CHICAGO & NEW YORK--(BUSINESS WIRE)--The recovery in many subsectors of the US CMBS market will bolster some efforts to modify legacy commercial loans, but Fitch Ratings continues to expect no recoveries from "hope notes" as their structures do not provide sufficient incentive for their borrowers to repay.
Hope notes divide one loan into an A note, which pays interest, and a B note, which generally accrues interest until a capital event occurs. Typically, a servicer will require a borrower to contribute additional equity to a transaction before consenting to a modification. This additional equity generally receives a preferred return prior to the B note receiving principal.
Some hope notes have not been disposed yet. The usage of hope notes peaked in 2011, when $3.5 billion were modified, followed by $2.7 billion in both 2012 and 2013 before volume fell dramatically in 2014. Fitch thinks that dispositions of hope notes take approximately 3.5 years on average from the time the loan transfers to special servicing to the ultimate disposition date.
The $300 million Bush Terminal loan is one recent example; it paid off in December, resulting in a full recovery to the A note, while the B note sustained an approximate 99% loss. Fitch anticipated this outcome in our review of GCCFC 2007-GG11 in November 2015.
At issuance, the loan split into two pari passu pieces, with $250 million securitized in GCCFC 2007-GG11 and $50 million included in CGCMT 2008-C7. The loan comprised 13.5% of the GG11 transaction and was secured by a portfolio of 16 buildings totalling six million square feet of industrial/flex/office space located in Brooklyn, NY. Tenants included manufacturing, data centers, warehouses and others; in 2014, the Brooklyn Nets NBA team announced their intention to move their training facilities to the site.
At origination, the loan was underwritten by the lender on a pro forma basis as the property was slated for redevelopment. Occupancy at the property had been gradually declining and was approximately 62% as of June 2015, compared with 87.2% at issuance, partly reflecting the space being kept vacant for redevelopment.
The loan transferred to the special servicer in January 2011 due to payment default. It was modified in April 2012 and split into an A note of $190 million and a B note of $110 million. The collateral sustained significant damage from Superstorm Sandy and was transferred back to the special servicer, where it was again modified and returned to the master servicer. In 2013, a new equity partner began executing on the conversion plans. The loan was eventually refinanced by Bank of China and SL Green in December 2015.
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The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.