OREANDA-NEWS. As additional modified A/B notes are resolved loss severities are increasing for U. S. CMBS, a trend Fitch Ratings expects to continue according to a new report.

A/B loan modifications have become a less common workout strategy among special servicers over the past two years as many underperforming legacy loans have already been modified and liquidity has returned to the market. Approximately $1.15 billion of loans were modified into A/B notes in 2014 and 2015, which is one-third of the peak volume of $3.58 billion in A/B modifications in 2011. 'We've been seeing an uptick in CMBS loss severities of late as modified A/B loans are transferring back to special servicing,' said Director Melissa Che.

Loss severities are likely to continue increasing as modified A/B loans transfer back to special servicing. The primary reason: adverse selection. 'Many A/B loan modifications have still not stabilized and are unlikely to be able to refinance in the current market,' said Che. If the outstanding B notes are considered writedowns, the loss severity for A/B loans would be approximately 23%. As for ratings impact, there's not likely to be any as Fitch typically models no recoveries on the subordinate B notes.

Fitch has identified 26 previously modified A/B loans ($2.14 billion) as transferring back to the special servicer post-modification. Of that total, 16 transfers took place in the last two years. Fitch has identified 186 loans ($11.73 billion) that were modified into A/B loans within the Fitch-rated CMBS conduit universe.