Two numbers describe the same liquidation, and the one that reaches the trustee report is always the larger.
A liquidated conduit loan produces two severity numbers. Marlowe Tower carried a balance of $61.0 million and its property sold for $45.2 million, an appraisal severity of 25.90 per cent. What the trust actually wrote off was 37.24 per cent. The gap of 11.34 percentage points is the liquidation fee, the special servicing fee, legal and property protection expenses, and — three quarters of it — the repayment of interest the master servicer had already advanced to the certificate holders.
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Marlowe Tower is an office loan of $61.0 million in a fixed-rate conduit. It defaults, spends 22 months in special servicing, and the property is sold for $45.2 million. The shortfall is $15.8 million, or 25.90 per cent of the balance. That is the appraisal severity, and it is the number most published loss studies report.
The sale proceeds do not reach the certificate holders. They pass through a queue of claims that rank ahead of every class, and what emerges at the far end is what the trust actually collects.
| Item | $m | Per cent of loan |
|---|---|---|
| Sale proceeds | 45.20 | 74.10 |
| Less liquidation fee, 1 per cent of proceeds | −0.45 | −0.74 |
| Less special servicing fee, 25 basis points over 22 months | −0.28 | −0.46 |
| Less legal and property protection expenses | −0.95 | −1.55 |
| Less repayment of servicer advances | −5.24 | −8.59 |
| Net proceeds to the trust | 38.28 | 62.76 |
| Realised loss | 22.72 | 37.24 |
The two severities differ by 11.34 percentage points of the loan balance, and the gap splits unevenly. Fees and expenses account for 2.75 percentage points. The repayment of advanced interest accounts for 8.59 percentage points, which is three quarters of the whole.
That money has already been spent, and on whom is the point. When the borrower stopped paying, the master servicer advanced the missing interest out of its own funds so that the certificate holders were paid on schedule. Those payments went down the waterfall in seniority order, which means overwhelmingly to the senior classes, since they hold 70.0 per cent of the deal. The advance is then recovered off the top of the sale proceeds, ahead of everybody. That reduces what reaches the trust, which raises the realised loss, which is written against the bottom of the capital structure.
The junior classes fund the timely payment of the senior classes, and the transfer is invisible unless this bridge is built. No line in a trustee report is labelled with it.
One qualification, stated plainly. A balance-sheet lender holding the same asset for 22 months without collecting a coupon would also have lost the carry, so its economic loss is not 25.90 per cent either. What the trust does differently is capitalise that carry into a principal write-down and hand it to a different party from the one that received the payments. Part of the 11.34 percentage points is carrying cost any lender would bear, and which the appraisal measure simply ignores.
Every additional month in special servicing adds one month of advanced interest and one month of special servicing fee to the queue. On this loan that is $219,386 plus $12,708, or $232,095 a month of extra realised loss. Severity is not a property statistic. It is a property statistic and a stopwatch.
Two consequences follow. Published severity averages are not comparable across deals unless the advancing conventions and the workout durations are comparable, which they are not. And the appraisal reduction, which caps further advancing once a new appraisal comes in below the balance, cuts realised severity rather than raising it: with the reduction in place the advance repaid is $5.24 million, without it $7.10 million, and severity is 37.24 per cent against 40.29 per cent. That is 3.05 percentage points handed back to the class that will absorb the write-down, by the same mechanism that stops its coupon.
Three loans are liquidated in the worked transaction. Realised severity exceeds appraisal severity on all three, by between 9.0 and 11.3 percentage points.
| Loan | Balance ($m) | Proceeds ($m) | Appraisal sev. | Realised sev. | Loss ($m) |
|---|---|---|---|---|---|
| Marlowe Tower | 61.0 | 45.2 | 25.9 per cent | 37.2 per cent | 22.72 |
| Oakfield Corporate Center | 28.0 | 17.6 | 37.2 per cent | 46.3 per cent | 12.96 |
| Beaumont Plaza | 31.9 | 25.7 | 19.3 per cent | 28.3 per cent | 9.03 |
| Total | 120.9 | 88.5 | — | — | 44.71 |
Total realised loss is $44.71 million, or 4.47 per cent of the original pool. Class H, which has no credit support by construction, lost 100.0 per cent of its $37.5 million. Class G, with 3.75 per cent of credit support, absorbed the excess: $7.21 million of a $15.0 million class, or 48.0 per cent of it. Class F, with 5.25 per cent of support against 4.47 per cent of losses, was untouched. Had the pool been underwritten on appraisal severity, class G would have been expected to survive.
The severity figure quoted on a call is a residual, not a measurement. The bridge that produces it is five lines long, and every one of those lines ranks ahead of the certificates.
Appraisal severity is the loan balance less the sale price, divided by the balance: 25.90 per cent on Marlowe Tower. Realised severity is the balance less what reaches the trust after fees, expenses and advance repayment, divided by the balance: 37.24 per cent. The difference on this loan is 11.34 percentage points.
They increase the realised loss, yes. Advanced interest is repaid off the top of the liquidation proceeds, ahead of every certificate class. On Marlowe Tower that repayment is $5.24 million, or 8.59 percentage points of the 11.34-point gap between appraisal and realised severity. Fees and expenses account for the other 2.75 points.
One month of advanced interest plus one month of special servicing fee. On a $61.0 million loan at a 6.35 per cent coupon that is $219,386 plus $12,708, or $232,095 a month of additional realised loss. Over the 22 months this loan spent in special servicing, duration drives more of the severity than the sale price does.
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