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Loans Lose All Value, and More

Boscov’s, a regional chain of department stores based in Reading, Pa., has received an honor few companies get. Its name, like Google’s, has become a verb.

Tom Grill | Photographer's Choice RF | Getty Images

Or at least it has gained that stature in the world of commercial real estate.

Trepp, a data collection and analysis firm, offered the verb form this week after an unfortunate commercial real estate securitization trust disclosed that it took huge losses last month on five department store locations that had been secured by leases to Boscov’s.

“To be Boscoved,” said Trepp, is to suffer losses on a loan of more than 100 percent of the amount lent. That happened on all five of the loans that were included in the Bank of America Commercial Mortgage Series 2006-3, a securitization sold by the bank in 2006.

You might think that, in making a loan, the worst that can happen is to lose all you lent. But in the wonderful world of commercial real estate, you can do much worse.

That is because the securitizations authorize the bank servicing the loans — in this case the same bank that made the bad loans — to keep collecting its fees even if the borrower is not making payments. The servicer is also authorized to take out cash from the securitization for other costs, like paying property taxes or making repairs to keep the property from falling apart.

Those costs can keep coming for a long time after a loan stops producing income. Eventually, the property is foreclosed and sold, and the securitization gets whatever is left after the fees are paid. If the properties are not worth the fees and expenses — as happened in each one of the five loans on Boscov’s stores — then the securitization is docked for the extra charges.

Eventually can be a long time. Boscov’s filed for bankruptcy in 2008 and almost immediately renounced the leases on many of its stores. But the five stores in question were not sold until late October, halting the need for the securitization to keep throwing good money after bad. Wells Fargo, the trustee for the securitization, notified investors of the details last week.

The defaults were simply the latest bad news for the market for commercial mortgage-backed securities, which until early this summer appeared to be slowly recovering. In June, nearly $7 billion in new securitizations were sold to investors. That would not have seemed like much in the heady days of 2007, when $45 billion in new securities were sold in a single month. But it was the highest for any month since that year.

Until June, prices of existing securities seemed to be rising, and banks were showing more willingness to make commercial real estate loans and hold on to them until they had enough to package into a securitization. But early this year, the American International Group, encouraged by the seemingly solid market, offered to buy back a package of residential mortgage-backed securities that the Federal Reserve Bank of New York had taken when it rescued the insurance giant in 2008. The Fed decided to instead offer the securities to the market.

It turned out that while banks had been happy to mark up values of such securities, they were less interested in actually buying more of them. When the securities began to be sold in June, the low prices being received “kind of shocked the market,” said Manus Clancy, senior managing director of Trepp. Investors grew wary of buying new issues, and banks made little money when they securitized the loans they had accumulated. Their desire to make more loans declined, and so did the supply of new securitizations being put together.

At the same time, the proportion of loans in existing securitizations that were delinquent, which had seemed to decline in the spring of this year, began to rise again.

If the commercial mortgage-backed securities market is growing quiet again, that will not cut off all commercial real estate loans, since banks keep some and insurance companies remain active lenders. But without an active securitization market, interest rates could rise at the same time that many loans made at the peak of the market — in 2006 and 2007 — need to be refinanced.

Unlike home mortgages, commercial mortgages — for such things as apartment and office buildings, industrial sites and hotels, as well as retail stores — normally have maturities of 10 years or less, and need to be refinanced when they come due. As the market heated up early in this decade, maturities grew shorter and more interest-only loans were made. It seems likely that some loans that are now making payments will be unable to be refinanced — especially since many are underwater, creating the possibility of more defaults.

Yamada Taro | Photodisc | Getty Images

The Bank of America securitization that bought Boscov’s loans may not be the worst-performing deal, but it does seem to have an unusually large number of disastrous loans. Trepp searched its database for loans with losses of more than 100 percent reported in 2010 and 2011, and found 47 of them. No other securitization had more than two such loans, but this deal had six — the five Boscov’s loans that were settled in October and a sixth that was settled in July.

All told, that securitization invested in eight mortgages secured by Boscov’s leases, only one of which turned out to be a good loan. Boscov’s rejected the leases on the other seven, on properties in Pennsylvania and Maryland. The first one to be liquidated, a store in Upper St. Clair, Pa., was sold late last year, with losses of only 81 percent of the amount lent.

On those seven loans, the costs run up for servicing fees and other expenses amounted to $38 million. But when the properties were sold, the net proceeds amounted to just $27 million. All in all, the securitization lost $126 million on the loans. The loan on the Boscov’s store in North Wales, Pa., was the worst of the lot. On a loan of $13.8 million, the loss was $17.3 million, or 126 percent.

It may be worth noting that none of these loans looked especially risky when the securitization was being marketed. All the loans were for less than 70 percent of appraised values. When they were sold, they fetched, on average, about 15 percent of the original appraisals.

The way such securitizations work, the news has not been disastrous for all investors. The losses from defaults first go to junior tranches. When they are wiped out, the losses move to the next higher tranche. This securitization still has some tranches rated AAA, which presumably will escape unscathed. But last month’s write-offs caused by the Boscov’s loans wiped out three tranches and severely damaged a fourth. Three of those four were originally rated investment grade by Fitch and Standard & Poor’s.

Boscov’s has emerged from bankruptcy and is operating 40 stores in five states. It was not the borrower on the loans, merely the tenant, and under bankruptcy law it had every right to walk away from the leases on stores it no longer wished to keep.

Curious how it felt to have your name turned into a verb, I called Albert Boscov, the 82-year-old chief executive and son of the chain’s founder. Neither he nor two other top executives of the chain returned phone calls, so that question remains unanswered.

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