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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: <strong>CRE</strong> Finance World Winter 2017 34
A Different Kind of Credit Ratings Agency Corporate Commercial mortgagebacked securities, CMBS Re-REMIC and <strong>CRE</strong> CLO’s Residential mortgagebacked securities and RMBS Re-REMIC Asset-backed securities of all asset types Single-family rental securities; singleborrower and multiborrower Financial Institutions Morningstar Credit Ratings is redefining the credit industry’s expectation of what a ratings agency should be. Our insightful analysis provides informative opinions and greater transparency of the analytical process. Our focus on client service provides investors and issuers with a responsive alternative in the credit ratings and analysis business. We provide the information investors want to know. Investors can use our analysis to help make better-informed decisions because our analysts deliver a distinct Morningstar opinion on credit risk. And we’re transparent about our evaluation process, providing key details on how we reach our analytical conclusions. Experience analyzing new and complex asset types. We were the first agency to publish a single-family rental methodology. Our experienced CMBS, RMBS, and operational risk teams joined forces to develop a methodology that worked for the market. To monitor risk after the initial rating, we produce timely and insightful performance reviews and ratings surveillance on Morningstar-rated debt offerings. We strive to maintain an active dialogue with market participants Whether it’s a discussion about a new or complex transaction type, our analytical approach, or a question about our opinion on a particular issue, we welcome the conversation. You can always count on Morningstar to respond to your questions and deliver a meaningful perspective on credit risk. Visit global.morningstar.com/different5 to learn more or call +1 888 736-1924. ©2016 Morningstar. All Rights Reserved. Morningstar’s NRSRO ratings, outlooks, and analysis are provided by Morningstar Credit Ratings, LLC. Morningstar Credit Ratings, LLC is a wholly owned subsidiary of Morningstar, Inc., and is registered with the U.S. Securities and Exchange Commission as a nationally recognized statistical rating organization (NRSRO). 7.5 x 9.875
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