As measured by balance, nearly 90% of commercial mortgage-backed securities that came out before 2009 and are still alive suffer from interest shortfalls, according to a report released today by Fitch Ratings.
While interest shortfalls can have any number of causes, the main driver in CMBS is interest from underlying collateral that has not been advanced thanks to lower appraisal numbers. “This structured feature was introduced to limit interest advances on delinquent or defaulted loans to the extent the collateral value has declined,” the agency said.
Fitch added that shortfalls linked to appraisal reductions often disappear once the loan is repaid or liquidated at a loss.
The second largest catalyst for interest shortfalls in legacy CMBS are special service fees. These take place when assets are in special servicing and are withheld from the interest portion of general collections, hence feeding into interest shortfalls when a large enough portion of the portfolio requires a workout.
Servicers can also stop advancing interest on a loan when the value of the property has fallen to such an extent that those advances are deemed unrecoverable. In the case, the servicer will not advance any interest on the troubled loan. This differs from an appraisal reduction, which can lead a servicer to cut – but not eliminate – interest rates.
Fitch said a loan modification is another trigger for interest shortfalls in legacy CMBS. The severity and duration of the shortfall in these cases naturally depend on the terms of the modification.