Unexpected holdback stuns mortgage bond investors

A $164 million surprise exposes new risks in real estate financing

Unexpected holdback stuns mortgage bond investors

Investors in a Goldman Sachs-arranged bond deal for San Francisco apartment buildings were hit with a surprising twist at the end of 2022. After the companies that took out the loan for the deal defaulted, Midland Loan Services Inc. withheld $164 million expected by investors, highlighting new risks in the commercial mortgage-backed securities market.

Midland Loan Services Inc., serving as a mediator for bondholders, then announced an unexpected delay in disbursing $164 million owed to the investors. Such holdbacks are not uncommon in the realm of commercial mortgage bonds, yet the scale of this one was unprecedented, posing potential losses even to investors holding investment-grade bonds as rated by Kroll Bond Rating Agency.

This incident sparked concerns on Wall Street regarding unforeseen risks in the $1 trillion market for commercial mortgage-backed securities (CMBS), especially given the ongoing downturn in the real estate sector.

Stav Gaon, from Academy Securities Inc., pointed out that this could be the largest holdback ever witnessed in this segment of the US securities market. This move not only poses immediate financial implications for the investors involved but also introduces a layer of unpredictability regarding how servicers will handle troubled assets moving forward.

“This is a risk investors did not expect,” Gaon said in a Bloomberg report.

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The loan in question was initially taken out by Veritas Investments and Baupost Group in 2020, covering over 60 apartment complexes in San Francisco and was later packaged into CMBS by Goldman Sachs in 2021. The ensuing challenges for apartment landlords, exacerbated by the Federal Reserve’s aggressive rate hikes, culminated in Veritas and Baupost defaulting on the $675 million loan.

Despite the ensuing controversy over the sale price of the loan, Midland proceeded to sell it to Brookfield for approximately $513 million, resulting in a loss of nearly 25% of the loan’s original value.

The situation became even complicated when Midland decided to withhold $164 million. Midland has yet to provide a detailed explanation for this significant holdback, though speculation suggests it may be a precaution against potential litigation costs, according to a Bloomberg report.

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