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CRE Finance World, Autumn 2013

Two transactions come to mind in this regard: The City View Portfolio in Houston, Texas ($72 million – JPMCC 2006-CB16 – 101% loss severity) and the Washington Mutual Buildings just outside of Los Angeles, California ($39 million – GECMC 2005- C1 – 117% loss severity). City View Portfolio Washington Mutual Portfolio In City View, a portfolio of eight Class B multifamily properties totaling 2,700 units, the portfolio performance deteriorated following the economic downturn and then suffered significant damage from Hurricane Ike in 2008. In 2010, the loan went into special servicing due to imminent default and became REO in 2011. Despite being sold for $27 million (nearly 20% above its appraised value), significant unpaid principal and interest, servicer advances, transaction expenses and servicing fees exceeded the sales price and the CMBS trust experienced a 101% loss severity. For the Washington Mutual Portfolio, after Washington Mutual, who occupied 100% of the buildings, was seized by regulators in 2008, the buildings were vacated and the loan was foreclosed upon by the servicer in 2009 and liquidated in 2012. A previous ruling obtained by the special servicer that the sponsor was liable under a recourse guaranty was overturned by the California Court of Appeals and the CMBS trust was required to refund in excess of $50 million to the sponsor resulting in a loss to the CMBS trust of nearly $46 million or 117% severity. Despite valuable assets, the cost of realization exceeded the sales proceeds in the above two examples resulting in losses in excess of the loan amounts contributed to the CMBS trust. Even if a CMBS investor had underwritten 100% losses for these assets, the incremental loss severity (in excess of the loan amount) would contribute to losses above and beyond those underwritten for the CMBS trust. While difficult to imagine, “losing more than your loan,” as demonstrated above, can happen. It is therefore imperative for special servicers to regularly recalculate their advances versus recoverable values to determine if their expenditures can indeed create recoveries. Just as borrowers abandon financially worthless assets, servicers too, from time-to-time, may determine abandonment to be the most responsible course of action. In all cases, all advances should be carefully considered. CRE Finance World Autumn 2013 28 #4 — Beware of Time — Not Always a Friend In a rapidly declining market or asset, time is often a critical element. As noted in the chart below, the amount of time that a loan spends in special servicing, as reported by Fitch, has been alarmingly on the rise and has nearly quadrupled to 24 months since 2009. This trend does not bode well for recoveries for two primary reasons: 1) generally, the better transactions get into and out of special servicing faster (meaning the more challenged assets remain), and 2) loans that are in special servicing for two or more years are generally headed to foreclosure, are often harmed by a lack of aligned and motivated ownership/management, and are also burdened by greater servicing fees and expenses. Table 5 Average Months in Special Servicing (2009–2013) Source: Fitch Ratings Further, given the lengthy lead times required for new appraisals that determine controlling holders who appoint special servicers, assets that are rapidly declining in value are often being directed by a controlling holder who may be out of the money on a “spot” basis. In these instances, the controlling holder’s interests are not necessarily aligned with the CMBS trust and the controlling holder may be more willing to pursue a longer-term strategy in the hopes of generating a recovery; by the time that there has been a shift in controlling holder status to the next senior most class, the damage may have already been done. Generally, we observe that well-leased cash flowing assets will benefit from additional time and that assets with diminishing cash flows, or cash flows that are highly volatile and subject to diminution (such as retail and hospitality), benefit from swift resolutions that “staunch the bleeding.” Notable cash flowing assets that have benefitted bondholders from gaining additional time to stabilize include: Stuyvesant Town (despite the controversy of the strategy at the time), Equity Office Properties, and Hilton Hotels, among others. Losing More than Your Loan


CRE Finance World, Autumn 2013
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