The primary reason that property owners express such a disdain for commercial mortgage-backed securities (CMBS) is that the financing vehicle is “mysterious.”
There is no source or website anyone can go to that will explain how a CMBS loan really works, and there is no one the owner can speak to at the loan servicing shops who will demystify the process.
CMBS loans are governed by IRS regulations and documents an owner will never typically see, let alone know about.
As the founder of a company that serves as a voice for property owners and borrowers, I have dedicated my entire career to demystifying CMBS. One way I do that is through quarterly webinars.
Each webinar covers a different topic. The 2015 webinar series has been specifically devoted to exposing the naked truth about CMBS. In a recent webinar, we focused on the eight myths of CMBS. What follows is a recap.
Myth No. 1 — It won’t cost much to miss the payoff date of your CMBS loan by a few days: Most property owners are now well aware that a CMBS loan has what is called an “open period.” The loan can only be paid off during that open period. Open periods are typically 90 days prior to the maturity date. Until the 90th day prior to the maturity date, the loan is locked out from pre-payment.
What may not be clear is that the borrower will be assessed a late fee for the missed balloon payment at maturity. For example, if the borrower has a $30 million loan that matures on Dec. 1, 2015, and the loan documents specify a 5 percent late fee due the day after the missed balloon payment, the borrower would be assessed a late fee of $1.5 million on Dec. 2, 2015.
Myth No. 2 — There is no such thing as a loss of 157 percent of the principal balance of a loan: In order to even fathom how it would be possible for a CMBS loan to have a loss beyond 100 percent, it is first necessary to illustrate how losses work on CMBS loans.
Let’s use an extreme example of a loan with these characteristics: (a) a single-tenant property valued at $20 million at the time the loan was originated, but which is now valued at $8 million due to 100 percent vacancy; (b) the loan amount is $15 million.
Now let’s assume the property was foreclosed on and ultimately sold by the special servicer for the full $8 million. Before any net sales proceeds can be distributed to the bondholders, the servicer first reimburses itself for all costs associated with the foreclosure and management and sale of the property, including all advances made to keep the bondholders current during the time from default to the sale of the property.
To have a 157 percent loss, the costs incurred by the servicers (keeping bondholders current, legal fees, etc.) would have been $16.5 million from the time of default to the sale.
Webinar attendees have raised an important question: “If the servicer had simply walked away from the loan, released its interest and gave the borrower the property free and clear, would the trust have been better off?” Shockingly enough, the answer is “yes.”
Myth No. 3 — The economics of the property in trouble are one of the most important factors when modifying the loan: The special servicer’s primary obligation is to maximize the recovery and minimize the loss to the bondholders. This obligation inherently creates a disconnect about what really matters to the borrower and what ultimately has to matter to the special servicer when making decisions about what to do with a problem property.
The special servicer will primarily focus on the following:
- fee opportunities;
- possible liability to the senior bondholders for its decision;
- adherence to real estate mortgage investment conduit (REMIC) rules;
- the status of the special servicer’s bond investment (as much as everyone would like to say this is not a factor)
- the servicer’s ability to buy the property itself through the fair market value purchase option.
Meanwhile, the owner is likely to focus on these issues:
- the best way to reposition the property;
- any new investment that will be required to modify the loan;
- how to get that new investment back;
- retaining control of the property.
A successful CMBS loan restructuring is achievable, but it must be a win-win scenario for both parties. In all negotiations, the biggest factor to a successful outcome is to understand how to meet the other party’s objectives.
Myth No. 4 — If a property owner qualifies for a new CMBS loan, it will surely be approved to assume an existing CMBS loan: The common belief is that the underwriting performed by the servicer for a CMBS loan assumption is the same as the underwriting performed to obtain a new loan. In other words, if a buyer of a property can obtain a new CMBS loan with no problem, the buyer should qualify to assume an existing loan if it chooses to do so.
In fact, this has little to do at all with the approvals. The servicers are tasked with ensuring the CMBS trust is in no worse position after the buyer assumes the loan than it was with the previous owner. The process is similar to balancing a scale, or at least ensuring it is tilted more heavily to the buyer.
The problem with this approach, however, is that the seller only has access to the seller information and the buyer only has access to the buyer information. So, how can the buyer and seller know how they compare to each other on the “scale”?
That is one of the key benefits to an advocate. In other words, the advocate is able to see both the seller and buyer information and will be in the best position to negotiate with the servicers for a positive outcome.
Without access to both sides of the transaction, the buyer and the seller are ill-equipped to negotiate conditions.
Myth No. 5 — CMBS restructuring negotiations are not like a poker game: As an owner in need of a loan modification, extension or other request, you will be asked to submit your “order,” or loan modification request, to the special servicer as a first step in the modification process.
Since you likely don’t know the specific modification structures acceptable to the special servicer, this process can feel like trying to order at a restaurant when you don’t have a menu or any idea what the establishment serves.
Now assume you are playing poker and the person you are playing against can see your cards, but you can’t see his cards. It would be a very unfair poker game to say the least.
This is how it feels when you modify your loan without the help of someone — without the menu — or access to the other person’s card hand. All too often I hear from attorneys that they are constantly negotiating against themselves.
Myth No. 6 — The CMBS industry is standardized, consequently it really doesn’t matter which asset manager you are assigned within a special servicing shop: Nothing could be further from the truth. Personalities and personal approaches always matter, regardless of the industry. For example, court cases are affected greatly by the particular judge assigned to the case.
Although no one asset manager has the authority to hand out decisions independently like a judge, the asset manager’s personality and biases will greatly impact the result.
Myth No. 7 — The special servicer doesn’t really want to own my property. As long as I have a good solution and fresh capital, the servicer will work with me rather than foreclose: A quick look at the amount of modifications versus foreclosure resolutions should dispel this myth. In 2014 alone, there were approximately 125 loans modified while there were over 422 liquidated (sold as REO or sold through a note auction to a third party).
Less than 30 percent of the time in 2014, the loan was modified versus foreclosed.
If you think back to the examples of the loans with over a 100 percent loss, it should be clear that the special servicers will not hesitate to foreclose, even when there are options available that make more sense.
Myth No. 8 — The servicer has an incentive or obligation to look out for the owner’s best interest following a securitization: At securitization, servicers enter into a pooling and servicing agreement (PSA), which governs their servicing actions. The servicing procedures in the PSA are designed to: (1) ensure compliance with REMIC provisions of the tax code in order for the trust to maintain favorable tax treatment; (2) to protect the bondholders. There is no party in a CMBS structure that ultimately is tasked with looking out for the owner’s best interest.
The overall feedback from industry professionals who listened to the webinar was that they were shocked and somewhat depressed by the information. The good news is that many listeners said it cleared up their questions on a particular situation.
In all cases, it is better to do your homework rather than enter into a CMBS loan agreement blindly. An informed owner is a happy owner.
Ann Hambly is the founder and CEO of Grapevine, Texas-based 1st Service Solutions, a commercial real estate advisory firm specializing in CMBS loans. Since 2005, 1st Service Solutions has advocated over $15 billion of commercial real estate loans on behalf of borrowers. She can be reached at [email protected].