Large Loan Special Servicing - Know Before You Go

CRE Finance World, Summer 2012

Large Loan Special Servicing — Know Before You Go Edward L. Shugrue III CEO Talmage, LLC W transactions as a possible means of taking control of (B-Note) that is held outside of the CMBS Trust) is designated1. Who’s in Charge?In a typical CMBS transaction, the junior-most holder of an interestin the mortgage (whether the lowest rated bonds inside of theCMBS Trust, a Rake bond or a subordinated mortgage participationith $84 billion of CMBS loans currently in specialservicing and more than $300 billion of CMBS loanscoming due over the next five years, opportunisticequity investors have been actively investing in CMBS the underlying real estate or simply as a distressed debt or a as the controlling holder and has the right to appoint the loan’s restructuring play. Having advised a number of these investors on special servicer pursuant to the PSA. Importantly, a Mezzanine potential transactions and having been retained as the special lender, structurally subordinate to the mortgage debt, has no such servicer by those who acquired a controlling holder interest, we rights as it is a lender to the owner of the property secured by its have developed a “Top Five — Know Before You Go” checklist to equity in the mortgage borrower as opposed to a lender that has assist clients in navigating the many complexities and misconceptions an interest in the mortgage loan that is secured by the real proper- of CMBS transactions and special servicing. ty. In a typical large loan CMBS transaction, the controlling holder will maintain its status until it has been appraised away (typically Background when its tranche is worth less than 75% of its original value based As a starting point, many real estate equity investors consider the upon 90% of a new appraisal) and control shifts to the next most legacy CMBS market following the financial crisis to be the 2012 senior class that is in the money. version of the RTC investment opportunity of the early/mid-1990s. While the two opportunities share many similarities, particularly from While the controlling holder concept makes sense, the mechanics a real estate perspective, they differ materially, in structure. Unlike that govern the determination of the controlling holder (under the the RTC distressed loans that were primarily held as portfolio loans PSA), are often materially out of sync with the realities of current in whole-loan, single-tranche structures, affording opportunities market values. As illustrated below, since new appraisals are often for relatively straightforward work-outs and restructurings, CMBS not required for 90-days (or more) following a monetary event of loans are primarily held in inflexible REMIC formats with multi-tiered default (and at defined intervals thereafter), the controlling holder capital structures that create tension between the various holders (who appoints and directs the special servicer) could be significantly of certificates based upon their relative seniority (often referred to out of the money and yet, under the PSA, still be allowed to remain as tranche warfare). The REMIC (Real Estate Mortgage Investment in charge of the loan and drive a loan modification in its own Conduit) structure, which is essential for pooling mortgages from a best interests. tax perspective, does not allow, among other things, for the REMIC bond’s interest rate to be increased in a restructuring. Figure 1 Determining the Controlling Holder Further, in addition to the relatively inflexible REMIC structure that governs the majority of CMBS transactions, each CMBS transaction is controlled by its own unique Pooling and Servicing Agreement (PSA) that imposes many other limitations on workouts. Among these are limitations on the final maturity of the loan, the selection and payment of the special servicer who manages the borrower relationship, and rules regarding asset valuations and the determina- tion of the controlling holder (typically, the most junior in the money mortgage class) who is entitled to appoint the special servicer. While many of the real estate challenges of today are similar to those of the real estate crisis of the early 1990s (too much leverage, declining cash flows, zombie sponsors, etc.), the structures built around legacy CMBS create new challenges to resolving mortgage loans. Understanding the basic rules of the road of CMBS loans and having a general roadmap of what can be accomplished when seeking to modify a modern-era CMBS loan is critical to successfully investing in the space. CRE Finance World Summer 2012 64


CRE Finance World, Summer 2012
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