Special Servicers Handle CMBS Loans Before and During Defaults
Unlike loans from banks and private lenders, CMBS loans are not serviced by their original lender. During the CMBS loan origination process, the borrower is assigned a separate servicing company, referred to as a master servicer. If the master servicer is large, they may further assign the loan to a primary servicer, also known as a sub-servicer.
However, this servicing arrangement only continues as long as the borrower remains current on their payments and avoids going into financial or technical default. CMBS loan borrowing covenants can be strict, and even if a borrower is current on their payment, if they fail to send required documentation to their servicer on time, lose a major tenant, or make unapproved upgrades to their property, their loan could go into a “technical default.”
When a CMBS loan goes into default or looks like it’s approaching default, the loan is assigned to a new servicer, called a special servicer. Like the other servicer, the special servicer’s obligation is to the investors in the commercial mortgage-backed securities that the borrower’s property collateralizes. The special servicer will take the steps it deems appropriate to ensure that bond payments continue as expected for the CMBS investors.
This could include engaging in a loan workout or modification, which could include forbearance. When a forbearance is issued, a borrower’s payments are reduced or eliminated for a specific amount of time, though they will generally be required to pay their loan payments back later, potentially with additional interest and fees. In more severe situations, such as when a loan’s debt service coverage ratio (DSCR) has fallen well below 1.0x, or if the borrower has committed fraud, the special servicer may attempt to go to court to repossess the property.
Special Servicers, CMBS Loans, and Property Repossessions
While some special servicers are relatively accommodating to CMBS borrowers and take a variety of actions in an attempt to get the borrower current on their loan, other special servicers may not be so accommodating and may attempt to take advantage of the situation to further their own financial interest. This is party because special servicers do not have a financial incentive to help the borrower; if the borrower gets back on track with their loan payments, the special servicer no longer gets paid.
However, the larger concern is that the special servicer may simply want to “steal” the property from the borrower. Once repossessed, the special servicer generally has the ability to purchase the property themselves, often at a steep discount. In addition, the longer they hold onto the property, the longer they receive special servicing fees. There is little to prevent this, as there are no governing officers or practical checks and balances on the special servicer’s activities.
A 2018 report determined estimated that 615 properties worth almost $22 billion were held by special servicers. Technically, IRS rules mandate that a special servicer can only hold onto a property for three years after repossession, however, these rules are often flaunted. In these cases, the special servicer is neither acting in the investors’ nor the borrower’s best interests.
However, property owners do have the legal ability to fight back, particularly in especially egregious scenarios. While litigation is expensive, it can help a borrower save their property from foreclosure. It’s important to note that borrowers often have more leverage when they have defaulted due to a technical reason rather than a financial reason (this is typically referred to as a non-monetary default).
For example, some technical defaults have occurred for relatively ridiculous reasons, such as for peeling paint on the door of a building’s apartments. This type of default is unlikely to hold up in court. Some states, but not all, do require a special servicer to “act in fair faith and good dealing.”
In addition, legal action may spur the CMBS investors to fire and replace the special servicer, which they have the legal obligation to do. A new special servicer may be more reasonable and attempt a loan workout rather than the foreclosure on the subject property.
Special Servicers and Pooling and Servicing Agreements (PSAs)
Technically, the abilities of special servicers are governed by pooling and servicing agreements. These generally established the rights and responsibilities of the borrower, the special servicer, the primary servicer (if there is one), and the special servicer.
Unfortunately for borrowers, many PSAs are 500 to 1000 words long, making them very difficult to understand and giving the special servicer wide leeway to act as they please. This is one reason why it’s so important for conduit loan borrowers to hire a highly experienced CMBS lawyer prior to signing a loan’s PSA.
The PSA will typically define the exact rules involved with special servicing and will also identify the special servicer that the loan will be assigned to in case of default. Some special servicers are notorious for bad behavior, so a borrower may wish to attempt to change the assigned special servicer (or even look toward a new lender) if they are assigned to a special servicer with a bad reputation.
It’s also important to realize that many elements of a PSA can be negotiated prior to the closing of a loan. Some are set in stone due to the legal obligations regarding the securitization process, but others, particularly regarding the situations in which a loan may go into a technical default, and when a special servicer may attempt to repossess the property, can often be negotiated during the closing process.
Who are the Largest Special Servicers in the U.S.?
It may be useful for potential borrowers to note the largest special servicers in the U.S. so that they can research each of them before agreeing to a CMBS pooling and servicing agreement. Currently, the largest special servicers in the U.S. include:
PNC
CWCapital Asset Management LLC
KeyBank
BNY Asset Solutions, LLC
Bank of America
CBRE Loan Services
Key Commercial Mortgage
Lument
LNR Property LLC
Midland Loan Services, Inc. (now part of PNC)
Ocwen Financial Corporation
Prudential Asset Resources
Situs Servicing, Inc.
TriMont Real Estate Advisors
Wells Fargo Commercial Mortgage Services
This list may also be useful for distressed real estate or distressed note investors, who may be able to buy these real estate-owned (REO) properties directly from the special servicer, or, alternatively may be able to buy distressed notes from these special servicers.