- The Line Reports from The Trigild Conference: Special Servicing Perspectives
- November 2, 2010 | Author: Peter K. McKee
- Law Firm: Andrews Kurth LLP - Dallas Office
Kevin Donahue of Midland Loan Services moderated a panel of special servicers from Wells Fargo, Berkadia, Situs and KeyBank to discuss the state of the industry amid signs that "extend and pretend" policies are themselves in transition.
The panelists described different patterns based on their portfolio characteristics:
Wells Fargo's Courtney Boscoe, who handles portfolio and CMBS distressed assets within the bank, said that his group saw a 100% increase in the first half of 2010, but that the outflow in the fourth quarter has so far exceeded the inflow.
Lea Land, who handles CMBS special servicing for Wells Fargo, noted, however, that transfers to special servicing continued to increase, and she expected a second wave of troubled borrowers who would be unable to survive in a persistently weak economy.
Berkadia's Michael O'Hanlon observed differences according to loan vintage: delinquencies among the 1996-2003 cohort of loans peaked six months ago and has been subsiding, while the 2005-2007 cohort's delinquencies were on the rise. The debt markets have opened up, he noted, but there is a pronounced bias toward institutional quality or "core" assets. As a result, most CMBS product will find refinancing to be a struggle.
Clark Rogers of KeyBank saw a leveling of assets transferring into special servicing. Price deflation has subsided, and there is even some pickup in values in certain markets. He saw real problems, though, with the large floating rate loans that were common before the crisis. There is little alternative to dramatically resizing those, he noted.
Jan Sternin of Situs Asset Management recounted her firm's recent experiences in managing a portfolio of 5,000 loans from an array of receiverships: those loans, she said, were moving steadily from sub-performing to non-performing.
What are the drivers?
Land found that hotels were a recurring problem, especially the 1- and 2-star properties. In the office sector, tenants continue to drive rents lower as space demands are recalibrated. Retail and multifamily rents are under far less pressure.
Boscoe saw correlation between CRE delinquencies and areas such as Florida, Arizona, Michigan and California which suffered through residential price bubbles.
O'Hanlon pointed to continuing issues in Phoenix, Las Vegas, Detroit and Columbus in their loan portfolio. He concurred that large floating rate hotel loans were in the last year of their automatic extension and were underwater from valuation perspective. With any increase in rates from their now-historic lows, it will only prove that much harder for them to perform.
Has the pace of resolutions increased?
"Not for land and unfinished subdivisions," said Sternin. "Although discounted payoffs are more frequent." O'Hanlon added: "We're actually getting bids in 2010; in fact, we've sold 125% more in the first half of 2010 than we did in all of 2009."
Is the bid-ask spread narrowing for distressed assets? Said O'Hanlon: “Just getting bids is an improvement." Boscoe thought investor returns were unrealistic in 2009, and cited the example of sub-6% cap rates on a Sacramento apartment project as a sign that those expectations were abating. Land characterized the CRE markets as bumping along the bottom, which prompted Donohue's observation that so much product still has to go through deleveraging and repricing.
So what are servicers doing to address their loan portfolio issues?
Land indicated that Wells was frequently granting extensions and other modifications, and was actively looking to receivers. Donohue said that Midland had increasingly used receivership sales on CMBS assets to keep the debt in place. Boscoe's group at Wells was looking more to note sales, he said, but he added that they were watching for flips and insisting on provisions that amounted to "flip insurance."
Donohue cited Fitch statistics that looked at the correlation between the asset's duration in special servicing and loss severity:
for REO, assets were held an average of 29 months and suffered a 71% loss;
for note sales, assets were held an average of 8 months and incurred a 53% loss; and
for discounted payoffs, assets were held an average of 13 months and experienced a 43% loss.
O'Hanlon pointed out that special servicers have obvious capacity pressure, and that rating agencies and others are looking at "assets per asset manager" metrics.
Are bulk sales the answer?
"They can be effective," said O'Hanlon, "but they tend to work better for smaller assets where the cost of special servicing makes those types of assets more expensive to hold." And what of Lennar's highly touted sale of 240 assets with a $1.2 billion face value? "They have $40 billion in assets," he added, "that's just clearing the underbrush."
What's the biggest problem facing special servicers?
Rogers commented that this cycle has shown that intercreditor agreements do not work well in reverse, echoing other panelists who bemoaned the complexity added by junior participants. Added Sternin: "Complex structures and loan documents often just don't marry well."
What about regulatory impacts?
Rogers said that regulation, while appropriate in modest amounts, added complexity and ultimately chilled innovation. He added: "And we should be wary of unintended consequences."
Sternin described the new regulations as increasing transparency, but the additional reporting adds costs as systems have to be upgraded to accommodate new requirements (the Investor Reporting Package 2.0 is one such example).
O'Hanlon returned to the theme of unintended consequences: "When the FDIC created their loan modification guidance, they imposed a 120% LTV requirement for collateral releases over industry objections. With the deep drop in values from loan origination, many workouts couldn't get done because of the collateral release requirements, and eventually it had to be reworked. It just made no sense."
Donohue then turned the discussion to CMBS 2.0: "What is needed?"
The panelists mentioned that "governance has to be fixed," alluding to tensions that have arisen between senior and b-piece/special servicer interests in particular. But they also pointed to new multi-borrower deals in the market as an encouraging sign, together with new b-buyers entering the market and senior bonds being oversubscribed on current deals.
What about the CMBS borrower? Is anything being done to enhance servicing performance?
"Not really," said one panelist. "Servicer timeliness is still the issue."
What about loan put-backs for breached reps and warranties?
O'Hanlon pointed out that there can be substantial costs incurred in pursuing a breach claim against the loan seller. "There is no special servicer liquidation fee for repurchase pursuant to a breached rep," he concluded.
Donohue said that Midland had had limited success in pursuing buy-backs, but pressure will build if losses continue.