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CRE Finance World, Summer 2014

Hope Notes Hope Notes, or the B-piece of A/B structures created through loan modifications, are also impactful. The Hope Note refers to the B-piece that is split off from the first lien collateral of a CMBS loan as part of a modification implemented by the special servicer during a workout. This B-piece is often reported on the IRP as a new line, and very often the delinquent status and workout strategy of this new B-piece is not provided, or when provided is often not informative or indicative of heightened credit risk (under common practice). The new A-note of the A/B modification often is returned to the master as resolved and not delinquent, even as the B-piece remains outstanding and subject to heightened risk. In terms of loss frequency experienced by the B-notes that have been fully resolved (paid out of the trust), 56% have experienced a loss, with 46% experiencing a significant loss. In terms of loss severity, Hope Notes that took a significant loss (greater than 2%) had a median loss severity of 95% — more often than not Hope Notes were essentially wiped out as part of the ultimate loan resolution. Chart 6 Modified A/B Structures (Source: DBRS CMBS Advisor and CMBS.com) In the history of CMBS, there have been approximately $4.3 billion of Hope Notes that have been cut from first lien loans. Of the Hope Notes that took a significant loss, delinquency reporting has been hopeless. Just 3% reported delinquency that would have been picked up in common practice delinquency metrics, and none reported a workout strategy that would have been picked up (although 30% reported a workout strategy of other TBD). Both in terms of loss frequency and loss severity, the B-piece of A/B structures are a significant concern to market participants and are thus included in a newly proposed delinquency metric (described in the section below). Conclusions and Ramifications From the above information, DBRS found that it would be more appropriate to include note sale, DPO, deed in lieu of foreclosure CRE Finance World Summer 2014 46 and the B-piece of A/B modifications in the delinquent statistic8, in addition to REO and foreclosure – DBRS defines this as DQ I. In addition, a separate, more prudent computation would add the other or TBD workout strategy – DBRS defines this as DQ II. Chart 7 Historical Final Workout Strategy (Source: DBRS CMBS Advisor and CMBS.com) Historically, these additional workout strategies accounted for 42% of all workout strategy assignments. Many of these loans would already be included in commonly cited delinquency numbers because of their payment status. But historically, many have been excluded – a phenomenon that coincides with upticks in the number of loans that are transferred into special servicing at any given time. The historical delinquency rates can be seen in the charts below as defined by the three definitions presented. Chart 8 Historical Delinquencies Statistics (Source: DBRS CMBS Advisor and CMBS.com) Delinquency Reporting in CMBS


CRE Finance World, Summer 2014
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