A rising number of secondary assets are achieving lower loss severities upon dispositions of troubled loans, which could lead to a decline in overall REO loss severity by the end of 2011, a Barclays Capital report said.
The Barclays report cited the recent Fair Lakes Promenade shopping center, securitized in BACM 2006-3 (top 15 loan), sale for $39.5 million to LaSalle Investment Management. This an example of where the sale could end up as a zero loss severity liquidation in the February remittance report. Typical loss severity for REO liquidations is around 60%, according to Barclays analysts.
The deal's A2 tranche is expected to be mostly paid off as a result of this disposition. Analysts also noted that the REO sale could possibly create excess proceeds that would be applied to default interest. Default interest is an extra coupon that is tagged onto the loan once it goes into delinquency and is usually claimed by the special servicer, Barclays said. Default interest on securitized loans is typically original WAC plus 5%.
In other words, the excess proceeds from a liquidation wouldn't be used to subsidize interest shortfalls or principal write-downs tied to other properties.
"It is our understanding, based on Pooling and Servicing Agreement terms, that the loss severity in such scenario would still be reported as zero and that the trust will not be entitled to any proceeds exceeding loan balance and trust expenses," analysts said in the report. "Since this additional default interest could be sizable, it may present an additional motivating factor for special servicers to push loans into REO. In addition to the default interest, special servicers might be entitled to the reimbursement of collection costs that could also be fully or partially funded from excess sale proceeds."
If excess proceeds remain after the special servicer is compensated for the default interest on the senior loan, the residual would typically be applied to the mezzanine loan. If there is no mezzanine loan, the residual would typically go to the borrower.