Fitch Warns About Participated Loan Structures

Recent CMBS ratings news

December 1, 2003

By PATRICK CROWLEY

Fitch Ratings is reporting that agreements requiring multiple parties in servicing and workout decisions are becoming so complex they could frustrate borrowers, delay necessary action to preserve collateral, increase trust expenses and result in additional and unnecessary losses. Simple structures that limit involvement to one master and special servicer, without “interference” from third parties, are preferred, Fitch said in a statement.

“Fitch is concerned that recent participated loan structures are inefficient and the lack of uniform intercreditor provisions and servicing procedures are causing confusion in the market,” Fitch Senior Director Daniel Chambers said in the statement. “Fitch is concerned that history will repeat itself, and the lessons we learned with syndicated loans from the early 90’s will be forgotten. Excessive coordination required among servicers and multiple subordinate investors will slow servicer responsiveness, and delays will inevitably lead to greater loan losses.”

A new report from Moody’s Investors Service indicates that small increases leverage at certain levels on commercial mortgage-backed securities (CMBS) can result in a big delinquency increase.

When the debt service coverage ratio (DSCR) of the buildings being mortgage dips below 1.20 times (x), the delinquency rate doubles from 1% to 2%, Moody’s found. A second trigger kicks in when the DSCR falls below 1.10x. Then, the delinquency rate more than triples from 2% to more than 7%. So as leverage increases delinquency increases disproportionately much faster, leading to credit quality deteriorating at an accelerating rate.

“This risk profile means that the margin of error dissipates quickly with an increase in leverage, and that credit risk is not a linear phenomenon,” report author Sally Gordon of Moody’s said in a statement. The study also discovered that delinquency by loan size follows a classic bell-shaped curve, with midsize loans between $3 million and $10 million having higher delinquency rates than either smaller or larger loans.

Moody’s is also reporting that substitution and release provisions within single-borrower loans for CMBS are popular with borrowers and can be structured as sound credits. The typical borrower is secured by multiple properties that are cross-collateralized.

“The borrowers are most commonly REITs or pension fund advisors that value flexible loan arrangements along with the attractive cost of funds available through a CMBS securitization,” Brian Furlong, who wrote the report for Moody’s, said in a statement. He added that substitution and release rights provide such borrowers with operational flexibility, such as the capacity to sell, purchase, renovate or recapitalize their assets.

Meanwhile, Fitch has affirmed GEMSA Loan Services’ primary servicer rating of CPS1 and its master service rating of CMS1-. The primary servicer rating is based on GEMSA’s continued strong ability to effectively service mortgage loans in CMBS transactions. The master servicer rating considers GEMSA’s demonstrated ability to oversee third party servicers and to accurately report and remit to CMBS trustees. As of Sept. 30 GEMSA’s servicing portfolio comprised 7,771 loans totaling $59.31 billion, including $19.9 billion in CMBS, and the company was named master servicer on 24 CMBS transactions totaling $17.7 billion while overseeing 19 third party primary servicers.

On the ratings front Moody’s has placed four classes of the $69.2 million GMAC Commercial Mortgage Securities Inc. mortgage pass through certificates series 2000-FL1 on review for possible downgrade. Class C (rated ‘A2’), Class D (‘Baa2’), Class E (‘Baa3) and Class F (‘Ba2’) are under scrutiny because of a loan representing 41.6% of the pool’s outstanding balance. The loan is secured by a 775,000-square-foot Class A office complex in the Denver suburbs that is the headquarters of Level 3 Communications. Moody’s said in a statement it is concerned about the decline in the credit profile of Level 3 Communications as well as the “significant deterioration in the Denver office market.”

Moody’s upgraded the $36 million Class D of Four Times Square commercial mortgage pass-through certificates series 2000-4TS from ‘Ba1’ to ‘Baa2’ because the outlook for the certificates future performance is in line with Moody’s initial expectations.

Fitch also took some action on ratings, upgrading Southern Pacific Thrift and Loan Association’s commercial pass-through certificates series 1996-C1. The $2.9 million Class E was upgraded from ‘A’ to ‘AAA’ and the Class F, $11.1 million, was bumped to ‘AAA’ from ‘BB+’. The action was attributed to increased subordination levels resulting from the paydown of the pool’s certificate balance.

And Fitch affirmed the following classes of Chase Commercial Mortgage Securities Corp.’s $607.5 million commercial mortgage pass-through certificates Series 2001: Class A-1, ‘AAA’; Class A-2, ‘AAA’; Class X (interest only), ‘AAA’; Class B, ‘AA’; Class C, ‘A’; Class D ‘A-‘; Class E, ‘BBB’; and Class F “BBB-‘. The affirmations reflect the minimal collateral paydown since issuance. The year-end 2003 weighted average DSCR is 1.38 x, compared to 1.38x at year-end 2001 and 1.29x at issuance.

Patrick Crowley is a political reporter and columnist and former business writer for The Cincinnati Enquirer. Email Patrick at: pcrowley@enquirer.com