An eminent domain action this year that a recent Barclays Capital report indicated might hurt certain investors in one CMBS deal was a one-off event that could have been worse. But it is nevertheless is worth noting as it serves as a reminder that this known but rare risk can crop up occasionally.
“I think the most interesting part here is actually the fact that it’s very difficult to identify those cases before they actually occur,” said Julia Tcherkassova, one of the authors of the securitization research report, when asked about the eminent domain risk.
“If you look at just the loan tape…you would never capture this loan as a potential problem,” she told National Mortgage News. “Just all of a sudden it pays off…and the payoff occurs really quickly because there’s no transfer to special servicing required.”
Typically, there is a standard section in the pooling and servicing agreements that govern all CMBS deals that covers condemnation and eminent domain, but the latter risk does not occur that often, Tcherkassova noted.
“You can literally count those instances on just one hand,” she said. “So going forward, I…think those instances will [continue to] be extremely rare and they should not impact the valuation of the underlying CMBS securities dramatically.”
Occasionally, however, they do happen. Citing an article in the Atlanta Journal-Constitution, the Barclays report indicated that because this year a school board bought a 56-acre site with a paying tenant under eminent domain, the A-2 and interest-only tranches of a 2004 CMBS deal might suffer.
According to the report, under the PSA, a loan affected by eminent domain can be paid off without a prepayment penalty. Prepayment clauses are usually waived and the event is not considered a servicing transfer. All of this makes this type of prepayment tough to see coming, the report noted.
The Barclays researchers said in their report they believe the property’s seizure was the catalyst for an unexpected payoff of a note that represented roughly 7.6% of the 2004 deal.
“In this case…it was bad for the IO tranche because it shortened the life of the IO…but overall on the deal it was not so bad because it did not increase the loss,” Tcherkassova said.
Within the limited universe of eminent domain instances out there in CMBS land this is really one of the better-case scenarios, she said.
“In some instances eminent domain actually might result in losses,” Tcherkassova said. “The government has to come up with a fair value for [the] building, [based on] what they think they should pay.
“What they think they should pay is not necessarily what you think the loan is worth,” she added. “That’s the problem. In this instance we actually got really lucky because we actually got a payoff. In many instances, eminent domain actually results in liquidation with some loss severity. It does not have to be full payoff.”
In addition, “I think in this particular instance they got an additional fee from the tenant…who has to terminate the lease early,” Tcherkassova noted. This, combined with the money from the school board, meant there was enough to cover the entire principal of the loan, she said.
The involvement of a school board in eminent domain is not considered typical in the context of CMBS deals, Tcherkassova noted.
“When you have a performing property that’s located in an area that’s not necessarily adjacent to any of the airports [or] railroads, where it’s kind of a natural risk for potential eminent domain, you don’t expect it,” she said.
Tcherkassova said one other example of eminent domain in the CMBS universe that comes to mind, for example, was an industrial loan in an older deal that was backed by assets close to the Chicago area’s O’Hare airport.