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CRE Finance World, Winter 2012

Special Servicing — Challenges and Recommendations Edward L. Shugrue III CEO Talmage, LLC S are scheduled to mature over the next five years are not As illustrated below, the role of the special servicer is straight-forward in Figure #1 as there is only one client, the CMBS trust.In Figure #2, however, the special servicer represents both theCMBS trust and the B-note equally. Finally, in Figure #3, whilethe special servicer represents both the CMBS trust and the B-ome $81 billion of CMBS loans are currently in SpecialServicing, while more than $130 billion have been subjectto special servicing over the last three years. Additionally,many of the more than $300 billion of CMBS loans that likely to qualify for market refinancing and will therefore be subject note, in order to effectuate a resolution other than foreclosure, it to special servicing. We examine CMBS loans that have been must also negotiate for the consent of the mezzanine holders to modified and extended in special servicing and ask three questions: any modification. (1) Was the resulting modification fair to the CMBS bondholders vs. the “mortgage loan, taken as a whole?” (2) Is the “Controlling Figure 2 Holder” concept flawed? (3) How are special servicers aligned with Typical CMBS Capital Structures & Special Servicer Responsibilities bondholders? Then we will consider how CMBS structures can be improved to address these issues and other potential conflicts going forward. Figure 1 Specially Serviced Loans/Upcoming CMBS Loan Maturities Further, under the strict tax rules of Real Estate Mortgage Investment Conduits (REMICs), which account for the vast majority of the $600 billion of currently outstanding CMBS, there is no way to allow bondholders within the Trust to benefit from additional interest Are CMBS Loan Modifications Fair to CMBS Bondholders? compensation that might result from a loan modification. This is Under CMBS servicing agreements, special servicers are required true because, once issued, coupons on REMIC bonds are not to adhere to the “Servicing Standard.” Pursuant to the standard, permitted to be modified. The subordinate debt, held outside of the the special servicer has a duty not just to the CMBS trust but to the CMBS trust, however, is not limited in this way. As a result, assuming “mortgage loan, taken as a whole,” including subordinate notes. As that the special servicer has been successful in negotiating a illustrated in the capital structures below, to the extent that CMBS constructive loan modification with amortization and an increased bondholders are secured by properties with subordinate mortgage coupon, none of the excess coupon can be directed to the CMBS financing (typically in the form of “Rake Bonds” or “B-Notes”), the bondholders and is typically allocated to the subordinate debt. The special servicer has a duty to represent those subordinate holders REMIC structure, in this instance, unintentionally disadvantages as well as the trust holders. Further, if the B-note is credit-tranched the CMBS holders vis-a-vis the subordinate lenders. As a result of and held by multiple parties, it is the responsibility of the special this structural anomaly, many loan resolutions that are deemed to servicer to fashion a resolution that is in the best interest of all be in the best interest of the whole mortgage loan have resulted of the mortgage participants. That is the case even if diverging in the CMBS bonds trading at a discount post-modification, even perspectives exist as to the best resolution for the asset (depending though the bonds are widely expected to repay at par at maturity. upon the relative seniority of the different tranches). A publication of Winter issue 2012 sponsored by CRE Finance World Winter 2012 41


CRE Finance World, Winter 2012
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