The strong recovery in commercial real estate has enabled borrowers to resolve a lot of problem loans made before the financial crisis, but Fitch Ratings continues to expect no recoveries from "hope notes" as their structures do not provide sufficient incentive for their borrowers to repay.
Hope notes divide a single loan into two parts: an A note that pays interest and a B note that generally accrues interest until a capital event occurs. Typically, a servicer will require a borrower to contribute additional equity to a transaction before consenting to a modification. This additional equity generally receives a preferred return prior to the B note receiving principal.
Use of hope notes peaked in 2011, when $3.5 billion of securitized commercial mortgages were modified, followed by $2.7 billion in both 2012 and 2013 before volume fell dramatically in 2014. Fitch thinks that dispositions of hope notes take approximately 3.5 years on average from the time the loan transfers to special servicing to the ultimate disposition date.
The $300 million Bush Terminal loan is one recent example; it paid off in December, resulting in a full recovery to the A note, while the B note sustained an approximate 99% loss.
At issuance, the loan split into two pari passu pieces, with $250 million securitized in GCCFC 2007-GG11 and $50 million included in CGCMT 2008-C7. The loan comprised 13.5% of the GG11 transaction and was secured by a portfolio of 16 buildings totaling six million square feet of industrial/flex/office space located in Brooklyn, N.Y. Tenants included manufacturing, data centers, warehouses and others; in 2014, the Brooklyn Nets NBA team announced their intention to move their training facilities to the site.
At origination, the loan was underwritten by the lender on a pro forma basis as the property was slated for redevelopment. Occupancy at the property had been gradually declining and was approximately 62% as of June 2015, compared with 87.2% at issuance, partly reflecting the space being kept vacant for redevelopment.
The loan transferred to the special servicer in January 2011 due to payment default. It was modified in April 2012 and split into an A note of $190 million and a B note of $110 million. The collateral sustained significant damage from Superstorm Sandy and was transferred back to the special servicer, where it was again modified and returned to the master servicer. In 2013, a new equity partner began executing on the conversion plans. The loan was eventually refinanced by Bank of China and SL Green in December 2015.