Anyone have an acquisition model for Distressed Second (Position) Lien Mortgage Note?
I have been try to track down a model that analyzes buying the b piece and or mezz debt on a distressed asset. Any idea where I can get one (sans cost). Thanks.
A1: Est. value of asset A2: 1st position debt A3: A1-A2 = value of second position.
Unless I am not understanding the question, the value of a second position is the value of the asset less the first position.
Depends, some mezz deals put the holder of the mezz piece in the first position to take over the asset if they want. So theres some considerable modeling that goes on there.
If its a striaght B position than its as simple as SK says, all you need to think about is "hey, what is the probability of me making my money back on this one?"
It also depends on why you are buying the subordinate piece, do you want to buy off the 1st position holder then take over the asset? Lots of reasons why you would buy it and lots of ways to model. If you just want to buy subordinate pieces and hope you get paid off more often then not its pretty simple stuff.
I would qualify SK's comment by saying that his math is correct if the B piece is impaired and can take title to the asset. Then it is effectively an automatic path to the equity so, as with all equity, the value of the position is the unlevered asset value less the debt with priority over the equity. However, as SHB suggests, if the B piece is "money good" then the value is just the NPV of contractual cash flows (or conversely the return is just the yield to maturity). SHB--I think when SK states "first position" debt he is not referring to the first-loss piece, but the senior/1st mortgage.
In summary, the approach to analyzing discounted subordinated debt is typically to underwrite returns under various scenarios. The two most obvious scenarios are (1) what happens if I get paid off at par? and (2) what happens if the sponsor surrenders the asset and I have to foreclose and/or cure the senior debt?
Note that with debt, the exercise is often less about "valuation" and more about adequacy of returns for a level of risk, and the math is less about discounting future cash flows and more about quantifying risks: what is my last-dollar basis relative to current value? to peak value? to replacement cost? What's my debt yield (NOI / last-dollar basis)? What's my coverage ratio? What's the refi gap if I have to take possession of the property and cure the senior?
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