The New World Order for Special Servicers: Is the Cure Worse than the Disease?

CRE Finance World, Summer 2012

The New World Order for Special Servicers: PNC Real Estate/Stacey M. BergerExecutive Vice President Is the Cure Worse Than the Disease? Midland Loan Services S concerns over special servicing issues manifest in legacy is critical to the long term viability of the CMBS market.transactions related to master and special servicing activities toCMBS investors and market participants. Potential conflicts ofinterest must be identified and disclosed to be mitigated — thisince the unprecedented market disruption in 2008, newissue CMBS transactions have incorporated a number ofsignificant changes intended to address senior investortransactions. These issues deal with subordinate investor control rights, special servicer compensation, potential conflicts As the CMBS origination and issuance market has continued to of interest, and affiliate transactions. As described in detail below, improve, investors have expressed concerns about underwriting CMBS issuers have been responsive to senior investor demands and credit quality in newly originated loans as well as issues in addressing these issues. However, some of the new provisions related to the management and resolution of specially serviced may have unintended consequences and create unforeseen assets. While significant enhancements to the structure and future problems. provisions of new transactions related to special servicing have been implemented, a number of continuing changes appear to Many of the issues expressed by CMBS senior investors result from be reactionary to circumstances in legacy transaction that have a lack of information regarding the specific resolution alternatives already been addressed and mitigated. There is a feeling among the that the special servicer has evaluated and analyzed as part of its special servicers actively negotiating new deals that they are being process to determine how to maximize recoveries. Addressing this punished for the perceived sins of others. Special servicers are not lack of information directly provides an alternative to the continuing the parties responsible for originating the loans that defaulted — imposition of new restrictions on special servicers. Special servicers they are the experts who were retained to represent the interest are prepared to provide much greater information about the resolution of bond holders who bear the losses associated with credit issues. strategies that they considered and analyzed, and how the actual Reducing future compensation for special servicers will not result financial results compared with the selected resolution alternative. in benefits to CMBS investors. This will build confidence and allow senior investors to understand and appreciate the special servicers’ compensation in relation to The biggest concern among special servicers is that changes to its results. the new issue fee structured affect their economics in ways which create future challenges. Changes to the special servicing fee Additional disclosure and better transparency related to special structures for different asset management and resolution strategies servicer resolutions is a fundamental change that would address create compensation schemes and economic incentives that may the underlying concerns of senior CMBS investors. This is a much be in conflict with the servicing standard. Under the servicing better alternative to the continuing attempts to “manage” special standard, the special servicer selects the resolution strategy which servicer future behavior by issuers through new provisions to the maximizes net recovery without regard to their compensation or pooling and servicing agreements. Issuers seem intent on appeasing economic interests. Special servicers take compliance with the investors by being tough on special servicers — resulting in a servicing standard very seriously, and a breach of the servicing continual assault on special servicing compensation. If better standard could have dire consequences. information on special servicer resolutions is made available through modifications to the Commercial Real Estate Finance Servicers are required to maximize recoveries on a net present Council Investor Reporting Package (CREFC IRP), this additional value basis for the collective investors in a CMBS trust without disclosure can be implemented for legacy CMBS transactions as regard to the servicers’ economic interests. However, there is a well as new issue deals. concern expressed by investors in legacy CMBS transactions, that certain controlling class holders and special servicers are pursuing CMBS market participants and government regulators have raised resolution strategies or engaging in conduct that results in the significant concerns over the potential conflicts of interest between deferral of realized losses or higher revenues for the special ser- special servicers, subordinate investors and senior investors. This vicer to the detriment of the senior investors. The special servicer issue is best addressed by providing full disclosure of affiliate has a standard of duty with respect to all of the investors, while A publication of Summer issue 2012 sponsored by CRE Finance World Summer 2012 15


CRE Finance World, Summer 2012
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