Equal-priority notes share interest, principal and losses by balance, but only one trust controls the workout.
A pari passu loan is one mortgage loan split into several A notes of equal priority, each sold into a different CMBS trust, which share interest, principal and losses in proportion to their balances. An illustrative $180.0 million office loan split into notes of $70.0, $60.0 and $50.0 million pays each trust 38.9, 33.3 and 27.8 per cent of every dollar. Liquidated for $140.0 million, it produces a $52.2 million loss, a 29.0 per cent severity, which lands as $20.3, $17.4 and $14.5 million in three different deals.
Worked in full in CMBS and CRE CLOs by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Large loans are too big for one conduit pool. Rather than tranche them into senior and junior notes, the originator slices them vertically into pari passu notes of equal priority and places each note in a different securitisation, often months apart. Investors in each deal own a slice of the same property, but only one trust's servicer and controlling holder runs the loan. Knowing how the split works answers two questions: how much of a given deal is really exposed to that property, and who decides what happens when it defaults.
| Note | Held by | Balance | Share | Trust pool | % of pool | First-loss class |
|---|---|---|---|---|---|---|
| A-1 (controlling) | Trust 1 | 70.0 | 38.9% | 1,000 | 7.0% | 30.0 |
| A-2 | Trust 2 | 60.0 | 33.3% | 850 | 7.1% | 25.5 |
| A-3 | Trust 3 | 50.0 | 27.8% | 900 | 5.6% | 27.0 |
| Whole loan | 180.0 | 100% |
The coupon is 6.25 per cent. Each trust's first-loss class is 3 per cent of its pool. The co-lender agreement names A-1 as the controlling note, so the loan is serviced under Trust 1's pooling and servicing agreement and Trust 1's controlling class directs the special servicer for the whole loan.
Share of note i = note balance ÷ whole loan balance
A-1 = 70.0 ÷ 180.0 = 38.9%; A-2 = 60.0 ÷ 180.0 = 33.3%; A-3 = 50.0 ÷ 180.0 = 27.8%
Whole-loan interest = 180.0 × 6.25% = 11.250 a year
A-1 receives 4.375, A-2 3.750 and A-3 3.125, each before its own trust's servicing fees.
Amount owed = principal 180.0 + unreimbursed advances and unpaid interest 7.2 = 187.2
Net proceeds = sale 140.0 − liquidation fee 1.4 (1 per cent) − costs 3.6 = 135.0
Loss = 187.2 − 135.0 = 52.2; severity = 52.2 ÷ 180.0 = 29.0%
Loss to note i = 52.2 × share: A-1 = 20.3, A-2 = 17.4, A-3 = 14.5
Excel: =Loss*NoteBalance/SUM(NoteBalances)
The advances line is simplified here. Each trust's master servicer advances interest on its own note and is repaid from that note's share of proceeds, while property protection advances are typically made under the lead trust's agreement and repaid from the whole loan before anything is distributed. With equal priority and equal coupons, the pro rata outcome is the same: A-3's share of the 7.2 is 2.0.
| Trust | Loss | % of pool | First-loss class written down | First-loss class remaining |
|---|---|---|---|---|
| Trust 1 | 20.3 | 2.03% | 68% | 9.7 |
| Trust 2 | 17.4 | 2.05% | 68% | 8.1 |
| Trust 3 | 14.5 | 1.61% | 54% | 12.5 |
Losses are allocated within each trust reverse-sequentially, so each deal's first-loss class absorbs its share. Had the whole $180.0 million loan sat in Trust 1 alone, it would have been 18.0 per cent of that pool, and a $52.2 million loss, 5.22 per cent of the pool, would have exhausted the $30.0 million first-loss class and taken $22.2 million from the classes above it. That is the reason for the split: it spreads one large exposure thinly across several pools. It is also why concentration measures such as the Herfindahl score of a CMBS pool must be computed on each trust's note balance, not the whole loan.
Control does not follow the money. Trust 1 holds 38.9 per cent of the loan but its controlling class directs the workout for 100 per cent of it. Trusts 2 and 3 bear 61.1 per cent of the loss with, typically, consultation rights only. A non-controlling note holder is betting on another deal's B-piece buyer.
| Sale price | Net proceeds | Loss | Severity | A-1 | A-2 | A-3 |
|---|---|---|---|---|---|---|
| 170 | 164.7 | 22.5 | 12.5% | 8.7 | 7.5 | 6.2 |
| 155 | 149.8 | 37.3 | 20.7% | 14.5 | 12.4 | 10.4 |
| 140 | 135.0 | 52.2 | 29.0% | 20.3 | 17.4 | 14.5 |
| 125 | 120.2 | 67.0 | 37.2% | 26.1 | 22.3 | 18.6 |
| 110 | 105.3 | 81.9 | 45.5% | 31.8 | 27.3 | 22.7 |
At a $110 million sale, A-1's $31.8 million and A-2's $27.3 million losses each exceed their trusts' first-loss classes by $1.8 million, and the next class up takes a loss, while Trust 3's $22.7 million still sits $4.3 million inside its own. The same property can be a rated-bond loss in two deals and a first-loss event in the third, purely because of pool size and subordination.
Every pari passu note takes its balance share of interest, principal and loss: 38.9, 33.3 and 27.8 per cent here, turning a $52.2 million loss into $20.3, $17.4 and $14.5 million across three deals. The split dilutes the exposure in each pool but concentrates control in one. The book's deal model, with its reverse-sequential loss allocation and appraisal reductions, is in the free CMBS and CRE CLOs workbooks.
One of several notes of equal priority carved from a single mortgage loan and placed in different securitisations. Each note receives its balance share of every payment and loss. In the illustrative case, a $50.0m A-3 note is 27.8 per cent of a $180.0m loan, so it takes $3.125m of the $11.250m annual interest and 27.8 per cent of any loss.
The holder of the controlling note, named in the co-lender agreement, usually acting through the controlling class of the trust that holds it. Here Trust 1 holds 38.9 per cent of the loan through note A-1 and directs the workout for all of it, while Trusts 2 and 3, bearing 61.1 per cent of any loss, typically have consultation rights only.
To fit large loans into pools of normal size and spread the exposure. The illustrative $180.0m loan would be 18.0 per cent of a $1,000m pool; split into three notes it is 5.6 to 7.1 per cent of each. A $52.2m loss in one pool would exceed a $30.0m first-loss class by $22.2m; split, no trust's first-loss class is exhausted.
This article is one calculation from CMBS and CRE CLOs. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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