What valuation reductions mean for future CMBS loan losses
Like delinquency rate For commercial mortgage-backed securities to settle into a new normal after the onset of pandemic chaos, other market metrics provide an indication of further difficulties ahead.
One of those data points is appraisal reduction amounts, which come into play when a CMBS loan encounters a trigger event such as a serious default or insolvency. The calculation of a loan’s ARA is determined not only by the appraised value of a property, but also by factors such as the outstanding loan principal balance and reserve funds.
There were 111 CMBS loans outstanding with ARAs at the end of 2019, but by November 2020 that figure had climbed to 409, according to a new report from the Kroll Bond rating agency.
“Based on the current economic environment, the lagging effect of commercial real estate performance on the economy as a whole, and given that 90% of overdue and specially managed loans have no ‘ARA, we expect the absolute dollar volume of ARAs to continue to increase through 2021. “Kroll analysts wrote.
The largest outstanding valuation reduction is for a Kushner Companies property: a 250,000 square foot commercial condo located at 229 West 43rd Street in Times Square, which has since suffered financial hardship since. before the pandemic and saw his reduced value from $ 470 million to $ 92.5 million in August.
Retailing in general was one of the hardest hit sectors, with 156 loans outstanding with valuation cuts totaling $ 1.7 billion. As shown in the table below, the accommodation industry has a higher number of loans subject to cutbacks, although its total cutback amount is significantly lower.
Valuation reductions can impact CMBS bondholders in several ways, per Kroll. They lead to reductions in the amount of principal and interest payments that agents are required to advance, resulting in lost earnings for holders of subordinate certificates. It can also cause control of the CMBS transaction to move to a higher class.
After New York, Texas is the state with the greatest exposure to loans with appraisal cuts, according to the report. The cuts there are dominated by two office buildings in Houston’s energy corridor, which have suffered from downsizing from the oil industry and new supply in the region. Two Westlake Park saw its estimated value drop from $ 124 million to $ 24 million, while Three Westlake Park fell from $ 121 million to $ 38 million, according to Trepp.
According to Kroll’s analysis, about half of all valuation reductions made over the past two years appear to have been ‘automatic’, meaning that an updated valuation was not received within the timeframe. specified from 30 to 60 days, so that an ARA value equal to one-quarter of the outstanding principal balance of the loan was applied by default.
Historical analysis found that valuation reductions were a good predictor of potential losses. Of 59 loans ceded between 2014 and 2019 that had non-automatic ARAs, 44 resulted in realized losses greater than their original reduction amounts.
Still, “[w]While a historical perspective can give indications, in these uncertain times past results may not predict future losses, ”analysts note.