Goldman Sachs Group put together a mortgage-backed bond deal in 2021. Nothing unusual about that. The money went to a group purchasing 61 multifamily properties with a total of 1,719 rent-controlled units in San Francisco. The floating-rate, interest-only, first lien mortgage loan had an initial balance of $674.8 million.

By the end of 2022, the borrowers defaulted, as Mortgage Professional America noted. The loan was sold off at a deep discount, according to Bloomberg. Then came the rest of the bad news. Special servicer Midland Loan Services told the investors of a holdback of $164 million.

Holdbacks happen on occasion in CMBS financing, but this was big. As Bloomberg noted, it exposed multiple classes that had been rated as investment grade by Kroll Bond Rating Agency to potential loss and has raised fears among some investors that servicers will make surprise decisions that affect their returns in deals.

In February 2023, Fitch Ratings gave the overall package, GSMS 2021-RENT, a AAA investment-grade rating, with an explanation of key rating drivers.

“The affirmations reflect stable servicer reported net cash flow (NCF) and improved occupancy since issuance,” the agency said at the time. “According to the September 2022 rent roll, portfolio occupancy for the residential units has improved to 88.9% compared to 74.7% in December 2020 when portfolio occupancy had been impacted by the pandemic. Fitch’s NCF has improved to $34.2 million compared to Fitch’s NCF at issuance of $27.1 million and YE 2020 servicer-reported NCF of $28.0 million due to the improving occupancy.”

The firm also noted, “The Veritas Multifamily Portfolio Pool loan transferred to special servicing on Nov. 3, 2022 due to imminent maturity default. The sponsor, a joint venture between Veritas Investments and affiliates of Baupost Group, indicated it was not going to exercise its one-year extension option or be able to pay off the loan at the scheduled loan maturity in November 2022. As of February 2023, the lender and borrower were negotiating a potential cooperative sale of the properties to a third party along with other potential workout options.”

The collapse of a highly-rated mortgage-backed bond might bring up memories of the Global Financial Crisis in which many bonds backed by residential mortgages with strong ratings were found to be less than what they appeared.

This has reportedly spooked Wall Street and investors. They already see a big downturn in markets, as GlobeSt.com has extensively reported. The prospect of special servicers holding back payments adds to the risk. Some of the investors in the deal reportedly were Angelo Gordon, LibreMax, and Lord Abbett.

“This is a risk investors did not expect,” Stav Gaon, a strategist at Academy Securities Inc., told Bloomberg. “There’s no reason to think that something like this won’t happen again.”

He also said that there may have been a good explanation of the action, and that it was likely the biggest such action in that type of security.