CRE FinanCE W Rld

Lurking Behind the CMBS
Maturity Wall in 2017,
Interest Shortfalls
Eric Thompson
Senior Managing Director
Kroll Bond Rating Agency
Larry Kay
Director
Kroll Bond Rating Agency
A
s we approach 2017, the long-awaited final chapter
of the CMBS Wall of Maturities trilogy is upon us. The
maturing loans that come due next year currently total
approximately $102 billion and were largely originated
at the height of the last market peak, between 2005
and 2007. While the sheer volume of these loans has been well
publicized, there has been less focus on the amount of workout
fees that will be associated with the large volume of corrected
mortgage loans (mostly 2007 originations) that come due in 2017.
To the extent market constituents aren’t already doing so, CMBS
investors should brace themselves for the consequences of these
fees, which generally cause certificate interest shortfalls.
The 2007 originations were made during the best of times, including
peak real estate prices and abundant liquidity. With credit widely
available, aggressive underwriting also prevailed during this period,
raising the question ‘were the worst loans made during the best
of times?’ Based upon the amount of loans that were corrected,
the answer to this question in many cases is ‘yes’. Based on
information from our KBRA Credit Profile Portal (KCP) and Trepp,
LLC, there are currently $8.62 billion of corrected loans (351
loans) maturing next year, which currently serve as collateral in 83
securitizations. We’ve included the top fifty corrected 2017 mortgage
loan maturities by current principal balance in the appendix. These
loans ($5.75 billion) account for approximately two-thirds of the
corrected 2017 maturities total principal balance.
Typically, the special servicer receives a workout fee for a corrected
loan equal to 1.0% of each payment of interest and principal
(including the balloon balance) for as long as the loan remains
a corrected loan. If a 1.0% fee (most common percentage) on
the balloon balance of all 2017 corrected loan maturities were
assumed, the aggregate interest shortfall amount across all of
the related trusts is sizeable, at $86.2 million.
Correcting a Non-Performing Loan
Underperforming loans are generally transferred to the special
servicer due to a 60-day delinquency, a maturity default, as well as
an imminent or material non-monetary default, or bankruptcy event.
Once a loan is transferred to special servicing, the special servicer
may be entitled to receive various fees including a workout fee
or a liquidation fee. Generally, a specially serviced mortgage loan
achieves “corrected” status if and when the circumstances that
caused such loan to be transferred to special servicing have been
cured or otherwise addressed. For example, a specially serviced loan
would typically be considered corrected in the following cases:
if the borrower makes three consecutive debt service payments
after a payment default; if the circumstances cease to exist in the
servicer’s judgment with respect to an imminent default; or there is
a cure of the related material non-monetary default, or bankruptcy
event. Once a loan is corrected, it will be transferred back to the
master servicer; however, if the loan is subsequently transferred back
to special servicing, the special servicer will no longer be entitled
to a workout fee. Instead, if the loan is liquidated, the special servicer
will be eligible for a liquidation fee.
In CMBS 1.0 conduit transactions, liquidation and workout fees were
generally equal to 1% of the disposition proceeds or subsequent
collections of principal and interest, respectively. In CMBS 2.0
and 3.0 conduit transactions, liquidation and workout fees are
typically equal to the lesser of $1.0 million and 1% of the disposition
proceeds or subsequent payments of principal and interest,
respectively. The special servicer can receive either a liquidation
fee or workout fee, but not both. The fees are supposed to help
incentivize the special servicer to successfully workout, or liquidate
a defaulted loan.
Corrected Mortgage Loans Can Generate Significant
Interest Shortfalls
Interest collected on the underlying loans is typically passed through
to certificateholders after certain amounts are netted out at the
top of the waterfall, including fees payable to the master and
special servicer. The remaining interest is then typically distributed
to the certificateholders on a sequential basis, from the senior (pari
passu among the most senior classes, if applicable) to subordinate
classes. It is possible that, once servicing fees are netted out,
there may not be sufficient interest available to make scheduled
distributions on a class or classes of certificates. This will result
in interest shortfalls on these classes.
A workout fee can be significant in any one transaction and,
depending on the size of the fee relative to the outstanding
transaction balance, could potentially generate interest shortfalls
throughout the capital stack, including senior classes that are or
were originally rated investment grade. One example is in the Bank
of America Commercial Mortgage Inc. (BACM) Series 2007-2
transaction. In this transaction, there are eight corrected mortgage
loans with an aggregate outstanding principal balance of $309.4
million. Of these loans, the second largest is the Beacon Seattle
& Washington D.C. Portfolio ($128.6 million) loan which matures
in May 2017. With a 1.0% workout fee, interest shortfalls on the
Beacon loan’s current outstanding balloon balance would be $1.29
million and would cause shortfalls in the capital stack up to the AJ
class. Based on our understanding of the modification terms, the
borrower is not responsible for reimbursing the trust for these fees;
and as a result, the fees will be additional trust fund expenses. The
Beacon Seattle loan is part of a whole loan combination with a
current outstanding balance of $920.5 million that was split
into seven pari passu notes. The six other pari passu notes with their
respective current outstanding principal balances are as follows:
CRE Finance World Winter 2017
34