Verstavo · Arc II · How the Money Is Structured ← Reading Credit

Lesson 3 of 15

The Capital Stack; Fixed vs. Floating

Two questions decide how you read a loan before you read a single number. Who eats the loss first? And can the borrower’s number lie to you?

Start with the stack, because it tells you whose problem any given loss is. Money goes into a building in layers, and those layers absorb loss in a strict, agreed order — from the bottom up. Common equity is first to be wiped. Then preferred equity, then mezzanine debt, then the senior mortgage, each protected by everything junior to it. This order is the single most important fact about any capitalized asset, because it converts “the building is worth less” into “which specific dollar is impaired.” A 20% decline in value is catastrophic to the equity and completely invisible to a senior lender with 60% leverage. Same event, opposite meaning, decided entirely by where you sit in the stack.

So the reader’s first move on any loan is to locate the seat. A distress signal is only frightening in proportion to how little cushion sits beneath your position. Learn to ask “who is this a problem for?” before you ask “how big is the problem?” — because the same headline is a funeral at one level of the stack and a non-event two levels up.

Now the second question, which is subtler and more powerful: is the loan fixed-rate or floating-rate? This is not a plumbing detail. It changes what kind of thing you are even reading.

A fixed-rate loan is, for reading purposes, collateral that cannot lie. The rate is locked, the payment is locked, the borrower has no dials to turn. So the loan’s health lives almost entirely in the collateral: the NOI, the coverage, the value. When a fixed-rate loan is in trouble, the trouble shows up in the numbers, because there is nowhere else for it to hide. You read the building.

A floating-rate loan is a different animal, because there is a manager in the picture with dials to turn — extensions, modifications, rate caps, interest reserves, a maturity that can be pushed. Floating-rate collateral tends to be transitional (a lease-up, a renovation, a business plan mid-execution), which means the manager is supposed to be intervening. But that same discretion means distress can be dressed. A rate cap masks the pain of higher rates. An interest reserve keeps a loan current that would otherwise breach. An extension resets the clock before the wall arrives. So on a floating-rate loan, you do not just read the building — you read the manager’s behavior, because the manager can make a struggling loan present as a healthy one, and the tell is in the actions, not the reported ratio.

Compress it to a sentence you can carry: fixed is collateral, floating is a manager. On a fixed-rate loan, distrust the building. On a floating-rate loan, distrust the story the manager is telling with extensions and reserves. This distinction sits underneath the rest of the course — it is why the maturity wall bites hardest on floating paper, why CRE CLOs (all floating, all managed) demand a manager-watch discipline, and why “the loan is current” means one thing on fixed paper and something you have to interrogate on floating paper.

The lab

Suggested exercises

  1. Find the seat. Open the Capital Structure view and take one deal apart layer by layer, as far as the tape reveals it. Pick a value decline — 15%, then 30% — and name exactly which layer absorbs it. Write down who loses sleep at each level, and who genuinely doesn’t.

  2. Fixed or floating — and what to distrust. In the Loan Browser, pull one fixed-rate loan and one floating-rate loan of similar size. For each, write the one question you would most want answered. You should find yourself asking about the building on the first and about the manager’s conduct on the second. If you’re not, go back and re-read why.

  3. Spot a dressing. Floating, actively managed paper is where the dials are, so look at the CRE CLO read and find a loan carried along by the mechanisms that can flatter it — an interest reserve, a rate cap, a recent extension. In three sentences, describe how that loan could be reported current and still be in trouble. You are learning to read the manager, not just the ratio.

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