C.M.O. 2.20.2009

Credit Market Overview
February 20 2009

News of “The Donald’s” bankruptcy filing in Atlantic City was immediately countered by “The Donald” saying it was only a licensing deal representing less than 1% of his net worth. Representing a little more than 1% however is his latest project in Chicago, which brings to light the problems in the mezzanine financing market. Mezzanine debt fits between equity and 1st mortgage debt on the balance sheet.

The “Mezz” market is in the news these days because of the rising default rate among this type of financing. “If you count the total number of mezz loans there are, you have gotten close to the number of mezz loans that are going to have problems” Mission Capital Advisors’ David Tobin says.

Mezz financing is attractive to some investors as it could produce returns in the teens if levered and if the borrower defaulted the investor had the right to take over the property. “We were very comfortable when we underwrote these assets, if we end up owning them, then that’s just great.” Mark Nunneley, CAO of Ashford Hospitality Trust Inc. said in November of last year.

Great until you take over a property and the property stops generating enough cash to cover the 1st mortgages, no less the mezz debt. Other well known funds that are involved in the mezz debt market include FortressInvestment Group LLC, Fillmore Capital Partners LLC and Petra Capital Management.

To the extent that this will prove a money losing proposition for the hedge funds and private equity firms out there, a provision in the stimulus package could land up making all that back and more.

Sen. Max Bascus helped pushed through a measure on the stimulus bill that allow companies restructuring debt to defer possible taxes for as long as five years and then pay those taxes over the following five years.

The ultimate cost of the program to the Treasury was estimated to be about $1.6BN with ultimate being the operative word. The near term cost (next 3 years) will be closer to $42BN as the loss in tax revenue is front loaded and the receipts back loaded.

Enjoy the weekend.

Jim Delaney

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