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CRE Finance World, Summer 2013

Whether the strategy of extending these loans instead of liquidating them proves fruitful, or hurtful, will largely depend upon what happens with the economy between now and 2017, in the meantime. In addition, interest shortfalls and accrued interest are almost likely certain to occur in the event of an A/B Note modification: Of all modifications that involve a B-Note, the B-Note interest rate is less than the original interest rate 64% of the time. This in itself creates an interest shortfall. When there is no complementary A-Note reduction (perhaps signaling an ability of the borrower to better meet their current debt service obligation), then the B-Note interest rate is less than the A-Note interest roughly half of the time, the rest of the time the B-Note interest rate is equal to, or many times greater than the A-Note rate. In those instances where the A-Note interest rate is modified (signaling a lack of ability for the borrower to meet its current debt service obligation), the B Note rate is almost always (88% of the time), less than the original A Note. A combination of the A and B Note portion of the structure performing with reduced interest rates creates even greater interest shortfall prevalence. Chart 16 A/B Note Structures and Interest Rate Modifications Property Cash Flow Another key driver of liquidation price declines is the decline in the property’s latest reported net cash flow before the transfer to the special servicer. As seen in the graph below, which charts liquidation price changes against reported net cash flow change over the life of a loan, this relationship is evident despite the fact that the special servicers rarely report any updated cash flow in the CREFC IRP throughout the liquidation phase (the graph below was produced with the latest reported cash flows prior to the transfer to special servicing). The importance of this relationship is a forceful argument CRE Finance World Summer 2013 64 for the industry to establish greater transparency of property cash flows for loans that are in special servicing; many times all reported cash flows on a loan are cleared from the IRP loan periodic once a loan transfers to special servicing. Chart 17 Value Decline and NCF Change Chart 18 Net Cash Flow Change It comes as no surprise to see that the hardest hit property types in terms of value declines were also those with cash flows that were particularly sensitive to years of CRE cash flow distress.7 Hotels experienced a wide fluctuation in net cash flow during the Great Recession and the weaker retail centers were also hit hard as a direct result of a pullback in consumer spending. At the other end of the spectrum, the decline in home ownership rates of the U.S. economy greatly benefited multifamily rental properties. The direction and extent of cash flow swings during the years of distress in our dataset translated into liquidation price changes as measured against the original appraised value of the properties; the properties that had highly volatile cash flows also experienced more volatile liquidation prices. Anatomy of a Loss


CRE Finance World, Summer 2013
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