Definition
A B-Note is the subordinate portion of a commercial real estate loan that sits behind the senior A-Note in the capital stack. Both notes are secured by the same mortgage, but the B-Note is paid after the A-Note and therefore carries higher risk and usually earns a higher interest rate.
How A-Notes and B-Notes Work
In large commercial loans, lenders often divide a mortgage into multiple pieces. The safest portion becomes the A-Note, while the riskier portion becomes the B-Note.
- A-Note: senior debt with first claim on loan payments.
- B-Note: subordinate position with higher yield but greater risk.
- Same collateral: both are secured by the same underlying property.
- Waterfall payments: A-Note lenders are paid first before B-Note holders.
Why B-Notes Exist
B-Notes allow lenders to split risk across investors. Conservative lenders may hold the A-Note, while higher-yield investors purchase the B-Note portion. This structure helps finance large deals while matching investors with different risk tolerances.
Position in the Capital Stack
The B-Note sits between senior debt and equity in the capital structure. It carries more risk than the A-Note but less risk than mezzanine debt or equity.
- Senior Debt – A-Note
- Subordinate Debt – B-Note
- Mezzanine Debt
- Preferred Equity
- Common Equity
Investor Considerations
- Higher yield: investors receive a higher interest rate to compensate for risk.
- Subordination risk: losses hit the B-Note before the A-Note.
- Control rights: B-Note holders may have limited control compared with senior lenders.
- Default exposure: recovery depends on property value and senior debt balance.
Example
A $50 million commercial mortgage might be split into a $40 million A-Note and a $10 million B-Note. If the property performs well, both lenders receive their payments. If the property defaults and sells for less than the loan balance, the B-Note investors typically absorb losses first after the senior lender is paid.
Common Pitfalls
- Misunderstanding subordination: B-Notes are exposed to loss earlier than senior debt.
- Overestimating control: B-Note holders may have limited influence over loan servicing.
- Market liquidity risk: secondary markets for subordinate loan pieces can be thin.
- Underestimating downside: property value declines can quickly wipe out subordinate positions.