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CRE Finance World, Winter 2012

Special Servicing — Challenges and Recommendations An alternative to the typical REMIC structure is a “Grantor Trust” of its economic investment (typically 75%) through application of structure, although it can only be used in single borrower transactions. realized losses, or, in the case of rake bonds and B-notes, through Unlike REMIC structures, grantor trust structures permit bond appraisal reductions / ASERs (Appraisal Subordination Entitlement coupons to be modified in connection with a loan modification. Reduction),1 whereupon the controlling holder designation shifts to A grantor trust structure was employed in the $7 billion GSMS the next most senior class that is still “in the money.” In instances 07-EOP CMBS (“EOP”) transaction, one of the largest stand-alone where the controlling holder owns a B-note, they are allowed to post CMBS issuances ever. collateral to “true-up” their investment and retain their controlling holder status. Talmage, LLC was an Operating Advisor for the EOP restructuring that was completed in December 2010. A cornerstone of the For the most part, the controlling holder concept makes sense, transaction was taking advantage of the increased grantor trust particularly in a stable and/or gradually declining market. However, flexibility to pass through additional coupon to the CMBS investors. in an environment where asset valuations are rapidly declining, In addition to significant amortization, additional collateral and CMBS mechanics do not always react quickly to such changes, increased compensation to the CMBS Trust, Blackstone, the sponsor, and controlling holder status may be slow to migrate up the capital was able to opportunistically retire substantial portions of the structure. In these cases, a controlling holder (who appears to mezzanine debt at a discount, thereby deleveraging the transaction be clearly out of the money and to no longer retain an economic and increasing its alignment with bondholders. As a result of these interest on a “spot” basis) may be allowed to remain in place and efforts, the EOP transaction was quickly removed from special to dictate a special servicing resolution that unduly benefits their servicing and all of the bond classes have traded at or near par unique interests. Although special servicers are required to adhere since the completion of the modification. to the servicing standard and act for the benefit of all constituents as a collective whole, whether any particular loan resolution meets Since the REMIC structure eliminates many of the special servicer’s that standard is a subjective judgment and the controlling holder is tools that can benefit the CMBS trust (primarily increased interest in a position of significant influence over any loan resolution. compensation), special servicers will typically seek to maximize amortization to the trust, keep loan extensions relatively short, In many cases, the status of the controlling holder is determined by increase reserves and create alignments and incentives for the the property values underlying the CMBS. However, new appraisals borrower to accelerate the repayment of the loan (such as rate are not typically required until 60-90 days following a monetary step-ups outside of the trust over time, modified release prices default and/or the loan’s maturity. Additionally, the special servicer to incent asset sales, and cash flow traps). often has up to an additional 90 days to complete the appraisal process. Remarkably, therefore, in an adverse economic climate Is the Controlling Holder Concept Flawed? where property values are declining precipitously and time is of the In a typical CMBS transaction, the majority holder of the junior-most essence, the special servicer by contract can delay the valuation mortgage interest (whether the BB - NR CMBS bonds, the rake process for up to six months. Furthermore, since the appraisal process bonds” or the junior-most B-note) is designated as the controlling has many subjective elements (such as capitalization rates, discount holder and appoints the special servicer for the underlying loan rates, absorption rates, rental rates, etc.) and is exclusively controlled or pool of loans. In most CMBS conduit transactions, the B-piece by the special servicer, we have not been surprised to find numerous buyer (the purchaser of the most junior bonds, typically “BB” self-ordered appraisals that kept the controlling holder (and special through “NR”) is a special servicer (e.g. LNR, CWCapital, C-III servicer) in place by the slimmest of margins. Asset Management, etc.). Even where the controlling holder is not itself a special servicer, it generally has the right to appoint While generally supportive of the controlling holder concept, we a special servicer of its choice. feel that the timing of the appraisal process should be significantly accelerated and that measures should be taken to make ASER Investors at the onset are satisfied with this arrangement because appraisals truly objective. Too often, we have seen controlling holders the controlling holders/special servicers have “skin in the game” who were clearly “out of the money” direct a special servicing and have aligned interests for maximizing trust asset recoveries. solution to create an “extend and pretend” loan at the expense The controlling holder will remain in place until it has lost a majority of the senior CMBS trust. CRE Finance World Winter 2012 42


CRE Finance World, Winter 2012
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