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CRE Finance World, Autumn 2012

Improve CMBS Servicing Quality? Change the Business Model The value of commercial mortgage servicing rights is based on the through new issuance. Servicing profit margins are difficult to contractual right to receive a number of revenue streams. A portion maintain when portfolio loan counts decrease. The economics of the servicing fee represents compensation for the services associated with managing a portfolio of long term, fixed rate associated with the primary and master servicing activities. A mortgage servicing rights is challenging. large portion of the servicing fee represents excess interest that could either be allocated by the issuer to interest only bonds or the In addition to the issues related to profitability in managing a servicing fee. Typically the aggregate servicing fee is increased commercial servicing business in today’s economic environment, the to include this excess interest strip, which results in a revenue accounting for mortgage servicing rights creates further challenges. stream higher than the cost to service. The servicing fees are Because commercial mortgage servicing rights represent a long expressed as a fixed term, non-terminable contractual revenue stream, they are accounted “The residential mortgage percentage (typically for as an asset on the servicer’s balance sheet. The value of this servicing business has received in basis points) of the asset amortizes over time as revenues are realized and the duration considerable attention from outstanding principal of the future cash flow streams shortens. Additionally, the value regulators to ‘fix’ structural balance of each loan. of mortgage servicing rights is subject to regular mark-to-market issues, and improve servicing These servicing fees valuation analyses. Changes in the value of the mortgage servicing quality and responsiveness. decline over time rights assets as a result of reductions in projected cash flows will Fortunately, CMBS servicing as loans amortize, cause impairment charges. Higher defaults and resulting involuntary is not similarly broken.” mature and payoff, prepayments, lower interest rates than projected or increased or are liquidated by servicing expenses can result in mortgage servicing right impairment the special servicer. charges. These charges are a direct reduction of earnings for the Additionally, servicers owner of the servicing rights. Impairment charges for mortgage receive revenue associated with the interest earnings (“float”) from servicing rights create earnings volatility, which could be a serious debt service payments, escrow and reserve deposits and payoffs. issue for public companies and regulated financial institutions. The revenues from float are dependent on short-term interest rates. The primary and master servicers also receive a portion of the One further complication related to commercial mortgage servicing borrower paid fees associated with asset management activities rights is the proposed new regulatory rules. The pending Basel such as assignments, assumptions and defeasance. The revenues III capital requirements are punitive for commercial mortgage associated with borrower paid fees are compensation for episodic servicing rights. The additional capital requirements for mortgage events, and are generally shared with special servicers. In some servicing rights will result in a reduction in the associated returns cases, these fees are capped at a fixed dollar amount. on investment and therefore, their value. Additionally, Basel III may increase the capital required for CMBS master servicing advances, Servicing expenses generally increase over the life of a CMBS increasing serving costs and further reducing the value of the transaction as a result of inflation and increased servicing activity. mortgage servicing rights. The to-be-developed Dodd Frank risk The costs related to primary and master servicing for delinquent retention rules may also have an impact on the sale of servicing or defaulted loans transferred to a special servicer are significantly rights as part of the securitization sponsors’ profits at issuance. higher than for performing loans. Servicing for specially serviced loans has a variety of activities that require experienced loan administrators, All of these economic issues create problems for servicers related manual interactions with the special servicer, re-boarding of loans to the acquisition of future CMBS mortgage servicing rights. The after modifications, servicing advance administration and increased result will be lower valuations and reduced proceeds to the issuers reporting and surveillance. In the current economic environment who are selling the servicing rights. A fee-for-services business primary and master servicers are faced with much higher workloads, model eliminates the regulatory and accounting issues for servicers, record low short term interest rates and shrinking portfolios as and will create a much stronger and more competitive CMBS loans payoff or default at a much higher rate than can be replaced servicing market environment. A publication of Autumn issue 2012 sponsored by CRE Finance World Autumn 2012 11


CRE Finance World, Autumn 2012
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