By Shankar Ramakrishnan

Summary

A failed sale of a New York City office tower led to a significant delay in downgrading a commercial mortgage bond to junk status, impacting investors post-pandemic.

Introduction

On August 27, 2023, Reuters reported that a failed attempt to sell 1740 Broadway, a New York City office tower, caused over a year-long delay in credit rating agencies downgrading a commercial mortgage bond to junk status. This delay impacted investors relying on ratings for assessment of credit quality.

The Rating Downgrades

The top-rated AAA tranche of the 1740 Broadway commercial mortgage-backed securities (CMBS) was downgraded by S&P and DBRS Morningstar in August and November 2023, respectively. The reason for the delayed downgrade, occurring at least 17 months prior, stemmed from the economic fallout of COVID-19, leading to the previous tenant’s departure.

Sequence of Events

An investigation by Reuters revealed that the failure to sell the property in late 2022, alongside delayed appraisals, led to an overly optimistic outlook on the property’s potential sale price. Credit rating agencies indicated they had shared their rationale and methodology for the ratings with the public, but did not provide additional comments.

A Blackstone spokesperson stated that the firm aimed to collaborate with pertinent parties to resolve the issue.

Broader Implications

The unfortunate losses associated with 1740 Broadway, even at the AAA tranche, caused concern and reminiscent of the housing crisis of 2007, according to Paul Feinstein, CEO of Audent Global Asset Management. Credit ratings are vital across the financial system for assessing default risk, and the delays in downgrading raised alarms among investors regarding similar bonds cumulatively valued in billions.

Ownership History

Blackstone acquired 1740 Broadway in 2014 for $605 million, securing financing through a CMBS. The main tenant at that time was L Brands, which owned Victoria’s Secret. After the tenant announced its departure in March 2022, Blackstone defaulted on the loan. The property was then handed to Green Loan Services, appointed as the special servicer in April 2022 to manage the distressed asset.

Sale Negotiations and Appraisals

Green Loan Services identified a potential buyer immediately, but due to rising interest rates, the buyer withdrew in December 2022. Consequently, the lack of an independent appraisal delayed the property value assessment, which continued to affect rating agency models that overestimated the property’s worth.

An expected appraisal was postponed again when the special servicer was changed to Midland Loan Services in February 2023. Finally, an appraisal conducted in July 2023 revealed the property was worth just $175 million, insufficient to meet the obligations of AAA bondholders.

Conclusion

S&P adjusted its ratings on the bonds, moving from AAA to BB+, illustrating the drastic drop in value as the bond price declined significantly in the market. Investors were left reeling amid the fallout from this key New York property, a stark reminder of the vulnerabilities within commercial real estate investments post-pandemic.