Appraisal reductions on properties included in commercial mortgage-backed securities deals are increasing in frequency and severity. There are now $14.8 billion of properties backing CMBS loans that have seen appraisal reductions, a steep rise from a year ago when the number stood at $2.4 billion. At the same time, CMBS delinquencies are expected to top 5% by year-end as property values and cash flow drops.
The range of appraisal reductions on CMBS properties this year has varied greatly, according to data from Trepp. The $81 million West Oaks Mall loan is notable for a $57 million reduction in the appraised value of the property, which occurred after tenants Linen 'N Things and Steve and Barry's University Sportswear filed for bankruptcy. But the $90 million Westin Aruba Resorts & Spa loan saw an appraisal reduction of just $1.6 million on the underlying hotel.
When a loan is transferred to special servicing, a new property appraisal needs to be completed within 120 days. If the loan amount is more than 90% of the new appraised value of the property, the special servicer will reduce the amount of interest and principal payments advanced to bondholders. This leads to interest shortfalls among the bondholders and has lead some AAA-rated bonds to trade more like
interest-only bonds, with investors assuming that they won't get a return on their principal, one analyst said. "Many are trying to estimate how long they will continue to see interest payments before they are shut off," the analyst added.
The most severe drop seen so far was an appraisal reduction of almost 90% on the properties underlying a $135.6 million delinquent loan that was part of Wachovia Bank Commercial Mortgage Trust 2005-C20. The properties, malls in Macon, Ga., and Burlington, N.C., have seen occupancy levels plummet as a result of tenants moving to newer malls in the area, according to data from Fitch Ratings.
Wachovia is predicting a peak-to-trough value decline of 47% for the office sector, with a 46% decline for the retail sector, said Marielle Jan de Beur, senior analyst. Expectations are that values won't level off until 2011. Larry Kay, a director at Standard & Poor's, said that geographically, California seems to be feeling the brunt of the impact due to high unemployment levels. Delinquency rates on properties in the state shot up from .28% at the end of 2008 to 2.30% in June. "We could see more appraisal reductions occur in this state, reflecting the increase in delinquencies," he added.