A liquidated conduit loan produces two severity numbers. Marlowe Tower carried a balance of $61.0 million and its property sold for $45.2 million, an appraisal severity of 25.90 per cent. What the trust actually wrote off was 37.24 per cent. The gap of 11.34 percentage points is the liquidation fee, the special servicing fee, legal and property protection expenses, and — three quarters of it — the repayment of interest the master servicer had already advanced to the certificate holders.
The queue in front of the certificates
Marlowe Tower is an office loan of $61.0 million in a fixed-rate conduit. It defaults, spends 22 months in special servicing, and the property is sold for $45.2 million. The shortfall is $15.8 million, or 25.90 per cent of the balance. That is the appraisal severity, and it is the number most published loss studies report.
The sale proceeds do not reach the certificate holders. They pass through a queue of claims that rank ahead of every class, and what emerges at the far end is what the trust actually collects.
The liquidation of Marlowe Tower. Appraisal severity 25.90 per cent; realised severity 37.24 per cent.
Item
$m
Per cent of loan
Sale proceeds
45.20
74.10
Less liquidation fee, 1 per cent of proceeds
−0.45
−0.74
Less special servicing fee, 25 basis points over 22 months
−0.28
−0.46
Less legal and property protection expenses
−0.95
−1.55
Less repayment of servicer advances
−5.24
−8.59
Net proceeds to the trust
38.28
62.76
Realised loss
22.72
37.24
Three quarters of the gap is advanced interest
The two severities differ by 11.34 percentage points of the loan balance, and the gap splits unevenly. Fees and expenses account for 2.75 percentage points. The repayment of advanced interest accounts for 8.59 percentage points, which is three quarters of the whole.
That money has already been spent, and on whom is the point. When the borrower stopped paying, the master servicer advanced the missing interest out of its own funds so that the certificate holders were paid on schedule. Those payments went down the waterfall in seniority order, which means overwhelmingly to the senior classes, since they hold 70.0 per cent of the deal. The advance is then recovered off the top of the sale proceeds, ahead of everybody. That reduces what reaches the trust, which raises the realised loss, which is written against the bottom of the capital structure.
The junior classes fund the timely payment of the senior classes, and the transfer is invisible unless this bridge is built. No line in a trustee report is labelled with it.
One qualification, stated plainly. A balance-sheet lender holding the same asset for 22 months without collecting a coupon would also have lost the carry, so its economic loss is not 25.90 per cent either. What the trust does differently is capitalise that carry into a principal write-down and hand it to a different party from the one that received the payments. Part of the 11.34 percentage points is carrying cost any lender would bear, and which the appraisal measure simply ignores.
Duration is severity
Every additional month in special servicing adds one month of advanced interest and one month of special servicing fee to the queue. On this loan that is $219,386 plus $12,708, or $232,095 a month of extra realised loss. Severity is not a property statistic. It is a property statistic and a stopwatch.
Two consequences follow. Published severity averages are not comparable across deals unless the advancing conventions and the workout durations are comparable, which they are not. And the appraisal reduction, which caps further advancing once a new appraisal comes in below the balance, cuts realised severity rather than raising it: with the reduction in place the advance repaid is $5.24 million, without it $7.10 million, and severity is 37.24 per cent against 40.29 per cent. That is 3.05 percentage points handed back to the class that will absorb the write-down, by the same mechanism that stops its coupon.
The same gap on every loan that fails
Three loans are liquidated in the worked transaction. Realised severity exceeds appraisal severity on all three, by between 9.0 and 11.3 percentage points.
Three liquidations in one conduit pool, each run through the same bridge.
Loan
Balance ($m)
Proceeds ($m)
Appraisal sev.
Realised sev.
Loss ($m)
Marlowe Tower
61.0
45.2
25.9 per cent
37.2 per cent
22.72
Oakfield Corporate Center
28.0
17.6
37.2 per cent
46.3 per cent
12.96
Beaumont Plaza
31.9
25.7
19.3 per cent
28.3 per cent
9.03
Total
120.9
88.5
—
—
44.71
Total realised loss is $44.71 million, or 4.47 per cent of the original pool. Class H, which has no credit support by construction, lost 100.0 per cent of its $37.5 million. Class G, with 3.75 per cent of credit support, absorbed the excess: $7.21 million of a $15.0 million class, or 48.0 per cent of it. Class F, with 5.25 per cent of support against 4.47 per cent of losses, was untouched. Had the pool been underwritten on appraisal severity, class G would have been expected to survive.
What to do with it
Underwrite severity through the bridge, not off the appraisal. Take the sale assumption, then subtract the liquidation fee, the special servicing fee for the months assumed, expenses, and the advances that will have accrued by the resolution date.
Read the transfer date as a price. A loan that has sat in special servicing for two years at a 6.35 per cent coupon has accumulated a loss that has already happened and has not yet been written.
Treat an appraisal reduction as two events. It costs the junior class its coupon immediately, and it hands that class 3.05 percentage points of severity back at the end.
The severity figure quoted on a call is a residual, not a measurement. The bridge that produces it is five lines long, and every one of those lines ranks ahead of the certificates.
The workbooks behind this article
Every figure above is a live formula in the free companion files for
CMBS and CRE CLOs. Each workbook ends with a Checks sheet
setting the printed figure beside the computed one. No account and no email address.
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