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CRE Finance World, Summer 2014

Delinquency Reporting in CMBS A publication of Summer issue 2014 sponsored by CRE Finance World Summer 2014 43 ommonly cited delinquency statistics used broadly by market participants in CMBS tend to exclude a number of loans that have a high propensity for loss — at times even higher than those loans which are included. Specifically, loans that are not late on their payments but are specially serviced and experiencing a workout strategy associated with elevated risk of loss, other than REO/foreclosure, are excluded from commonly cited delinquency statistics. The exclusion may have come as a consequence of past investor reporting package (IRP) changes, rather than being based on an assessment of the credit risk associated with these loans. This becomes evident as DBRS considers monthly occurrences of high risk loans not being flagged as delinquent. For example: • Loans that are awaiting a discounted pay out (DPO) with high economic vacancy or otherwise distressed performance, but remain less than 30 days late on their payments. • Loans where foreclosure/receivership has been initiated but the workout strategy is dual tracked and reported as DPO as the special servicer is allowing the borrower time to sell the distressed property. • Loans where an A/B structure has been created in a modification; the A-note has been resolved and returned to the master as a performing loan, but the B-note has a high propensity for loss and is not reporting a delinquency status or workout strategy in the IRP. • Transactions that have numerous loans designated as “other or TBD” as the special servicer’s workout strategy that are facing imminent default. Many times these loans, while not yet late on their payments, have a rational expectation of large problems in the future. This commentary measures the historical frequency of default and loss severity of CMBS loans that experience different depths of delinquency and different workout strategies. It also looks at the migration of loans from otherwise benign delinquency and/ or workout strategies. The commentary calls into question broadly quoted and disseminated delinquency statistics in the sector, which many times will not reflect the actual risk observable in the underlying loans. Specifically, DBRS notes that there is little reason to not include DPO, note sale and even “other or TBD” into CMBS delinquency statistics given the prevalence of loss experienced by loans under these workout strategies. Additionally, DBRS observes that modified A/B structures tend to escape commonly cited delinquency metrics as the A-piece returns to performing while the B-piece does not typically report delinquency. The commentary considers the ramifications of delinquency reporting for the CMBS fixed-rate conduit universe as well as individual transactions if such loans were included in delinquency statistics. This proposed change in delinquency reporting tends to identify loans that get transferred to the special servicer for reasons of imminent default as oppose to pure delinquency — catching them earlier. In addition, the reporting includes loans that cure their defaults during the loan workout as part of the ultimate resolution, but still experience a loss through DPO or note sale. The change in reporting creates an important change to the overall cited delinquency of the CMBS universe, and can have an outsized impact on the cited delinquency at the transaction level. The change would thus be very important for those participants who do not have time to assess specially serviced loans individually but rely on commonly cited delinquency. Background The CREFC IRP assigns each active loan a status, which is used to inform market participants of delinquency1. In most cases, when a loan becomes more than 30 days delinquent on its loan payments, it is transferred to the special servicer and a workout strategy is then assigned2, a loan can otherwise be transferred without delinquency due to assessed imminent default. The workout strategies are meant to indicate the preferred path of the special servicer in their attempt to maximize recoveries to the trust from the distressed loan. In practice, workout strategies are often dual tracked (e.g., special servicers will pursue foreclosure at the same time as they negotiate an expedited resolution with the borrower). Within the data, the special servicers are often seen to flip back and forth from one strategy to another, and there is also a prevalent use of ambiguous strategies such as other or TBD. In DBRS’s data set of fixed-rated conduit CMBS loans, there are approximately 43,741 loans outstanding. Of these loans, 3,776 (8.6% by loan count) are currently at the special servicer with an assigned workout strategy. Common Practice The CMBS delinquency rate has historically been very similar across publishing sources, with only minimal deviations in the method of computation. Common practices among major publishing sources include: C Erin Stafford Managing Director Global CMBS DBRS Tom Yang Senior Financial Analyst, U.S. CMBS DBRS David Nabwangu Senior Vice President U.S. CMBS DBRS


CRE Finance World, Summer 2014
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