CMBS: Special Servicers
Special servicers are the firms trying to correct mortgage loans in the later stages of delinquency or in actual default. Their role has become increasingly important as a result of the tremendous number of troubled loans. According to a report by Standard & Poor’s (S&P), servicers have been training their staffs to address the unique aspects of these loans, packaged as commercial mortgage-backed securities (CMBS). Almost 50 percent of these unresolved assets are loans originated in 2006 and 2007. Many of the loans are more complex than older ones, which mean it takes longer to resolve them, either by a full workout, a discounted payoff or foreclosure sale. Because of the time period in which they originated, many of the newer loans lack some of the safeguards present in the commercial loans originated before 2004.
For example, says the report, pre-2004 loans are likely to have lower loan-to-value ratios than newer ones. Consequently, borrowers in those years are likely to have more equity in their collateralized properties due to principal amortization and other underwriting elements. These borrowers are more likely to protect their investments and may be better positioned to weather the current downturn. On the other hand, borrowers with newer vintage loans have different factors to consider if refinancing is not an option or their equity has been diminished. Newer vintage loans, particularly those issued in 2006 and 2007, often have more complex debt structures and tend to have larger balances. As a result, more of these loans are breaching performance levels that require transfer to special servicers familiar with the specialized processes needed to work out nonperforming assets.
Loan Characteristics
The S&P report says the characteristics of loans issued at different points in the economic cycle are likely factors driving their performance over time. Loans issued more than five years ago generally have stronger track records of performance before causing a breach that transfers a loan to special servicing. On average, through mid-year 2009, older loans performed for an average of eight years before defaulting or tripping another special servicing trigger. That time frame drops to 3.4 years for newer loans. The ratio of newly transferred problem loans to resolution has steadily increased since 2007. As a result, S&P expects the number of new loan transfers to special servicers to remain high as unresolved asset inventories remain concentrated with newer vintage assets. S&P also expects future resolutions to involve more discounted payoffs (DPOs) and foreclosures than full payoffs. As reported last year, full payoffs declined to less than 20 percent of all loan resolutions, while the number of DPOs and foreclosures was climbing.
Special servicers may face more competition in recruiting and hiring qualified personnel. A number of special servicing companies have announced packaged pools as an alternative exit strategy. To conduct loan pool sales, special servicers typically use a sealed bid method to obtain offers, although they may opt to use an auction in some cases. Special servicers also may hire external firms to assist them; this could help reduce asset manager workloads. In seeking new servicers, S&P generally looks more favorably on those with a consistent track record of handling and resolving a steady flow of complex assets.
High Volume
According to the real estate data from Trepp LLC, delinquent CMBS that totaled to less than $20 billion in October 2008 mushroomed to $55.2 billion at the end of November 2009. The volume of delinquencies could reach $90 to $100 billion this year. As a result, it is very possible that there will be an increasing number of defaulted loans being resolved one way or another. By one account, about 60 percent of maturing commercial mortgages last year were given one-year extensions. Underlying the problem of resolving such defaults is the fact that property values have fallen 43 percent across the board.
Liquidation Alternatives
A special servicer generally can utilize one of two different workout strategies. One is a sale or liquidation of the assets, and the other is working with the borrower so that the property need not be sold. The first of these alternatives is most often the one chosen. In practice, the special servicer may be obliged to utilize the method prescribed in the servicing agreement established in the CMBS trust.
The servicing standard generally requires the special servicer to execute the strategy that gives bondholders the highest recovery on a net present value basis. Alternatives may be foreclosure, restructure, workout of note or sale, whichever yields the highest recovery on a net present value basis.
Real Estate Focus is provided by Somerset’s Real Estate Team for our clients and other interested persons upon request. Since technical information is presented in generalized fashion, no final conclusion on these topics should be made without further review. For additional information on the issues discussed, please contact Michael Fritton, CPA. Whether you are a building owner, building manager, real estate developer, real estate professional or an investor, we hope to provide you with timely information so you may be proactive in making your business decisions.
This article was written by and published herein with the permission from professionals of BDO Seidman, LLP. John Tax is a director in the Real Estate and Hospitality Services Practice in BDO’s New York office. Somerset is a member of the BDO Seidman Alliance, a nationwide association of independently owned accounting and consulting firms.
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