NEW YORK CITY—Earlier this month, the $300-million securitized loan on Bush Terminal in Brooklyn, a six-million-square-foot industrial and office complex better known as Industry City, paid off with a full recovery to the loan's A note and a near-total loss on the B note. It serves as an illustration of why Fitch Ratings continues to expect no recoveries from so-called "hope notes." 

The reason for the ratings agency's dismal assessment is that hope notes, which divide single loans into an interest-paying A note and an interest-accruing B note, don't provide sufficient incentive for their borrowers to repay. That's the case even as improving conditions in many subsectors of the US CMBS market will give a boost some efforts to modify legacy commercial loans, according to Fitch.

Typically, Fitch says, a servicer on a hope note will require a borrower to contribute additional equity to a transaction before agreeing to a modification. This additional equity generally receives a preferred return prior to the B note receiving principal.

Borrowers' use of the hope note structure peaked in 2011, when $3.5 billion were modified, followed by $2.7 billion in both 2012 and 2013 before volume fell "dramatically" last year, says Fitch, which points out that some hope notes remain to be disposed. On average, Fitch estimates, dispositions of hope notes take approximately 3.5 years from the time the loan transfers to special servicing to its ultimate disposition date.

The outcome of the Bush Terminal deal was expected, as Fitch noted in last month's ratings actions on Greenwich Capital Commercial Funding Corp. commercial mortgage pass-through certificates series 2007-GG11. The ratings agency said in November that the Bush Terminal loan was the largest contributor to the expected losses on the 2007-GG11 pool, of which it comprised 13.5%.

When the loan was originated, it was underwritten by the lender on a pro forma basis since the property was slated for redevelopment. At issuance, the Bush Terminal loan split into two pari passu pieces, with $250 million securitized in GCCFC 2007-GG11 and $50 million included in CGCMT 2008-C7.

Tenants included manufacturing, data centers, warehouses and others; in 2014, the Brooklyn Nets NBA team announced that it planned to move its training facilities to the site. Nonetheless, occupancy at the 16-building complex had been gradually declining and was approximately 62% as of this past June, 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 complex 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.

At the time, a Credit Suisse report cited the Bush Terminal loan as "another example, one of the largest, of the growing trend of mod-recidivism." That is to say, "a previously modified loan will become delinquent or go to the special servicer again and, perhaps, even get re-modified."

Another example occurred in the fall of 2013, when the Discover Mills loan, part of JPMCC 2006-LDP9, went back into special servicing for balloon risk. The 1.2-million-square-foot shopping center in the Atlanta suburb of Lawrenceville, GA that backed the loan is now known as Sugarloaf Mills. Early last year, the loan's maturity was extended to December 2018 for both it's a and B notes.

The Bush Terminal loan was restructured in the fall of '13, a deal arranged by Iron Hound Management, and a new ownership group began executing on the conversion plans. The loan was eventually refinanced by Bank of China and SL Green Realty Corp. earlier this month.