An A/B note structure bifurcates a single commercial real estate mortgage into two tranches (a senior A-note and a subordinate B-note) that share the same collateral but receive different priority in the loan's cash flow and loss waterfall. Unlike a mezzanine loan, which is secured by a pledge of the borrower entity's ownership interests rather than the real property itself, both the A-note and B-note are secured by the same first mortgage lien on the same property.
The bifurcation is a contractual arrangement between note holders governed by an intercreditor agreement; it does not create separate liens but rather allocates the priority of payments and the control of enforcement rights among the two tranches.
The intercreditor agreement between A-note and B-note holders is the governing document that defines each tranche's rights throughout the loan's life and in the event of a default. In a standard A/B structure, the A-note holder receives all scheduled debt service until its balance is paid current before the B-note holder receives anything; this payment waterfall insulates the A-note from the first layer of credit risk.
The intercreditor also defines control rights: who can direct the servicer, who has the right to call for a foreclosure, and critically, who can cure a default and step into the A-note holder's position. B-note holders typically have cure rights (the ability to advance funds to bring a loan current and prevent foreclosure they did not authorize) and purchase rights that allow them to buy out the A-note at par plus accrued interest rather than allow the A-note holder to foreclose and eliminate the B-note.
In CMBS securitizations, A/B note structures frequently arise when a large loan is originated and the A-note is pooled with other loans for securitization while the B-note is retained by the originating lender or sold to a B-piece buyer. The B-piece buyer in a CMBS pool (who purchases the most subordinate securities in the securitization) may separately negotiate to acquire the B-notes on the largest loans in the pool, giving it both bond-level and loan-level exposure that concentrates risk but also provides enhanced control rights and information access.
The pricing differential between A-note and B-note reflects this structural subordination: B-notes price at yields substantially above the A-note, compensating the holder for absorbing the first dollars of credit loss on the underlying collateral.
The A/B note structure is analytically distinct from mezzanine debt even though both create a senior/junior debt capital stack. Mezzanine debt sits outside the mortgage entirely; it is secured by a pledge of the equity ownership interests in the property-owning entity, not by the real property itself, and is governed by a separate intercreditor agreement between the first mortgage lender and the mezzanine lender.
A B-note holder's rights run to the property through the first mortgage lien and the intercreditor with the A-note holder; a mezzanine lender's rights run to the equity in the borrowing entity and are subject to the mezzanine intercreditor. In a foreclosure scenario, these distinctions are critical: a B-note holder can participate in the mortgage foreclosure process through cure and purchase rights; a mezzanine lender must foreclose on the pledge of equity, a separate and faster process under the Uniform Commercial Code in most US states.