What to Make of Single Asset CMBS Credit Ratings amid Defaults
In the case of 1740 Broadway, the loan was backed by a single asset (the building). The loan was set to mature in 2025 (the loan was called BWAY 2015-1740 Mortgage Trust) and was a $308 million, fixed rate, interest only mortgage loan.
Very significant is the fact that there was no cash trap in the CMBS loan, allowing cash to go to the loan’s sponsor, Blackstone, once the L Brand lease expired.But let’s back up a bit and review a timeline of significant events:
Early 2021 – L Brands announces departure
L Brands, the building’s largest tenant, accounting for about 71% of the total rentable square footage, announced it would not renew its lease at the building, which was set to expire in March 2022.
April 2022 – Loan sent to Green Loan Services
An affiliate of Blackstone sent the loan to a special servicer called Green Loan Services, after the building’s owner defaulted on the loan. Special servicers like Green Loan receive compensation when the loan is in default, and if/when the loan is made current, they stop receiving fees.
End of 2022 – Absence of an Updated Appraisal
Since the initial default, no appraisal was required of the initial special servicer, Green Loan Services, until after a forbearance period granted by the special servicer expired at the end of 2022.
March 2023 – Loan transferred
The loan is transferred to a new special servicer, Midland Loan Services.
July 2023 – First appraisal since default
In July of 2023 the first appraisal since default was completed, with the appraised value declining to $175 million after being initially set at $605 million at the loan’s issuance. This is more than 15 months after the default.
August 2023 – Ratings lowered
It is not until August of 2023, more than 16 months after the default, that the ratings agencies lowered ratings on classes of bond holders. Keep in mind that credit ratings agencies for structured products like CMBS are retained by the loan’s sponsor and compensated for providing ratings on that debt.
Spring 2024 – Building sold
In Spring of 2024, 1740 Broadway was sold, and the AAA bondholders received 74 cents on the dollar, while lower tranches received nothing.
For 1740 Broadway, the ratings agencies appear to have been waiting for the updated appraisal, among other details, to adjust their ratings on the different classes of bond holders. This is even despite the loss of a material tenant and a pandemic-induced structural shift in office demand.
Ratings agencies also look to comparable assets to assess the risk of loss of principal to the bond holders when performing a liquidation analysis, which includes a dark value (the value of an empty building), and the land value.
In the end, the ratings agencies appear to have been assuming a higher appraised value than what came through when assessing comparable transactions and liquidation analysis.
In conclusions, there were four sequential issues resulting in the 26% haircut on the building:
- The lack of a cash trap in the CMBS loan.
- The long period the loan was serviced by two different special servicers.
- The slow pace of an updated appraisal on the asset.
- The lag in the credit ratings agencies downgrade.