Bondholders face a payment reversal event for the European Talisman-5 Finance plc CMBS deal. It's the second reversal event to occur this year in a European CMBS.

According to a regulatory notice from the issuer, Talisman-5 Finance plc misallocated payments between noteholders on the three interest payment dates of January 2011, April 2011 and July 2011.

As a result, the Class A notes appear to be owed €18.3 million ($25.2 million) of principal, which must be paid by the subordinate classes.

The cash manager will now be debiting the accounts of noteholders that were overpaid, and crediting the accounts of noteholders that were underpaid.

"If you happened to buy or sell the TMAN 5 deal in the last nine months, accounting for this reversal and making sure there is no principal or interest 'leakage' to your holdings could be tricky," according to a report from Trepp.

The misallocation was caused by a misinterpretation of the conditions required for a sequential trigger event to have occurred.  

The Trepp report said that, in the case of the TMAN 5 deal, the €50.1 million Reindeer loan was granted an extension last December. Originally, the loan was due to mature in January 2011.

However, the servicer extended the loan by 12 months to January 2012. As such, the loan was prevented from defaulting and it remained a performing loan.

That modification should have triggered a clause in the deal's waterfall that would have flipped the principal payments from pro rata to sequential. The Reindeer loan currently makes up over 21% of the deal's collateral.

"The non-payment in January 2011, based on the original loan terms without regard to the subsequent amendment, may have constituted a sequential trigger event because the Reindeer loan represented more than 10% of the loan pool," Bank of America Merrill Lynch analysts said in a report. "The announcement by the servicer of the misallocation of principal payments indicates that this was in fact the case, in our view, and that principal payments should have been applied on a sequential basis on each of the payment dates since January 2011, rather than on a pro rata basis."

All five classes of bonds in the deal will be impacted. According to the Trepp report, the A class will see about €18 million in additional principal payments flow through. For classes B, C, D, and E, the cash manager will be looking to recoup the funds.

There have been other instances in other European CMBS transactions where the cash manager has retroactively clawed back payments made in error from the noteholders.

In March and in September, Trepp reported a controversy surrounding the application of principal payments in the Fleet Street Finance 3 CMBS securitization. At issue had been whether the proceeds from the €222 million GSW loan — the second largest in the deal — should be applied pro rata or sequentially.

"It is often unclear which transaction party is responsible for monitoring waterfall triggers and too commonly the issue falls somewhere between the cash manager and the servicer," BofA Merrill analysts explained. "Cash managers often assert that they rely on the servicer to notify them when a waterfall trigger occurs because the trigger is effected at the loan level where the cash manager has little visibility. Servicers often assert that they manage loans and are not involved with payments at the note level; rather it is the cash manager who is responsible for payments at the note level."

The Commercial Real Estate Finance Council Europe are currently working to create a set of best practices for how CMBS transactions should be structured in the future. These recommendations will address the way the servicer and cash manager interact, which is likely to help improve the monitoring and realization of waterfall switches in future European CMBS transactions.

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