senior Lender  110 ), and/or an assignment of a “soft second” pledge of the partnership interest of Landlord/Borrower  130 , to CM-SPE  136  or to Mezzanine Lender  102 .  
      Mezzanine Loan  100  may improve the positions and economics of all of the transaction participants. Because Mezzanine Lender  102  has a payment priority senior to that of Landlord/Borrower  130  and Principal Owner  132 , Mezzanine Lender  102  has a sufficient collateral position and limited risk. Mezzanine Loan  100  may be originated in the primary market at a lower interest rate and then subsequently traded between institutions at a higher price than other mezzanine loans. Mezzanine Loan  100  may be more attractive to borrowers, since they pay less interest, and more attractive later to secondary market investors, because they can readily trade it as a rated asset. The necessary parties may find it in their interests to enter the Mezzanine Loan agreement. CM-SPE  136  and Servicers  142 ,  152  may assume duties to intermediate between potentially-conflicting parties, Senior Lender  110  and Mezzanine Lender  102 .  
      Mezzanine Loan structure  100  may isolate the tenant&#39;s rent cash flows  108  from risks relating to owners  130 ,  132 ,  134 , the property, or senior mortgage  112 . Owner risks include (a) that Landlord/Borrower  130 , Principal Owner  132  or Owner  134  gets into financial trouble and diverts some or all of the rents that should be used to pay the Mezzanine Loan payment  156  to some other purpose, or (b) that Owner  134 , acting as property manager, fails to perform one or more of its obligations to Tenant  104  under the lease, which might allow Tenant  104  to terminate the lease, or to withhold some or all of the rents due until Owner  134  satisfies its non-performance. Real estate risks include a drop in property value, a drop in local real estate market, higher vacancies and lower rents, that the property itself is destroyed by some event or is taken by a governmental authority, or that an environmental problem, such as toxic waste, is found on the property. Isolating these risks may permit Mezzanine Loan structure  100  to be ratable by the rating agencies and have a lower interest rate and high liquidity in the secondary market.  
      In many alternatives, the Mezzanine Loan structure isolates risk to the credit of Tenant  104 , and isolates risk relating to the credit of Landlord/Borrower  130 , Principal Owner  132 , Owner  134 , the property&#39;s value, the property type, geographic area, market conditions, and other elements of real estate risk. As real estate cash flow risks are more isolated to the credit of Tenant  104 , and Mezzanine Lender  102  gains payment priority relative to the typical subordinate lender, the pricing or interest rate for Mezzanine Loan  100  may more closely reflect the credit of Tenant  104 , rather than of Landlord/Borrower  130 , Principal Owner  132 , or Owner  134  or be derived from the perceived long-term value of the property itself. This pricing or interest rate may typically be much better than the typical subordinate loan to a commercial lessor.  
      II. Mezzanine Loan Structure  
      A Mezzanine Loan may be generally structured as follows.  
      II.A. Legal Structure—Overview  
      In order to qualify a potential borrower, Mezzanine Lender  102  may prefer to offer to lend against leases of investment grade single tenant properties, or to multi-tenant properties, when Tenant(s)  104  is/are of investment grade or have sufficient credit quality in a larger, multi-tenant property that any bonds issued backed by Mezzanine Lender  102  can be tranched and structured to investment-grade blended levels.  
      The lease underlying a Mezzanine Loan  100  may be a “bond-type” lease, or a triple-net lease or a double-net lease. (These lease forms are discussed in § II.C.1.) That lease typically lets an entire property to a single investment grade tenant of commercial property, for example, office, warehouse or retail facilities. Such lease terms shift operating expenses, taxes, insurance costs and risks associated with owning and operating the property to Tenant  104 , so that Landlord/Borrower  130 , Principal Owner  132 , and Owner  134  have little or no responsibility to pay any operating expenses (see § II.C). In other alternatives, the structure may create reserves against these costs (see, e.g., § IV.G). In either event, these costs may be reserved out of the cash flow waterfall before paying Mezzanine Lender  102  and Investors  190 .  
      A special purpose entity, Borrower  130 , may be created to serve as the obligor on Mezzanine Loan  100 . Borrower  130  may be wholly owned by Principal Owner  132  and may, in turn, own the special purpose entity with direct ownership of the property, Owner  134 . In cases where there is a pre-existing Senior Mortgage  112 , typically Owner  134  is the obligor on that Senior Mortgage  112 . Mezzanine Lender  102  may require an opinion of counsel that Borrower  130  is non-consolidated with, that is, is bankruptcy remote from, Principal Owner  132 . In other cases, there may be other ownership relationships among entities  130 ,  132 ,  134 , or a single entity may perform the functions for two of the entities described herein.  
      Referring again to  FIGS. 1 and 2 , Mezzanine Loan structure  100  may use two agreements  140 ,  150  that are linked by two Depository Accounts  144 ,  154 . Depository Accounts  144 ,  154  may be controlled by independent servicers  142 ,  152 . The parties to Senior Agreement  140  may include Landlord/Borrower  130  and/or Principal Owner  132  and/or Owner  134 , Senior Lender  110  and a Senior Servicer  142 . Senior Agreement  140  may call for rents  108  to be paid into Senior Depository Account  144 , from which Senior Servicer  142  pays payment  146  to Senior Lender  110  and passes the remaining cash flow  148  into the Subordinate Servicing Agreement  150 . Subordinate Servicing Agreement  150  among Landlord/Borrower  130 , Subordinate Servicer  152 , and Mezzanine Lender  102  calls for Subordinate Servicer  152  to pay Mezzanine Loan payment  156  to Mezzanine Lender  102  (or to Investors  190  designated by Mezzanine Lender  102 ) and to remit the net excess cash flows  158  to Landlord/Borrower  130  or Principal Owner  132 . These two Servicing Agreements  140 ,  150  are linked by an obligation of Senior Servicer  142 , pursuant to Mezzanine Loan Agreements  140 ,  150 , to remit 100% of the gross excess cash flows  148  directly from Senior Depository Account  144  to the Subordinate Depository Account  154 . Because these agreements isolate the cash flow from any non-contractually specified use of the rent from the Tenant  104 , Mezzanine Loan  100  may be financed by Investors  190  based on the corporate bond rate of Tenant  104  (rather than the credit of Landlord/Borrower  130 , Principal Owner  132  or Owner  134 ), for example, with a spread to Mezzanine Lender  102 .  
      II.B. Senior Loan  112   
      A typical loan secured by real estate is underwritten against, and assumed to be repaid by, some combination of the property, the owner, and the tenant. These three broad elements are the criteria that define and represent the creditworthiness of and collateral for a typical real estate loan. More specifically, Senior Loan  112  may be based on the credit quality of Tenant  104 , the credit quality of Owner  134  and/or Principal Owner  132 , the ability and history of Principal Owner  132  in managing buildings, the strength of the local commercial real estate market in terms of vacancy rates, rent per square foot, the value of the building, and other factors. Based on these, Senior Lender  110  determines the percentage of that value it is willing to loan, over what period of time the loan is to be repaid, and the interest rate that it will charge Owner  134 . Senior Lender  110  may file a mortgage against the property. Senior Lender  110  may also obtain contractual guarantees from Landlord/Borrower  130  or Owner  134  as collateral that can be foreclosed upon in the event Owner  134  doesn&#39;t repay the loan.  
      II.C. The Lease  
      Tenant  104  signs a lease to pay to Landlord/Borrower/Owner  130 ,  134  a specified rent for a specified period of time. The amount paid may reflect the average “market rents” tenants pay in the geographic area for similar properties, and the design, materials, and condition of the specific property. However, the rents may be well above typical market rents without impact on Mezzanine Loan  100 . 
          II.C.1. “Hell or High Water” Payment Guarantee        

      To obtain a rating, it is desirable to structure the lease to ensure that lease payments will continue until Mezzanine Loan is repaid, with low risk of termination, and reduced variability in the lease cash flows (Rent  108 ). Preferably, the lease is a bond-type lease (see § II.C.1(a)), or else various insurance, capital reserves, or other guarantees are entered to provide assurance of timely payment of rents  108  equivalent to a bond-type lease (see §§ II.C.1 and IV). 
              II.C.1(a) Bond-Type Lease            

      In a “bond-type” lease, also known as a “hell-or-high-water” lease, the tenant is responsible for all property taxes, insurance, and operating expenses to run the property. The owner has no responsibilities for any economic aspect of the property. Under a “bond-type” lease, the tenant must make its rent payments every period of the lease, even if the building is destroyed, or a government agency takes the property. A “bond-type” lease is essentially equivalent to the tenant&#39;s corporate bonds, isolated from owner and real estate risks. The rent on a bond-type lease is generally lower than on other types of leases where the landlord retains more risk.  
      Bond-type leases arise most commonly in sale-leaseback transactions, where the current owner of a property sells the property to a financing source, and the financing source then leases the property back to the original owner. In such transactions, a bond-type lease may allow better financing, which in turn helps get the sale leaseback transaction done. 
              II.C.1(b) Synthesizing a Bond-Type Lease Using Hedging Structures or Lease Enhancement Insurance            

      In the next “tightest” lease form, the “triple net” lease (“NNN” lease), the tenant is responsible for all real estate expenses, including insurance, taxes, and operating expenses. In a “double net” (“NN”) lease the tenant is responsible for two of these three. Under most NNN or NN leases, in the event of casualty or condemnation the tenant may terminate the lease and discontinue paying rent. In some NNN or NN leases, the landlord may be responsible for certain specified expenses. For example, under a typical NN lease, the landlord may be responsible for roof and structure maintenance. Sometimes the landlord&#39;s responsibilities are subject to a cap, and expenses above the cap may be the responsibility of the tenant.  
      A net lease (either NNN or NN) isolates most repayment risks. For example, because the landlord is not responsible for utilities, a net lease isolates cash flows  108  from changes in electricity rates.  
      Preferably, the lease backing a Mezzanine Loan  100  is at the “tighter” end of the spectrum, with more risks and obligations allocated to Tenant  104  and fewer to Landlord/Borrower/Owner  130 ,  134 . For example, Landlord/Borrower/Owner  130 ,  134  should ideally have no responsibilities whose breach would permit Tenant  104  to terminate or abate rent.  
      In the event that Landlord/Borrower/Owner  130 ,  134  retains some roof and structure obligations, for example under a NN lease, Landlord/Borrower/Owner  130 ,  134  may be required to post, or otherwise pay periodic payments into, some form of capital reserve, for example, as discussed in § IV.G.  
      Additional alternatives for guaranteeing timely repayment are discussed in § IV, below.  
      In cases where a net lease leaves some uncertainty in the timeliness of repayment, the agencies may reduce the rating of the loan below that of Tenant  104 . Where these lease-related structural features are successful in securing payment obligations equivalent to a bond-type lease, the ratings agencies may rate Mezzanine Loan  100  at the credit rating of Tenant  104 . 
              II.C.1(c) Condemnation            

      The government may take private property for public use through condemnation or eminent domain proceedings by paying compensation to the property owners.  
      Most triple-net or double-net leases obligate Tenant  104  to continue to make payments under the lease in case of a temporary or partial taking that permits the continued use of the property. However, in the case of a total taking or a partial taking that renders the remaining portion of the property unsuitable for its intended use, the lease typically will terminate, and the lease may obligate Tenant  104  to pay an amount sufficient to retire the outstanding debt.  
      If the government takes a portion of the property that does not render the remaining portion unsuitable for Tenant  104  to terminate the lease, Landlord/Borrower/Owner  130 ,  132 ,  134  may be required to apply the condemnation award proceeds to partially prepay the debt and thereafter reduce the lease payments due to an amount sufficient to pay all the future debt service. To the extent Tenant  104  is not obligated under the lease to follow the above procedure, Landlord/Borrower/Owner  130 ,  132 ,  134  may provide for insurance to cover the condemnation risk. 
              II.C.1(d) Casualty            

      Landlord/Borrower/Owner  130 ,  132 ,  134  and/or Tenant  104  may be required to carry casualty insurance, and, in the case of damage or destruction, to apply all insurance proceeds to repairing or rebuilding the property as nearly as practicable to its previous fair market value and utility.  
      As part of the underlying lease, Tenant  104  may have assumed an obligation that, where the insurance proceeds are insufficient to restore the property, Tenant  104  must complete the restoration at its own expense. If restoration is economically impractical following a substantial casualty, often Tenant  104  may terminate the lease by paying a termination amount or by purchasing the property in an amount at least sufficient to retire the outstanding debt. To the extent Tenant  104  is not obligated for the above, the Landlord/Borrower/Owner  130 ,  132 ,  134  may provide insurance to mitigate the casualty risk.  
      Landlord/Borrower/Owner  130 ,  132 ,  134  may irrevocably direct Senior Lender  110  to pay all excess casualty insurance proceeds and condemnation awards above the amount necessary to satisfy the claims of the Senior Lender from such event into the Senior Depository Account  144 , for transfer to Subordinate Depository Account  154 . 
              II.C.1(e) Lease Enhancement Insurance            

      In some alternatives, all responsibility for maintenance of the property, including roof and structure, may be the obligation of Tenant  104 . Tenant  104  may have this obligation under the pre-existing lease, or it may be a negotiated modification at the time Mezzanine Loan  100  is originated, or at another time.  
      In some alternatives, if the existing lease leaves too much risk that Tenant  104  may terminate the lease or abate or reduce rental payments, for example, if Landlord/Borrower/Owner  130 ,  132 ,  134  may default on his obligations to maintain the property, then Landlord/Borrower/Owner  130 ,  132 ,  134  may be required to negotiate a “tighter” lease with Tenant  104 . Alternatively, Landlord/Borrower/Owner  130 ,  132 ,  134  may be required to provide a non-cancelable, fully prepaid lease enhancement insurance, casualty and condemnation insurance, or lease interruption insurance policy naming Mezzanine Lender  102  as insured, in an amount sufficient to pay the outstanding principal amount of Mezzanine Loan  100 , together with any accrued interest and the present value of the remaining interest payments. Business interruption insurance may also be obtained to cover the rent for twelve months or until other insurance pays. This insurance, available from AIG and/or from International Amalgamated Group (also known as “Fisher Shapiro”), New York, N.Y. (www.afisherco.com), may cost approximately 75-100 basis points as a one-time fee payable upon execution of Mezzanine Loan  100 . Such insurance is often required by the senior lender for its own benefit and may already be in place.  
      In some alternatives, any remaining risk (whether of condemnation, casualty, default of landlord obligations, repairs required by normal wear and age, etc.) may be covered by a capital reserve, for example, as discussed in § IV.G. 
          II.C.2. Loan Tenor        

      Mezzanine Loan  100  may be structured to require that full repayment of the loan occur within the shorter of the lease expiration or the mortgage maturity. (A commercial real estate mortgage may have a maturity date before the end of the loan&#39;s term or that period over which the loan amortizes to a balance of zero. For example, in a “120/360” loan, the payment amount will amortize the loan over a term of 360 months, but after 120 months, the mortgage matures and the full balance remaining is due as a “bullet” repayment.) Requiring full repayment of Mezzanine Loan  100  by the expiration of the lease reduces the risk that Tenant  104  may not renew the lease, and cease payments before the loan is paid. Similarly, requiring full repayment of Mezzanine Loan  100  by the maturity of the mortgage reduces risk that the financing underneath Mezzanine Loan  100  may be detrimentally disturbed, for example, if Landlord/Borrower/Owner  130 ,  132 ,  134  pays off the mortgage by selling the property, refinances the mortgage or, by prepays the mortgage out of the owner&#39;s equity.  
      II.D. Parties 
          II.D.1. Borrower/Landlord  130         

      Landlord/Borrower  130  and Owner  134  are typically partnerships, limited liability partnerships, limited liability companies, grantor trusts, or other form of a special purpose entity (“SPE”), chartered solely to own and lease the property, bankruptcy remote from Principal Owner  132 , with independent directors. Landlord/Borrower  130  may be structured to isolate the lease cash flow  108  from any business risks of Principal Owner  132  or Owner  134  and any performance risks of Landlord/Borrower/Owner  130 ,  132 ,  134  under the lease that would give Tenant  104  any right to abate rent. In some alternatives, Mezzanine Lender  102  may require approval of the charter or partnership documents for Landlord/Borrower  130 , for example, to limit Landlord/Borrower  130  from incurring additional debt, and may require proof of adequate capitalization of Landlord/Borrower  130  by Principal Owner  132 . Independent of the Mezzanine structure, many commercial properties are typically owned by such special purpose entities, typically pursuant to Senior Loan  112 , and the existing charter of that entity may in many cases satisfy the requirements of Mezzanine Lender  102  with little further charter modification. 
          II.D.2. Cash Management Lockbox        

      Rents may be isolated from owner risks by implementation of a lock box and cash management account or special purpose entity  136  with a stated cash flow “waterfall” or priority of payments. Landlord/Borrower  130  may irrevocably instruct Tenant  104  to remit all of its rent payments  108  to a “hard lock box”  136 ,  144 ,  154 . Lock Box  136  may be a bank account under the control of a third party financial entity or may be a special purpose entity under contract. Lock Box  136  may receive the rents  108 , distribute them according to a prioritized sequence of payments, and only after all these payments are made, distribute any remaining cash  158  to the Landlord/Borrower  130  or Principal Owner  132 . These features may reduce the risk that Landlord/Borrower  130  might withhold part or all of the required Mezzanine Loan payment  156 . The priority of payments made—or “waterfall”—usually pays Senior Lender  110  first, then any reserves, then Mezzanine Loan payment  156 , and then any balance remaining for Landlord/Borrower  130 . If Lock Box  136  already exists pursuant to Senior Loan  112 , Mezzanine Loan  100  may piggyback on that structure.  
      Cash Management Special Purpose Entity (CM-SPE)  136  may be specially created to own the lease for the life of Mezzanine Loan  100 , or to manage the lease. CM-SPE  136  may be assigned all rights to Rent  108 , and may assume obligations to collect rent  108  from Tenant  104 , pay the senior debt payment  146 , transfer the gross excess cash flow  148  to Subordinate Depository Account  154 , and report on these collection and payment efforts to Landlord/Borrower  130  and Senior Lender  110 . However, none of these activities of CM-SPE  136  affect the property itself, because title to the property and all rights relating to the property may remain with Landlord/Borrower  130 . CM-SPE  136  may be 100% owned by Landlord/Borrower  130  and/or Principal Owner  132 , and bankruptcy remote from Landlord/Borrower  130  and Principal Owner  132 . A trustee may be appointed for CM-SPE  136  that is mutually acceptable to Senior Lender  110  and Mezzanine Lender  102 . CM-SPE  136  may be chartered to exist for the life of Mezzanine Loan  100  or for the longer of the two debt tenors.  
      Landlord/Borrower  130  may covenant, represent or warrant to Mezzanine Lender  102  that it will cause all leases currently in effect or that are made in the future to be conveyed and pledged to the CM-SPE  136  and/or to Mezzanine Lender  102  along with a subordinate assignment  138  of the leases and that it will instruct in writing all current and future tenants to make their rent payments directly to Senior Depository Account  144 .  
      II.E. Agreements  
      Senior Servicing Agreement  140 , among Landlord/Borrower  130 , CM-SPE  136  (in structures that use such a special purpose entity), Senior Lender  110  and Senior Servicer  142 , may require Senior Servicer  142  to collect rents  108 , disburse payments  146  on Senior Loan  112  as due to Senior Lender  110 , transfer the gross excess cash flows  148  to Subordinate Depository Account  154 , and report on these collections and disbursements to the parties to Senior Servicing Agreement  140 . Senior Servicing Agreement  140  may also create a hard lock-box arrangement and Senior Depository Account  144 .  
      Subordinate Servicing Agreement  150  may create a Subordinate Depository Account  154  into which all gross excess cash flows  148  after payment  146  of Senior Loan  112  are transferred and deposited. Landlord/Borrower  130  may irrevocably direct the Senior Servicer  142  to cause all such transfers of the gross excess cash flow  148  to Subordinate Depository Account  154 . Subordinate Depository Account  154  may be maintained in the name of Subordinate Servicer  152  or Mezzanine Lender  102 . Mezzanine Lender  102  may have a perfected security interest in Subordinate Depository Account  154 . Subordinate Servicer  152  then disburses payments  156  to Mezzanine Lender  102 . Subordinate Servicer  152  then remits any net excess cash flows  158  to Landlord/Borrower  130 . Any misallocation of rents by Landlord/Borrower  130 , or Principal Owner  132  may give Mezzanine Lender  102  and its beneficiaries and affiliates full recourse to Landlord/Borrower  130 , Principal Owner  132  and Owner  134  for the unpaid principal balance of Mezzanine Loan  100 .  
      The parties may agree that the property will be managed by a mutually-agreed property manager  180 , with the approval of Mezzanine Lender  102  over fees, terms and scope of services. For any operating expenses that are not required to be paid by Tenant  104 , Mezzanine Loan servicing agreements  140 ,  150  may implement an irrevocable cash flow payment waterfall whereby all operating expenses are paid by servicers  142 ,  152  prior to Landlord/Borrower  130  or Principal Owner  132  receiving any cash flow. Such operating expenses may be paid out of rents  108  before payment  146  to Senior lender  110 , or may be paid out of cash flows  148  before payment  156  to Mezzanine Lender  102 , or may be paid out of cash flows  158  after payment  156  of Mezzanine Lender  102 .  
      In some cases, Senior Lender  110  and Mezzanine Lender  102  may enter an intercreditor agreement. For example, such an agreement may expressly provide that Mezzanine Lender makes no claim on the property itself, beyond the pledge of partnership interests in Landlord/Borrower/Owner entities  130 ,  132 ,  134 . The Intercreditor Agreement typically constrains Mezzanine Lender  102  from interfering with the discretion of the Senior Lender  110  in exercising any and all of its remedies. Senior Lender  110  may agree that, in the event of a non-monetary default (e.g., Landlord/Borrower  130  fails to timely send reports, provide access to books, etc.), Senior Lender  110  will not exercise rights to capture the rent cash flows  108 .  
      The entities and relationships described above are only one example among many possible alternatives. For example, because the contractual obligations of servicers  142 ,  152  to Senior Lender  110 , Mezzanine Lender  102  and to Landlord/Borrower  130  are clear, a single entity may perform several or all roles. Similarly, the Senior and Subordinate Servicer Agreements  140 ,  150  may be combined into a single agreement. In some alternatives, in view of the conflicts that may arise in the event of default by Tenant  104 , it may be desirable to allocate the tasks of paying the two Lenders  110 ,  102  to two different servicers  142 ,  152  in priority order, as described above. In other alternatives, it may be desirable to combine these two functions in a single servicer, or to combine Senior Depository Account  144  and Subordinate Depository Account  154  into a single account from which payments  146 ,  156  and  158  are made. In other alternatives, it may be desirable to split the functions among two entities, one for each half of the overall structure. Servicers  142 ,  148  may be the same entity or two different entities, and may be a bank or similar trust organization.  
      II.F. Collateral  
      In some cases, Mezzanine Loan  100  may be a non-recourse loan, for example, in cases where non-payment by Tenant  104  is covered by a credit default swap  260  or other financial hedge (see § IV.A).  
      In other alternatives, Mezzanine Lender  102  may have some recourse against Landlord/Borrower  130 , Principal Owner  132  or Owner  134 , to repay the remaining principal balance in the event of a default by Tenant  104 .  
      In some alternatives, Senior Lender  110  may approve a subordinate assignment  138  of the lease to Mezzanine Lender  102 . Mezzanine Lender  102  may have a lien against the lease rent cash flows  108  to CM-SPE  136 . In such cases, Tenant(s)  104  will be concurrently irrevocably directed to make rent payments  108  directly to the Senior Depository Account  144 .  
      In other alternatives, Mezzanine Lender  102  may take a pledge of partnership interest in the Landlord/Borrower  130 , Principal Owner  132 , or Owner  134 , but without any lien directly against the real estate. Under a pledge of partnership interest Senior Lender  110  retains the lien against the real estate, while Mezzanine Lender  102  obtains a right of foreclosure against the ownership of Landlord/Borrower/Owner  130 ,  132 ,  134 . Foreclosure on the pledge of partnership interest results in Mezzanine Lender  102  acquiring ownership of Landlord/Borrower  130 , Principal Owner  132  or Owner  134 , and thus the property itself, subject to curing any default to Senior Lender  110 . Mezzanine Lender  102  may then re-market the property, or else liquidate the property entirely.  
      In some alternatives, Mezzanine Lender  102  may have a right of foreclosure against the property itself. Foreclosure may relieve the obligation of Landlord/Borrower  130  to Mezzanine Lender  102 , subject to Mezzanine Lender  102  assuming all outstanding obligations under Senior Loan  112  to Senior Lender  110 .  
      Generally, the more recourse and better the collateral position Mezzanine Lender has against Landlord/Borrower  130  and the property, the lower the interest rate charged on Mezzanine Loan  100 .  
      Mezzanine Lender  102  may have recourse that mirrors the “bad boy act” provisions and non-monetary defaults of Senior Loan  112 .  
      The Mezzanine Loan agreements, including Senior Servicing Agreement  140 , and Subordinate Servicing Agreement  150 , may be entered contemporaneously with the origination of Senior Loan  112 , or contemporaneously with the entry of the lease between Landlord  130 ,  132 ,  134  and Tenant  104 , or may be entered later, underneath or behind and subordinate to a pre-existing senior financing  112 . Mezzanine Lender  102  may require the usual documentation for a commercial real estate loan, for example, a description of the property, the purchase price, details of the Senior Loan financing  112  (including the tenors and identity of Senior Lender  110 ), documentation evidencing that Landlord/Borrower  130  owns and controls the property, a copy of the lease between Landlord/Borrower  130  and Tenant  104 , appraisals, evidence of compliance with laws and regulations applicable to the property (including, for example, permits, approvals, licensing and zoning), title commitments, surveys, lien searches, property and liability insurance, environmental reports, physical condition reports, credit reports, background check on Principal Owner  132  and Landlord/Borrower  130 , and organizational documentation.  
      The loan may be underwritten based on the senior unsecured credit of Tenant(s)  104  and the underlying SWAPS benchmark rate for the average life of the tenor of the loan, which in turn may be based on the lease tenor. A spread may be added to the coupon appropriate to the senior unsecured borrowing rate of Tenant  104  to make the coupon attractive to buyers of the resulting Mezzanine Loan, plus a premium for prepayment and any additional spread or fees incurred to turn the lease into a bond-type lease, and perhaps a premium to serve as an incentive for an investment bank to fund the loan.  
      The loan documents may include conditions precedent, affirmative and negative covenants, representations and warranties, and miscellaneous provisions typical to commercial real estate and/or credit tenant financing structures, or tranched bond structures.  
      II.G. Rating  
      Traditional mezzanine loans are typically illiquid in the secondary market. In order to sell any mezzanine loan, the seller has to convince a potential buyer that the buyer should be willing to either foreclose on the partnership and thereby own the property, or that there is really no potential for the loan going into default. Foreclosure typically obligates the mezzanine lender to bring the senior mortgage loan debt payments current, maintain those payments current, invest additional capital in fixing up the property, market the space to new tenants and pay leasing brokerage commissions in order to eventually have a profitable property investment, and then keep or sell the property.  
      Further, in many mezzanine loan deals, the senior lender is concerned with the mezzanine lender “becoming the borrower.” The senior lender underwrote the property and the credit and real estate expertise of the owner/borrower, and may be reluctant to establish a contractual relationship in which, in the event of default, repayment of the senior loan may turn on the real estate management skills of the mezzanine lender.  
      Mezzanine structure  100  may reduce the likelihood that Mezzanine Lender  102  must foreclose on the pledge of partnership interest and any reduce the likelihood of the mezzanine lender acquiring such obligation.  
      If Tenant  104  is already rated, payments  196  on Mezzanine Loan may carry the rating of Tenant  104 . In some cases, where Tenant  104  is of investment grade but unrated, it may be possible to obtain a “shadow rating” for Mezzanine Loan  100 , independent of any rating of Tenant  104  per se. As discussed in §§ VII.C and VII.D below, the rating of Mezzanine Loan  100  may be higher than the rating of Tenant  104 , especially where Mezzanine Loan  100  is further enhanced, for example using the techniques described in § IV.  
      II.H. Pricing and Fee Structures  
      Interest rates for Mezzanine Loans  100  charged to Landlord/Borrowers  130  may be determined by a variety of pricing structures.  
      Pricing may be set by credit grade of Tenant  104 . For example, a Loan  100  backed by a lease to a AAA-rated tenant may bear a rate of 50-75 basis points over some benchmark, such as the treasury rate, Wall Street Journal prime rate or LIBOR, while AA, A and BBB tenants may bear rates with progressively larger spreads. Fees for lease enhancement insurance, etc. may be borne by Landlord/Borrower  130 .  
      In other alternatives, where Loan  100  is hedged by a credit default swap or other derivative  260  (see § IV.A), interest rate for Mezzanine Loan  100  might be 135 basis points plus the cost of the hedging derivative, such that the sum of the spread components reflects a credit spread appropriate to the credit rating of the tenant.  
      In other alternatives, the average price for credit default swaps for all companies of a given credit rating class may be averaged, and Mezzanine Loans  100  for all tenants of that class may be priced based on a spread charged relative to that average.  
      Notes  192  sold by Mezzanine Lender  102  may carry a gross coupon equal to the gross rate  156 , with deductions for any hedging premiums (see § IV.A) and any sub-servicing spread retained by Mezzanine Lender  102 . Thus, even though all notes may carry the same net coupon reflecting the AAA rating of the credit default swap seller, the net cost of capital to Landlord/Borrower  130  is based on the tenant&#39;s cost of funds, because the cost of the credit default swap is based on the credit of Tenant  104 .  
      For example, a Mezzanine Loan  100  against a lease in which Tenant  104  is IBM might be priced as follows: In our example, IBM might be rated A- and have a 5-year CDS of trading at 100 basis points. Mezzanine Lender  102  may then add its fees and profit, which might be 75 basis points. If the underlying treasury benchmark or swap rate is 4.4%, the total rate to Landlord/Borrower  130  is 4.4% (440 basis points)+100 basis points+75 basis points=615 basis points, 6.15%, plus origination fees of, for example, 60 basis points.  
      III. Alternatives  
      III.A. Interest-Only Variant  
      In some cases, Mezzanine Loan  100  may be structured as a fully self-amortizing level-payment loan.  
      In other cases, Mezzanine Loan  100  may be structured as an interest-only loan for an initial portion of the term, and the remaining term of the loan may use self-amortizing payments. For example, a ten-year loan may have an interest-only first year, under which the lease payments may flow through Servicers  142 ,  152 , and payment  156  to Mezzanine Lender  102  may be limited to interest only, without an amortization of principal. At the end of the year, Landlord/Borrower  130  may have an option to pay the entire principal (this principal will be equal to the initial principal of the loan). If Landlord/Borrower  130  does not exercise this option, then the loan may automatically roll into a self-amortizing nine-year extension term. The payments during this nine-year extension term will, of course, be somewhat higher than the equivalent payments would be under a full ten-year self-amortizing arrangement. Consequently, so that the debt service load during the nine-year extension term does not exceed the underwriting limit that Lender  102  applies to Tenant  104  and the underlying lease, the maximum amount to be lent on these terms will be somewhat lower such that the amount originally loaned as Interest Only is capable of being paid off from the available cash flows in the remaining nine years.  
      An interest-only arrangement provides a much lower debt service constant for Landlord/Owner/Borrower  130 ,  132 ,  134  during the first year. This may be especially attractive in cases where Principal Owner  132  intends to sell the property during that year.  
      Other payment structures may be agreed by the parties.  
      III.B. Bonding, Syndicating, or Securitizing the Loan to Investors  
      Mezzanine Lender  102  may obtain financing from a number of sources.  
      Mezzanine Lender  102  may obtain a warehouse line from a financing source.  
      Mezzanine Loans  100  may be sold as whole loans. The secondary market may be reasonably liquid because the expected loss rate on a Mezzanine Loan  100  may be lower than that of a corporate bond, as discussed in § VII.D.  
      The loan documents may give Mezzanine Lender  102  the right to assign, syndicate, sell, pledge, securitize, or participate all or any portion of a Mezzanine Loan to Investors  190 . In some instances, an Issuer Trust  194  may be created by Mezzanine Lender  102  to issue bonds  192 , make bond payments  196 , and make accounting and reports on the payments and balances. Issuer Trust  194  may be chartered to exist for the longer of the two debt tenors.  
      Mezzanine Bonds  192  may be issued as asset-backed securitization or collateralized debt obligations (“CDO”). The “asset” that technically serves as the bond collateral is a junior assignment  138  of the leases, a pledge of the partnership interests of Landlord/Borrower  130  (which typically includes ownership of the property owner SPE  134  as a subsidiary thereof). The pricing of bonds  192  may be based on the senior unsecured borrowing spread of Tenant  104  plus a spread to provide an illiquidity premium to cover minor cashflow inconsistencies. The tenors of Mezzanine Bonds  192  may extend for any desired amount of time, to a maximum tenor coterminous with the lease. Ten years may be a typical tenor. For AAA to BB rated tenants, the rate may be about 50-350 basis points above the senior unsecured borrowing rate of Tenant  104 .  
      The debt from the issuance of bonds  192  may be carried on the balance sheet of CM-SPE  136 , Mezzanine Lender  104 , or Issuer Trust  194 .  
      III.C. Mating Mezzanine Financing to Senior Financing  
      Mezzanine Loans  100  may be suited to the acquisition of assets, refinancing of assets, or taking out equity by layering mezzanine debt on assets that retain the existing senior debt  112 .  
      In the event that Landlord/Borrower  130  elects a public bond issue for senior financing  112  (for example, in a commercial mortgage-backed securities issue), it may be desirable to use a “hard” or “soft” lockbox structure for the payments, to ensure Mezzanine Lender  102  and Investors  190  that Landlord/Borrower  130  does not have the ability to divert rent cash flows away from the payment priority agreed to in the bond covenants and upon which they had based their investment decisions and financial evaluations. In contrast, where senior financing  112  is a private placement to a single lender (such as a life insurance company), lockbox arrangements may be less common, because of the greater flexibility Senior Lender  110  has to exploit its avenues of recourse. Mezzanine Loan structure  100  can be used with either form of senior financing  112 .  
      III.D. Multi-Tenant Leases  
      The use of a credit default swap  260  (see § IV.A.1) or other hedge (see § IV.A) may permit a Mezzanine Loan  100  on a property that is leased to multiple tenants. For example, in cases where all tenants are rated, a separate credit default swap can be purchased against each tenant, so that the overall risk becomes that of the seller of the credit default swap. If one or more of the tenants default on their lease(s), the swap counterparty pays off the remaining principal balance of the lease payments, which represents a partial repayment of Mezzanine Loan  100 . The remaining tenant or tenants continue to pay the remaining principal balance of the loan out of the rent payments they make.  
      III.E. Financing Secured by Leases of Other Assets  
      Mezzanine structure  100  may also be used to finance other types of assets. For example, a lessee  104  may lease an expensive piece of equipment (e.g., airplanes, manufacturing or data processing equipment, etc.). Where lessee  104  has a traded credit default swap, lender  102  may wrap the lease cash flow  108  in a credit default swap and securitize the lease cash flows  108  using lockbox structure  154  and other features described herein to protect the cash flow against default of lessor  104 .  
      IV. Further Reducing Risk to Investors  
      Even though the Mezzanine Loan structure inherently reduces default frequency and loss severity (see § VI.D), there may still be some risk of default by Tenant  104  and consequent loss.  
      The default risk of a Mezzanine Loan  100  may be hedged or insured through one or more of several alternative arrangements, even in alternatives where Mezzanine Loan  100  is made with no collateral from the property or ownership interest. Especially in alternatives where Mezzanine Loan  100  is isolated from the property, and collateralized solely by the creditworthiness of Tenant  104 , credit derivatives may be used to hedge out much or all of the default risk. These features may give Mezzanine Bonds  192  cash flow ratings comparable to those of a bond-type lease.  
      IV.A. Hedging Strategies  
      Financial derivatives may be used to hedge out any perceived residual loss risk during the aggregation and securitization period, particularly where Tenant  104  is an investment grade company, or where Tenant  104  has issued either bonds or publicly traded stock. Such derivatives may function as “surrogate” or “proxy” collateral, drawn from outside the traditional real estate finance paradigm. In some cases, such techniques may allow the rating of Mezzanine Loan  100  to surpass the rating of the tenant itself, and may allow a Mezzanine Loan to be made to the owner of properties leased to more than one rated tenant. 
          IV.A.1. Credit Default Swaps        

      In some cases, CM-SPE  136  or Mezzanine Lender  102  may purchase a credit default swap  260  from a swap dealer to cover default by Tenant  104  of rent payments  108 . Credit default swaps (“CDS”)  260  are a form of derivative contract in which the seller of the CDS sells protection against a default by a rated entity over a given term to the owner of an asset issued by the entity. Credit default swaps historically involved a swap of one type of risk for another, but have evolved into a custom contract to simply buy protection, much like insurance, against default. CDS&#39;s are principally used by investors to protect against default of senior unsecured bond issues of a corporation: a holder of an obligation of the corporation pays a seller of CDS protection a premium, typically monthly, and if the corporation defaults on the repayment of the bond, the seller of CDS protection pays the buyer of protection—and typically the owner of bonds—the principal amount due, often in exchange for the defaulted obligation.  
      A typical credit default swap contract provides that if Tenant  104  defaults on the lease, CM-SPE  136  provides notice to the swap dealer, and the swap dealer pays the balance of the principal and interest due on the loan. Such swaps are available, for example, from Deutsche Bank. The swap dealer may short bonds or stock to be able to deliver the contracted-for coverage in the event Tenant  104  defaults, and the dealer will manage risks internally to ensure that these shorts are neither overhedged nor underhedged.  
      Mezzanine Lender  102  may purchase CDS protection  260 , either as a lump sum on origination or out of the monthly fees. The CDS seller may agree to pay off Mezzanine Loan  100  (in full or in part), upon default of Tenant  104  upon legal notification of the tenant&#39;s default under the lease. Alternatively, the cost of CDS protection may be reduced by mutual agreement between Mezzanine Lender  102  and the Swap Dealer in return for Mezzanine Lender  102  giving Swap Dealer its pledge of partnership interest, some interest in the re-let lease rent, the loan repayment obligation of Landlord/Borrower  130 , or some other form of payment to Swap Dealer.  
      The price of the CDS  260  is based on the credit of Tenant  104 , the term of protection, and the amount of coverage. Lower credit tenants, longer terms, and higher amounts and higher coverage-to-loan ratios will each tend to increase the price of a CDS.  
      The default by a rated tenant on a lease obligation is an event of default that may put the tenant corporation into bankruptcy and trigger the CDS  260  payment (see § VII.D). Any remaining principal balance due will be fully repaid under the terms of its credit default swap contract. Since sellers of CDS protection are most often AAA-rated financial institutions, the risk of the ultimate repayment of Mezzanine Loan  100  becomes the risk of the AAA-rated CDS seller and Mezzanine Loan  100  may be rated at the rating of the seller of the CDS, rather than the rating of Tenant  104 . This may allow Mezzanine Lender  102  to reduce the interest rate it charges even further (subject to payment of the CDS premium at origination) and may improve the liquidity of the asset in the secondary market. 
          IV.A.2. Hedging Using Other Derivatives        

      In other cases, a Mezzanine Loan  100  may be hedged, for example, as follows. Consider an example Loan  100  collateralized by a lease with nine years&#39; remaining tenor. The risk to the principal may be hedged by buying put options on debt or equity securities of Tenant  104 , one put corresponding to each year remaining in the tenor of the Loan  100 . Each put option allows Mezzanine Lender  102  to tender securities to a counterparty, and demand payment at an agreed exercise price, even if the current market price of the securities is above the agreed exercise price.  
      Each put covers securities that, at the exercise price of the put, have a value equal to the principal that is to be retired in the corresponding year. Should Tenant  104  default on the underlying lease, the tenant&#39;s stock or bonds would drop in value significantly. For example, if Tenant  104  goes bankrupt in year 3 of a ten-year lease, then the put options expiring at the end of years 3, 4, 5, 6, 7, 8, 9 and 10 will together cover the remaining principal balance. This gain may offset any losses from default by Tenant  104 . If Tenant  104  reaffirms or Landlord/Borrower  130  re-lets the space successfully (see § VII.D, below), the hedge may simply earn additional income for Mezzanine Lender  102 . The cost of the hedge may be paid for out of the excess spread earned from the Loan  100 .  
      Similar arrangements may be synthesized using short sales of equity or debt of Tenant  104 , one short position for each time period remaining in the loan tenor. The shorts allow Mezzanine Lender  102  to purchase the stock or bonds cheaply and deliver them at the higher strike price of the short. If Tenant  104  company defaults on the lease, Tenant  104  may also likely declare bankruptcy. CM-SPE  136  may then liquidate the short position at a price of essentially zero, allowing CM-SPE  136  to retain the price of the short, and cover the default.  
      In other cases, the default risk may be covered by an insurance wrap, or other financial derivative.  
      In some cases, Tenant corporation  104  against which the CDS or other hedging derivative is written may be unaware that this hedging transaction exists. Similarly, in some cases Landlord/Borrower  130  may be unaware of the hedge. Because no agreement of these parties is required, Mezzanine Lender  102  may obtain protection against loss without collateral that is part of the real estate capital structure. Similarly, there is no need (and often no opportunity) to reapportion the real estate collateral priorities between Senior Loan  112  and Mezzanine Loan  100 .  
      In alternatives where the default risk is entirely hedged, the risk of Mezzanine Lender  102  and Investors  190  may be completely defeased, even though Mezzanine Lender  102  has no recourse to the property, to Tenant  104  or to Landlord/Borrower  130 .  
      IV.B. Over-Collateralization Account  
      Referring to  FIG. 2   d,  Mezzanine Loans  100  may be wrapped in Over-Collateralization Account  262 , set aside out of the excess spread above the blended senior unsecured borrowing rate of Tenant  104 , or by a premium at issue, to provide a significant recovery for Mezzanine Lender  102  or Investors  190  in the event of a default. Over-Collateralization Account  262  may be sized to provide six to eight months of payments to Investors  190 , depending on the local market conditions, to provide for the timely payment of bond payments  196  during the time it takes for Landlord/Borrower  130  to re-let the vacant space. Therefore, as long as Landlord/Borrower  130  re-lets the space within this time, and Senior Lender  110  does not exercise remedies that impact re-letting, Over-Collateralization Account  262  may ensure that there is no default in the bond payments  196 . If Landlord/Borrower  130  does not re-let the space in that period, there may be a cessation of payments  196  for some period, but ultimately payments may resume upon successful marketing of the vacant space, provided Senior Lender  110  does not have and exercise remedies during such period. Similarly, in the event that Tenant  104  defaults and enters bankruptcy, and Landlord/Borrower  130  chooses not to pay Senior Loan  112 , and Senior Lender  110  forecloses, this same Over-Collateralization Account  262  may be paid to the Investors  190 .  
      Over-Collateralization Account  262  may be targeted at 5-15% or more preferably, 7.5-10%, of the initial principal balance. In alternatives where Mezzanine Loan  100  is fully amortizing, this Over-Collateralization Account  262  grows relative to the principal loan balance over the tenor of the Loan  100  and may reach the average corporate bond recovery as a percent of remaining principal balance after 75% of the tenor has been reached. Depending on the degree to which bonds  192  have been repaid when such a default might occur, Over-Collateralization Account  262  may cover a significant portion, or even all, of the remaining principal balance.  
      In some alternatives, a separate Over-Collateralization Account  262  may be established to back each individual Mezzanine Loan  100  on a bankruptcy-remote basis from every other Loan  100  and its Over-Collateralization Account. In other alternatives, several Over-Collateralization Accounts  262  for several distinct Mezzanine Loans  100  may be pooled or cross-collateralized. For Investors  190  participating in a pool of Mezzanine Loans  100 , the expected default and recovery rates for such a pool may equal that of typical corporate bonds as early as 20% of the blended tenor of the pooled Loans  100 .  
      Use of an Over-Collateralization Account  262  may be most desirable in a securitized structure, such as a collateralized debt obligation. If Mezzanine Loans  100  are sold in whole loan form without an Over-Collateralization Account  262 , rather than pooled or securitized, the buyer may receive an additional excess spread to compensate for increased risk of loss.  
      IV.C. Borrower&#39;s Liability Survives Default or Bankruptcy of Tenant  
      The loan documents  140 ,  150  may provide that in the event that Tenant  104  defaults on any rent payment, then unpaid debt service  156  on the Loan  100  may accrue, with interest, due to Lender  102  from Landlord/Borrower  130  if and when Tenant  104  (or any replacement tenant) begins making rent payments  108 , regardless of when such payments may be made and regardless of any other remedies Mezzanine Lender  102  may have exercised or recoveries that may have been received on other financial structures. Further, until any shortfall has been recovered, the loan documents may provide that Mezzanine Lender  102  will receive 100% of the net cash flow and/or residual proceeds from the sale or refinancing of the property (subordinate to payment of any amounts due out of such proceeds towards Senior Loan  112 ).  
      The loan documents  140 ,  150  may provide that in the event that Tenant  104  enters bankruptcy, Landlord/Borrower  130  shall not take any action in connection with the bankruptcy without the prior consent of Mezzanine Lender  102 . Mezzanine Lender  102  may be given the right, without obligation, to, vote, file and prosecute any and all claims of Landlord/Borrower  130  in any bankruptcy of Tenant  104 . The loan documents  140 ,  150  may obligate Landlord/Borrower  130  to object to and use its best efforts to prevent any assumption and assignment of the lease to any future tenant with a lower credit rating than that of the original Tenant  104  as of the closing date of the Loan  100 .  
      IV.D. Obligations of Tenant on Reaffirmation of Lease in Bankruptcy  
      In some alternatives, if Tenant  104  enters bankruptcy, and Tenant  104  desires to reaffirm the lease, Tenant  104  may be required to pay of either one year&#39;s rent or 15% of the remaining principal balance of the rent for up to three years. In another alternative, Tenant  104  may covenant to pay the rent reserved by the lease, without acceleration, for the greater of one year, or 15%, not to exceed three years, of the remaining tenor of the lease. Since Senior Lender  110  has the senior lien on the lease and may or may not choose to pursue this recovery, it may be difficult to predict what recovery may be available to Mezzanine Lender  102  and Investors  190 . These covenants may be framed as obligations of Landlord/Borrower  130  to negotiate such prepayments by Tenant  104  as part of reaffirmation of the lease in bankruptcy.  
      IV.E. Full Recourse Due and Payable in Some Events  
      Mezzanine Loan  100  may become full recourse to Landlord/Borrower  130  and Principal Owner  132  in the event of certain “bad boy acts” or force majeur external events. “Bad boy acts” or “bad boy events” is an established term of art, varying slightly from transaction to transaction, generally relating to bad faith actions of the tenant, including misdirection of rent payments, erosion or destruction of collateral, requiring additional investment by the lender, or improper use of bankruptcy. Examples of “bad boy acts” may include any transfer or encumbrance of the property or any interest therein in violation of the loan documents, any change to the lease without the prior written consent of Mezzanine Lender  102 , a voluntary bankruptcy filing by Landlord/Borrower  130 , or in the event Principal Owner  132  or any officer, member, principal, representative or affiliate of Landlord/Borrower  130  files, solicits or joins in the filing of an involuntary petition against Landlord/Borrower  130 , lack of cooperation by Landlord/Borrower  130  or Principal Owner  132 , or any officer, member, principal, representative or affiliate of Landlord/Borrower  130  in a bankruptcy of Tenant  104  or Landlord/Borrower  130 , lack of cooperation in creating or perfecting the subordinate assignment  138  of the lease (whether initially or with respect to any replacement lease), any default under Senior Loan that is not caused by an act or omission of Tenant  104 , any termination of the lease by Tenant  104  except as a result of a casualty or condemnation, any default with respect to the special purpose entity covenants, or default with respect to the reporting requirements in the loan documents. External force majeur events may include environmental issues or new legislation that alters the bargain.  
      In certain events, Mezzanine Lender may have the right to require Landlord/Borrower  130  to prepay the Loan  100  in full by paying the outstanding principal balance plus all accrued interest and all other sums due under the loan documents, and possibly a prepayment consideration. These events may include any one or more of the following, unless approved by Mezzanine Lender  102 : (a) any reduction in the rents payable by Tenant  104 , (b) any refinancing, replacement, modification or restructuring of Senior Loan  112  resulting in an increase in the monthly payments due under Senior Loan  112 , or resulting in Senior Lender  110  or any new holder of Senior Loan  112  being unwilling to maintain the rights of Mezzanine Lender  102 , (c) any exercise by Senior Lender  110  of any rights or remedies under the Senior Loan documents, (d) if the lease terminates or for any reason Tenant  104  is no longer fully obligated under the lease, unless the lease is replaced with another satisfactory to Mezzanine Lender  102 , (e) if Landlord/Borrower  130  no longer owns fee title to the property, or (f) the occurrence of an uncured event of default under the Loan Documents.  
      The terms of a Mezzanine Loan  100  may limit the right of Landlord/Borrower  130  to prepay the Loan  100 , or may provide that any prepayment would include a yield maintenance premium.  
      IV.F. Limitation on Borrower Incurring Debt or Disposing of the Property  
      Loan documents  140 ,  150  may provide that any transfer of the property or of any ownership interest in Landlord/Borrower  130  or Principal Owner  132  shall require the prior written consent of Mezzanine Lender  102 . In some alternatives, Mezzanine Lender  102  may be given absolute discretion to approve any transfer that would result in (a) a change in control of Landlord/Borrower  130 , (b) Landlord/Borrower  130  or any single purpose entity holding equity in Landlord/Borrower  130  ceasing to be a single purpose entity, or (c) a dissolution or termination of Landlord/Borrower  130 . Any such transfer may be subject to a fee payable to Mezzanine Lender  102 .  
      Loan documents  140 ,  150  may limit the ability of Landlord/Borrower  130  or Principal Owner  132  to assume additional debt beyond Senior Loan  112  or ordinary trade payables, for example, by setting a minimum debt service coverage ratio, or a maximum level of trade payables.  
      IV.G. Required Reserves  
      In some alternatives, especially where Landlord/Borrower  130  is obligated under the lease to repair or maintain the property, and/or to pay taxes, insurance or any other monetary obligation, or where there may be some other risk exposure, Mezzanine Lender  102  may require Landlord/Borrower  130  to fund reserve accounts to cover these expenses. These reserves may be waived if reserves for the same purposes are maintained in connection with Senior Loan  112 .  
      In the event that Landlord/Borrower/Owner  130 ,  134  retains some roof and structure obligations, for example under a NN lease, Landlord/Borrower/Owner  130 ,  134  may be required to post some form of capital reserve, equal to an estimate of the maximum cost for roof and structure repairs, either as a monthly reserve and/or as a premium charged at origination of Mezzanine Loan  100 . In some alternatives, the capped amounts for the landlord&#39;s responsibilities may be reserved for out of the rents, placed in an initial reserve, or Landlord/Borrower/Owner  130 ,  134  may be required to take out a surety bond benefiting the Mezzanine Loan  100  in the amount of the capped obligation.  
      In some alternatives, any remaining risk (whether of condemnation, casualty, default of landlord obligations, repairs required by normal wear and age, etc.) may be covered by a capital reserve established to cover the risk. For example, Servicers  142 ,  152 , may service a Mezzanine Loan  100  structure backed by a double-net (“NN”) lease that leaves some responsibility for roof and structure with Landlord/Owner  130 ,  132 ,  134 . A third party may agree to advance the costs of repairs in the event the Landlord/Owner  130 ,  132 ,  134  defaults on a repair obligation, subject to repayment. This type of guarantee is offered by Midland Loan Services, Inc. of Overland Park, Kans., who may also serve as Servicers  142 ,  152 . The guarantee may, in turn, be backed by a capital reserve, or a pledge by Mezzanine Lender  102  of its own pledge of the partnership interests in Landlord/Borrower/Owner  130 ,  132 ,  134 , or junior assignment  138  of the lease. Note that this equity pledge or junior assignment may be pledged at almost no discount—Tenant  104  will only require expenditure for, for example, repairs to the roof and structure, if Tenant  104  intends to continue paying the lease.  
      The capital reserve may be funded in any of a number of ways. For example, it may be put up by Landlord/Borrower/Owner  130 ,  132 ,  134  at origination.  
      Alternatively, the capital reserve may be established by Mezzanine Lender  102 , funded by a premium of 50 basis points added to the interest rate charged to Borrower/Owner  130 , or an origination fee of about 75 basis points, to compensate Mezzanine Lender  102  for the expense of this enhancement. Mezzanine Lender  102  may contribute to this capital reserve until it reaches an amount agreed with the third party guarantor, typically about 25¢/sq. ft./year.  
      In some cases, reserves may be accumulated from each of several Loans  100 , and may be cross-pledged to Servicers  142 ,  152 .  
      A capital reserve established by Mezzanine Lender  102  may be the property of Mezzanine Lender  102 , in which case it will become additional profit to Mezzanine Lender  102  in the event the Mezzanine Loan  100  is retired with the reserve amount intact. IN other cases, the capital reserve may be the property of investors  190 , to be paid to them on retirement of Mezzanine Laon  100 .  
      V. Reaffirmation Database  
      It may be desirable to develop a database of leases, bankruptcies, reaffirmations of leases in bankruptcy, and rates of success in re-letting space where leases are not reaffirmed. Such statistical data on reaffirmation may substantially improve the ability of the rating agencies and investors to accurately assess the default probability for Mezzanine Loans  100 . This information may enable better, higher ratings and therefore better execution through lower overall cost-of-funds.  
      This database may be gathered by examining bankruptcy filings over several prior years in the bankruptcy and district courts in the United States, focusing on investment grade companies, and determining whether the identified companies are still occupying the same offices and other premises. If companies have vacated the premises they had occupied prior to filing bankruptcy, a researcher may attempt to identify whether the vacating of the property was related to the bankruptcy or was in the ordinary course of business. Examples where the companies vacated certain premises may be classified by the type of property that was vacated (i.e., office, warehouse, manufacturing, distribution, etc.), the geographic location, the size of the company, and the credit rating of the company at the time of filing.  
      Such database may enable investors and rating agencies to assess probability of reaffirmation by type of industry, property use, size of company, credit grade, and geography. This may improve the underwriting process, the ratings of securitizations, and the ultimate pricing and yields investors receive. The database may allow for Lender  102  to take out more spread in the form of the residual interest or premium price obtained, or lower prices and yet still lend profitably. Better default frequency information may cause Investors  190  to value Loans  100  and Bonds  192  more highly.  
      VI. Increased Opportunities for Structuring Financing  
      Referring to  FIG. 3 , in some cases, Senior Lender  110  takes a lien  302  on the property itself, and Mezzanine Lender  102  takes a pledge of partnership interest of the shares of Landlord/Borrower  130  and/or Principal Owner  132 , and/or the partnership or special purpose entity that owns the property. In this arrangement, all interests of Landlord/Borrower  130  and Principal Owner  132  have been encumbered, and there is no further collateral  306  available for a third loan.  
      In other cases, a Mezzanine Loan structure may be structured so that the Senior Lender  110  and Mezzanine Lender  102  take control  312 ,  314  of the lease payments, and leave the property itself and the partnership interests  316  unencumbered, available as collateral for third and fourth mortgages.  
      Referring to  FIG. 4 , Landlord/Borrower  130  may obtain financing whose payments exceed the total amount supported by the lease cash flows. In  FIG. 4 , the total monthly payments  480  on Senior Loan  416  (with a lien on the property) and second financing (a Mezzanine Loan)  400 , and whatever incidental expenses are to be borne by Landlord/Borrower  130  (such as taxes, maintenance, and utilities, to the degree these have not been contracted out to Tenant  104  under a double net or triple net lease) may equal the total  480  of the lease cash flows. Because the ownership interest remains unencumbered, Landlord/Borrower  130  may borrow an additional third amount  420  on a zero-coupon note collateralized by the ownership interest, to be repaid in a bullet payment  422  of principal and accrued interest at the end  424  of the lease tenor. This may provide increased leverage for owners of commercial real estate.  
      Further, the Mezzanine Loan structure may provide additional options and optimization of the capital structure for a real estate asset. The Senior Loan  416  may typically obtain a rating of the tenant&#39;s corporate bonds (or possibly better), suitable for a typical insurance company investment. The second financing  400 , under a Mezzanine Loan structure, may have a slightly higher yield and yet still be investment grade, suitable for the typical corporate bond investor. The third bullet financing  420  may carry a high yield appropriate for certain investors, for example, the typical junk bond investor. Thus, by balancing the amounts of the different tiers of financing, the Mezzanine Loan structure may provide some combination of greater cash flows for Landlord/Borrower  130 , higher loan-to-value leverage, lower interest rate, or longer tenor for Landlord/Borrower  130 .  
      A Mezzanine Loan structure may be used with a traditional mortgage, with commercial mortgage backed securities (CMBS), credit tenant lease (CTL) senior debt forms, or other senior financing.  
      VII. Investor Valuation of Mezzanine Bonds  
      A Mezzanine Loan  100  may have credit characteristic of a senior unsecured direct obligation of Tenant  104 , that can only go into default if Tenant  104  defaults on its rent obligation by entering bankruptcy. Even though a Mezzanine Bond  192  is subordinate to Senior Loan  112 , it may have credit characteristics of a senior unsecured term debt obligation of Tenant  104  backed by the underlying space lease obligation, and should perform in a similar manner. That is, a Mezzanine Loan  100  should go into default for the same reasons and under the same circumstances as any other senior unsecured debt of Tenant  104  in the corporate debt markets. As will be discussed in § VII.D, Mezzanine Loan  100  may actually perform better than corporate debt counterparts.  
      VII.A. Loan Pricing Arbitrage  
      Traditional commercial mezzanine loans are priced (that is, interest rate and various fees) by the risk associated with property value leverage or loan-to-value (“LTV”) and their rates are sensitive to change in LTV. Regardless of the credit quality of Tenant  104 , traditional mezzanine loan pricing increases fairly linearly with the increase in LTV. In contrast, the pricing of Mezzanine Loan  100  may be entirely independent of LTV leverage, and is related nearly solely to the credit quality of Tenant(s)  104 . Thus the pricing may be based on the senior unsecured borrowing rate of Tenant(s)  104 . As LTV increases, the credit quality of Tenant  104  is unaffected, and the pricing may remain nearly the same.  
      Therefore, Mezzanine Loan  100  may have an increasing advantage as LTV leverage increases. As tenant credit quality increases, pricing of Mezzanine Bonds  192  may decrease, decrease in staggered steps, or may remain fixed. Rates might be 10% for loans to A and BBB credit grade tenants and 9% for AAA and AA credit tenants. The spread between the loan rate and the bond coupon may be determined by the credit of a specific Tenant  104  and the tenor of the loans. If the average life of the Loan  100  or Bond  192  is six years, and the Swap rate for six years is 3.1%, and the tenant&#39;s unsecured borrowing rate spread is 175 basis points, then the base bond coupon would be 4.85%.  
      A further premium may be added to allow for prepayment, illiquidity, and subordination. The prepayment premium might be 75 basis points, depending on the credit quality of Tenant  104 , the lockout period, and the tenor of Bonds  192 . The illiquidity and subordination premiums may be fairly static. A portion of the premium allocated to illiquidity may compensate Investors  190  for the fact that this is a new asset class and investors may be expected to hold the Bonds  192  to maturity or until a secondary market in Mezzanine Bonds  192  develops. The portion allocated to subordination may compensate the Investors  190  for their position of being subordinate to Senior Lender  110  in the event of a default. The combined premium may be about 100 basis points. Thus, in the example, the Mezzanine Loan bond coupon might be expected to be about 6.6%. This would provide a spread of 340 basis points between the 10% loan rate and the bond coupon.  
      In 2003, commercial mezzanine loans are usually made at rates ranging from 12-13% for eighty-percent aggregate capitalization (80 LTV) to 20% or more for ninety-percent aggregate capitalization (90+LTV) and have repayment tenors of three to five years. In contrast, a Mezzanine Loan  100  may carry a rate of (5%-12%) for investment grade tenants (possibly higher for lower grade tenants), and may extend for about ten years.  
      Unlike traditional mezzanine debt, the Mezzanine structure may avoid the need for an inter-creditor agreement between Mezzanine Lender  102  and Senior Lender  110 . In many alternatives, the Mezzanine structure may not require such an agreement because Mezzanine Loans  100  give Mezzanine Lender  102  no interest in the partnership, and do not create situations in which Mezzanine Lender  102  can become the operator of the property, the obligor to Senior Lender  110 , or otherwise acquire any interest in the property.  
      VII.B. Valuation of Bonds Issued by a Mezzanine Structure  
      Mezzanine Bonds  192  may compare favorably with corporate bonds issued by Tenant  104 . Even though a Mezzanine Bond  192  may have a lower frequency of default, greater recovery and lower loss severity than a corporate bond of Tenant  104 , Mezzanine Bonds  192  may provide higher yields to Investors  190 .  
      Mezzanine Bonds  192  may be underwritten based on the character of existing leases and the credit quality of Tenant  104 . Real estate lease obligations are similar in many ways to corporate bonds and may be valued by bond valuation techniques that measure the certainty of the cash flows over the tenor of the lease. Like other lease collateralized loans, Mezzanine Bonds  192  may be valued based on the existing leases, tenant quality and default risk, a risk premium over treasuries of a comparable corporate bond, severity, duration, and the excess lease cash flows after servicing  146 ,  156  the mortgage debt, avoiding speculation on the real estate&#39;s future value.  
      VII.C. Subordinate, But Really Pari-Passu  
      Referring to  FIG. 5 , in alternatives where a Mezzanine Loan structure includes a subordinate assignment  138  of the lease rent and cash flows, the collateral is technically subordinate to the interest of Senior Lender  110 . Similarly, Mezzanine Loan payments are subordinate to Senior Loan  112 . In the event of a default by Tenant  104  or Landlord/Borrower  130 , Mezzanine Loan Bond payments  156 ,  196  are subordinate to Senior Lender  110  taking possession of the property and the rent cash flows. A default by Tenant  104  or Landlord/Borrower  130  could result in a foreclosure on Senior Loan  112  or Senior Lender  110  otherwise taking possession of the property and all of the rent cash flows  108 . All that Mezzanine Lender  102  may receive in this scenario is the remaining principal balance and any Over-Collateralization Account  262 .  
      However, as a practical matter, with a single tenant property, Tenant  104  either makes the entire lease rent payment or not at all. If Tenant  104  defaults, files for bankruptcy, and rejects the lease, Tenant  104  will not make the payment. In this event, Senior Lender  110 , who has a senior claim on the lease payments, will receive little or no payment, and neither will Mezzanine Lender  102 . In nearly all other scenarios, Tenant  104  makes the payment, and both Senior Lender  110  and Mezzanine Lender  102  receive their entire payments  146 ,  156 . Thus, as a practical matter, Senior Lender  110  and Mezzanine Lender  102  may be effectively pari-passu to one another with respect to the lease rent cash flows  108 .  
      VII.D. Evaluating Credit Default Risk  
      The credit risk of a Mezzanine Loan  100  is composed of the default probability and potential loss severity. As will be shown below, the probability of default on a Mezzanine Loan  100  is: 
 
Mezzanine Loan Probability of Default=P*(1-R)*(1-L) 
 
where 
 
P=Probability Tenant Defaults on Lease≈Probability of default on corporate bonds 
 
R=Probability Tenant Reaffirms Lease 
 
L=Probability Lessor Re-lets Space in 8 months 
 
 Industry surveys indicate that R, the probability that Tenant  104  reaffirms the lease in bankruptcy, is about 60%. Similarly, industry surveys indicate that L, the probability that Landlord/Borrower  130  re-lets within 8 months (that is, within the coverage lifetime of Over-Collateralization Account  262 , see § IV.B), is about 75%. Together, these suggest that the default rate on Mezzanine Bonds  192  may be about 10-40% the rate of default on the Tenant&#39;s corporate bonds. 
 
      The expected loss calculation is the following: 
 
Expected Loss=(Probability of default)*(remaining principal balance)*(1-Recovery Rate) 
 
 It is estimated that the frequency of default of a Mezzanine Loan  100  may be under 30% of the traditional corporate bond default rate. Loss severity on Mezzanine Loan  100  may be greater than that for a corporate bond in the first several years and less than that for corporate bonds in the later years of the tenor. Recovery rates may be superior to that of corporate bonds of Tenant  104  for a variety of reasons discussed below in §§ VII.D.1 to VII.D.5. Together, these calculations show that expected loss severity of Mezzanine Loans may be considerably better than that of corporate bonds. 
          VII.D.1. Reaffirmation of Leases in Event of Bankruptcy        

      When a corporation enters bankruptcy (step  502 ), the corporation will default on its corporate bonds and the bondholders join the bankruptcy as unsecured creditors. Most often, all of the corporation&#39;s leases go into technical or real default at the same time. At this point, the corporate bond and Mezzanine Loan  100  would both be in default. However, the corporate bond will remain in default until the bankruptcy is fully resolved and the courts determine how much money is to be paid against the remaining principal balance, or until the corporation exits bankruptcy and begins to resume payments under a negotiated arrangement.  
      Investors  190  of Mezzanine Bonds  192  may stand in better position than corporate bondholders.  
      First, the corporation in Chapter 11 bankruptcy may reaffirm (step  504 ) its lease for the space and then resume its lease payments without interruption (step  506 ), and thus the payments on Mezzanine Loans. Approximately 60% of companies maintain their headquarters office space while under Chapter 11 bankruptcy protection, and affirm their leases in the event of bankruptcy. For this reason, Mezzanine Loans  100  are most favorably written against property that are central to the core operation of the tenant&#39;s business, rather than facilities that could be readily eliminated in the event of bankruptcy.  
      In some cases, Tenant  104  may renegotiate (step  510 ) a reduced rent. Mezzanine Loan agreements  140 ,  150  may require that Landlord/Borrower  130  negotiate a reaffirmation that at least covers all required cash flows to pay the monthly payment  156  on Mezzanine Loan  100 , the senior debt service  146  and any expenses  182  to operate and own the building, for example, taxes, insurance, capital improvements, maintenance, and utilities. In the event that Landlord/Borrower  130  negotiates a rent amount that is insufficient to cover Loan payments  156  (step  512 ), the loan agreement may provide Mezzanine Lender  102  with full recourse to Landlord/Borrower  130  and Principal Owner  132  (step  514 ). So, even where Tenant  104  enters bankruptcy, payments  196  on Mezzanine Bonds  192  may continue uninterrupted (step  520 ). In this aspect, Mezzanine Bonds  192  may be superior to a corporate bond.  
      In some cases, Tenant  104  may default on its lease and rent payments  108 . Payments  146  to Senior Lender  110  will go into default, and Senior Lender  110  will foreclose on the property and attempt to recover its unpaid principal balance by selling the property. In cases where Mezzanine Loan structure  100  places no lien on the property, Mezzanine Lender  102  may receive no proceeds from this sale, and may have no recourse against Landlord/Borrower  130  or Principal Owner  132  or the property. 
          VII.D.2. Re-Letting Vacated Space        

      In the event that Tenant  104  declares bankruptcy and defaults, but does not reaffirm its lease and vacates the property (step  530 ), the remaining principal balance of Mezzanine Loans  100  may still be timely repaid. Landlord/Borrower  130  will usually have every incentive to re-lease or re-let the space to another tenant (step  532 ). In alternatives in which Mezzanine Loan agreements  140 ,  150  require that Landlord/Borrower  130  assigns any future leases and rent cash flows to the cash flow management structure  136 ,  140 ,  150 , payments  156 ,  196  will resume on successful re-leasing (step  520 ). In contrast, with a corporate bond, there is no analogous “substitution” provision.  
      On average, there is a 75% probability that space vacated by bankrupt Tenant  104  will be re-let in less than 8 months. In some alternatives, Over-Collateralization Account  262  (see § IV.B) may provide six to eight months of bond payments  196 , depending on the local market conditions. Therefore, as long as Landlord/Borrower  130  re-lets the space within this time, there may be no default in bond payments  196 .  
      Mezzanine Loan structure  100  may retain some element of real estate risk, in that a declining or bad real estate market may reduce the ability of Landlord/Borrower  130  to re-let the space after a default by Tenant  104 , in cases where the lease is terminated or Tenant  104  goes bankrupt and does not reaffirm the lease. 
          VII.D.3. Default        

      Thus, there are two scenarios that may lead to a default on Mezzanine Loan payments  156  and bond coupons  196 : (a) where Tenant  104  reaffirms the lease at a rent that is insufficient to cover the debt service  156  on Mezzanine Loan  100  (step  512 ). In these cases, Mezzanine Lender  102  may have recourse against Landlord/Borrower  130  and/or Principal Owner  132 , as discussed in § IV.E, and (b) where Tenant  104  rejects the lease and Landlord/Borrower  130  is unable to re-let the space, and Senior Lender  110  forecloses (step  540 ). In this case, any excess  542  of the foreclosure price over the principal remaining on Senior Loan  112  may be payable to Mezzanine Lender  102 . 
          VII.D.4. Loss Severity        

      Unless Mezzanine Loan  100  is pooled (e.g., as discussed in § III.B) or hedged or otherwise covered (e.g., using one or more of the techniques discussed in § IV), the severity of Mezzanine Loan  100  is 100% versus the historical average severity of 65-75% for corporate debt obligations. (According to “Default &amp; Recovery Rates of Corporate Bond Issuers,” Moody&#39;s (February 2002), the average corporate bond recovery is 35% of the remaining principal balance, drifting downward over the past several years, and varying considerably by industry sector). However, where such coverage has not been provided, Mezzanine Lender  102  and Investors  190  may receive a higher coupon whose excess spread may be viewed as the recovery.  
      Further, a Mezzanine Loan  100  may be a fully amortizing loan, while a typical corporate bond pays interest only during its tenor, with 100% of the principal due in the 10th year. Because of the amortization of the balance remaining in the Mezzanine structure  100 , the expected loss variance between the corporate bonds and a Mezzanine Bond  192  may increase over time. 
          VII.D.5. Recovery        

      Recovery rates on Mezzanine Bonds  192  may be compared to corporate bond default. When a corporation enters bankruptcy, a lengthy process ensues involving the corporate management, the courts and the creditors. After a considerable period of time, the creditors, including the bondholders, receive a percentage of what they are owed. This recovery can vary from 100% of the principal to nothing.  
      Mezzanine Loan  100  recovery may include amounts received from Tenant  104  on reaffirmation of the lease (see, e.g., §§ IV.D, VII.D.1), from a successor tenant (see § VII.D.2), from Over-Collateralization Account  262  (see § IV.B), from Landlord/Borrower  130  and/or Principal Owner  132  (see, e.g., §§ IV.C and IV.E), from insurance and hedging (see, e.g., §§ IV.A and II.C.1(b)) and various reserves (see, e.g., § IV.G).  
      Further recovery may be available from residual or “go dark” value of the underlying real estate. In addition, Senior Lender  110 , especially on a single-tenant building, may have reserves created from property cash flow to account for leasing commissions and tenant improvement costs. If the “go dark” value of the property plus the value of these reserves exceeds the sum of the balances due on Senior Loan  112  and Mezzanine Loan  100 , some recovery may flow to Mezzanine Lender  102  and to Investors  190 . Since Mezzanine Loan  100  is subordinate to Senior Loan  112 , the probability that these recoveries will be sufficient to pay down both loans may be fairly low, although the recovery rate increases over time as Senior Loan  112  and Mezzanine Loan  100  amortize.  
      Additional recovery may be possible in alternatives where Mezzanine Lender  102  has access to Tenant  104  as an unsecured subordinate creditor under the assignment  138  of lease, but this amount may be expected to be less than 5%.  
      VIII. Uses  
      Mezzanine Loan  100  may utilize 100% of excess cash flows to generate maximum proceeds for the acquisition of a net leased property occupied by a single credit tenant. Where maximum leverage is desired, a fully amortizing Mezzanine Loan  100  may be preferred. Where maximum proceeds are not necessary, bridge financing with a short-term interest only Mezzanine Loan  100  may be preferred. Mezzanine Loan  100  may be most attractive when the senior lender can offer a 30-year amortization schedule and the mortgage term equals or exceeds the expiration of the credit lease.  
      The Mezzanine Loan  100  structure may provide proceeds up to the present value of 100% of the cash flow in excess of the senior mortgage debt, where the discount rate is determined based on the credit of the tenant and the average life of the financing. The discount rate is equal to the average life SWAP rate plus the off the rack spread value of the tenant.  
      Owners of net lease real estate can use the Mezzanine Loan structure  100  to monetize underutilized cash flows through equity take out financing. Often, property owners can monetize excess cash flows at spreads below 200 Basis points, that is at rates just slightly above corporate line spreads, but without balance sheet recourse. This provides real estate CFO&#39;s with an attractive tool to raise capital without utilizing their existing corporate lines. Mezzanine Loan structure  100  may also be used by real estate fund managers to pay investor distributions reflecting the value created by new credit tenant leases, without the need to sell the property to realize such. Similarly, real estate developers can extract additional capital from completed properties leased to single credit tenants, and deploy the proceeds to new development projects. Since Mezzanine Loan structure  100  is a passive instrument, implementation alongside existing senior mortgage debt may be greatly facilitated.  
      IX. Computer Implementation  
      Mezzanine structure  100  may be managed by one or more computers. For example, one or more computers may be programmed to generate invoices, payments, statements, and other reports, maintain records, etc. for one or more of the steps described above.  
      Computer software  250  for originating, managing and analyzing Mezzanine Loans  100  may be provided, for example, by Lender  102  or a service bureau affiliated with Lender  102 . Such software may improve market efficiencies or capture surpluses in market inefficiencies. The software may further provide electronically integrated loan origination primary and secondary loan transactions, information management, and related services, data storage, risk management, allowing tenants  104  and Owner  130 ,  132  to consolidate and centralize activities for originating and servicing Mezzanine Loans  100 . The software may enable tenants, landlords, lenders, brokers or leasing agents, to (a) model a structure for Mezzanine Loans  100  in comparison to traditional financing alternatives, (b) apply directly to a lender&#39;s credit underwriting department for a loan based upon input provided, (c) receive electronic notification of credit determination, and (d) receive coordination support throughout the closing process. Access to the software may be provided over the internet on a thin client basis, from a central server array, or through other computer access networks. The computer may intermediate a series of vertical and horizontal corollaries in the commercial office and real estate finance markets, including tenant improvement construction loans, real estate and leasing information management, and coordination with other real estate finance markets. Initial underwriting of Mezzanine Loan  100  may be performed with the assistance of a computer model. Some of the transaction documents may be generated by word processing software.  
      Pricing information may be made available to landlord/borrowers at a web site. For example, the web site may provide specific pricing for specific tenants that have publicly-traded credit default swaps, or that have publicly-traded securities that can be used to synthesize a hedge (see § IV.A.2). The web site may also provide generic pricing information based on credit grade of the tenant. Some of this pricing information may be in password-accessible portions of the web site, while other information may be publicly-visible.  
      For the convenience of the reader, the above description has focused on a representative sample of all possible alternatives, a sample that teaches the principles of the invention and conveys the best mode contemplated for carrying it out. The description has not attempted to exhaustively enumerate all possible variations. Other undescribed variations or modifications may be possible. For example, where multiple alternative embodiments are described, in many cases it will be possible to combine elements of different embodiments, or to combine elements of the embodiments described here with other modifications or variations that are not expressly described. Many of those undescribed variations, modifications and variations are within the literal scope of the following claims, and others are equivalent.