Ann Hambly
When it comes to restructuring a bank or life company loan that is still on a lending institution’s balance sheet, the negotiation really boils down to two individuals — the borrower and the lender — agreeing on a solution that hopefully creates a “win-win” scenario.
Negotiating the possible restructuring of a CMBS loan is a completely different story, however. Therefore, it is important to understand the objective and motivations of the party you are negotiating with.
The special servicer, who is tasked with making decisions on a defaulted loan, has a number of objectives, and often they are competing objectives.
The special servicer’s primary obligation is to make a decision that results in the least amount of loss to all bondholders in the pool, without regard to its own bond position. That is the servicing standard that a special servicer agrees to when it signs a pooling and servicing agreement at the time of securitization.
A hypothetical example
So, what does all this mean in practical terms? Let’s walk through an example of a loan that is underwater. Let’s assume that the loan balance is $10 million and the value of the real estate today is $7 million. Let’s also assume that the property will need $1 million of tenant improvements and leasing commissions over the next two years. For the purposes of this example, the property is located in New York.
Let’s say that the bank that originated the loan is holding the loan on its books. The borrower schedules a meeting with his banker to discuss the situation. There are many options available to the bank and the borrower, but here are three logical ones to consider:
- The bank could lend the additional $1 million to the borrower and allow him to pay a reduced payment for a period of time while the property leases back up and the market recovers.
- The bank could write down the debt to an amount that the cash flow of the property could support.
- The bank could simply allow the cash flow for a period of time to go into a reserve account for tenant improvements and leasing commissions.
Now, let’s take the same set of circumstances and simply change the whole loan to a CMBS loan. Let’s compare all three options on the bank loan to see how it differs on a CMBS loan.
- Option one where the bank lends the borrower the tenant improvement, leasing commission costs cannot be done in a CMBS loan. There is no lender on a CMBS loan. There are only bondholders.
- Option two where the bank writes down the debt is rarely done in a CMBS transaction, especially for a loan that is $10 million. The only similar scenario for a CMBS loan is where the special servicer agrees to write down the debt $1 for every $1 of new money that the borrower pays the loan down. In other words, if the borrower paid $500,000, then the special servicer may agree to write down $500,000, thereby decreasing the debt by $1 million. Without new capital from a borrower, this is not an option.
- Option three where the loan is basically converted to a cash-flow loan and all cash flow is placed into a tenant improvement, leasing commission reserve is also something that is typically not considered in a CMBS loan because the bond holders still have to receive their monthly payments. One of the master servicer’s responsibilities is to serve as a credit enhancement to the bondholders. When the borrower does not make its payment, the master servicer advances funds from its own pocket to keep the bondholders current and they collect interest on the funds they advance. That is what makes this option prohibitive in a CMBS transaction.
Possible resolutions
So, what can be done in a CMBS loan restructuring in light of the circumstances outlined above? The special servicer will not give you, the borrower, a menu of options. You will either need an advisor on your team that knows this menu — and it varies by special servicer — or you will be forced to guess.
All borrowers who have attempted to restructure their CMBS debt without a knowledgeable advisor say that it feels like a one-sided negotiation. Indeed, it is.
There are many key factors that influence the decision of the special servicer, including:
- The maturity date of the loan and the likelihood of the property recovering its full value by that time
- The market in which the property competes
- The amount of new capital the borrower plans to bring to the solution
- The particular state in which the property is located
Location, location, location
So, let’s go back to our example and remember that this property is in the state of New York. It takes 445 days in New York to foreclose on a property, and it must be done through the court system, meaning it is a judicial process. The accompanying map shows the length of time to foreclose in each state.
The orange-colored states are the ones with a judicial foreclosure process, the green states are the ones where the process is non-judicial, and the blue states are where the process can be done either way.
The location of the property is critically important because the special servicer must advance the monthly payment to the bondholders every month until the property is foreclosed and then ultimately sold as an REO.
On a $10 million loan in New York and at least 445 days to foreclosure and then another year to sell the property, the total amount of bondholder payments that the servicer will have to advance can add up to $1 million to $2 million.
Calculating the net loss
Remember that the special servicer is obligated to make a decision that results in the least amount of loss to all bondholders in the pool. So, even in the best of circumstances, the net loss to the bondholders on the loan described above would be well over $5.5 million, not even factoring in the selling and disposal costs of the property. Here’s how the loss is calculated in our simple situation:
$7 million value of real estate (presumed sale price of REO)
Less $1 million of tenant improvement, leasing commissions
Less $1.5 million of advances to the bondholders
Net recovery = $4.5 million
Original loan amount= $10 million
Loss = $5.5 million
Now, if the solution that the borrower presented would result in less of a loss to the bondholders, the special servicer should proceed with that option.
To effectively negotiate with a special servicer on a CMBS loan, you really have to understand what motivates a special servicer’s decision-making process. Remember that the special servicer is not a lender, but rather a bondholder who will likely suffer significant losses in the coming years.
Ann Hambly is founder and co-CEO of 1st Service Solutions, a borrower advocacy firm based in Grapevine, Texas. To date, 1st Service Solutions has successfully restructured more than $5 billion of CMBS loans on behalf of borrowers, and has over $5 billion in process today.