Is It Time for CRE Loan Ratings Skepticism Again?

In the U.S. part of the Global Financial Crisis now 17 years back, credit rating agencies were one of the painful industry segments. Many properties and securitization deals were offered undeserved pumped-up ratings that convinced investors to pour money into poor investments.

But a recent debacle on AAA bonds from a CMBS deal has raised the specter of how trustworthy some ratings might be.

CRED iQ recently wrote about 1740 Broadway, “Special servicing workout fees, servicer advances, and other expenses totaled $62.3 million, which left only $117.2 million of net proceeds available to the Class-A investors, which had an unpaid principal balance of $157.5 million. This resulted in a $40.3 million loss (25.6% loss severity) to the A tranche and wiped out all subordinate tranches.”

“Despite common market knowledge of the degradation of value, 7% occupancy, and the unwillingness of Blackstone to invest in the stabilization of the building, the rating agencies maintained lofty ratings as recently as November 2023,” CRED iQ said. One rating agency “had a high ‘A’ rating” while a second one “had a “BB+” rating for the safest Class A bonds, which were originally rated AAA.”

Investors in the AAA tranche of the $308 million debt backed by 1740 Broadway in midtown Manhattan recently only got 74% of their investment back after the loan sold at a steep discount. Creditors in the five lower groups were wiped out.

The 1740 Building —formerly called the Mutual of New York, or MONY, building — was bought for $605 million by Blackstone in 2014. To help finance the deal, the firm took out a $308 million mortgage that was packaged into a CMBS and scooped up by the likes of Travelers Cos., Endurance American Insurance Co., and others, according to Bloomberg. Blackstone and the special servicer reportedly sold the building for $186 million a few weeks ago. Blackstone told Bloomberg that it had written off the property nearly three years ago.

That statement sounds similar to one the company made in an emailed statement to GlobeSt.com in October 2023 when it said it had completely written down the value of Playa District, the Los Angeles office campus the company bought in 2016 as “part of a broader portfolio, the remainder of which was sold prior to the pandemic.”

“Given the challenges facing the property, we began writing this property down over three years ago and completely wrote it off earlier this year,” the statement continued. “We aim to invest in sectors with strong fundamentals propelled by macro demand trends, which is why the majority of the real estate we own is in sectors like logistics, student housing and data centers and why less than 2% of our owned portfolio is traditional U.S. office.”

Bonds backed by single mortgages and tied to older office buildings dominated by one anchor tenant — like 1740 Broadway — are especially vulnerable, according to Bloomberg, and some analysts are already predicting further losses as more loans get sold for a fraction of their former value in tightening markets and credit crunches.

But this isn’t a systemic response to a strong ebb tide that left everyone beached. Instead, in a saying associated with Warren Buffett, the retreating water showed who had been swimming naked. That would be people and institutions who were overly excited by cheap money and who made questionable purchases

And this isn’t the only building where there may be problems, according to CRED iQ. “Across the [single-borrower, large loan, or] SBLL landscape, our analysis found that ~15% of all loans are reporting a DSCR below 1.10,” they wrote. “13.5% of SBLL loans operate at sub-breakeven DSCR levels. A few examples from CRED iQ data uncovered the Willis Tower in Chicago, that recently reported a 0.28 DSCR with 90.7% occupancy and also 5 Bryant Park in NYC, that reported a 0.73 DSCR with 81.3% occupancy. Stay tuned for an analysis of office buildings in distress that have not received updated appraisals.”