FEATURE ARTICLE, MAY 2012

PRACTICAL TIPS FOR CMBS BORROWERS
Yes, special servicers have wiggle room.
Ann Hambly

Did you know that your specific special servicer and controlling class representative (“CCR”) assigned to your pool is what matters most when you are seeking a restructure of your CMBS loan? That was never clearer to me than in a recent restructure we worked on with an owner of a retail property in Las Vegas that had suffered as a result of the local and national economy.

At the height of the CMBS market in 2007, the value of his property was well over $20 million, and, like many other owners, he got a new CMBS loan that year for $17 million.

His anchor tenant vacated the center in 2010 and cash flow was not even close to the amount required to keep the loan current. Like many good owners, he kept feeding the property while he made it clear to his master servicer that he needed some relief. Well, everyone knows by now that a master servicer cannot give him any relief — that is not its job. He had never defaulted on a CMBS loan before and did not realize that. Eventually, he used up all his spare money and stopped feeding the property. His loan was eventually transferred to the special servicer. The special servicer can offer him relief, if warranted.

He and his special servicer worked for many months and eventually agreed upon a restructure of his loan. One of the first things special servicers must do when a loan is transferred to them is to determine the value of the property. They typically do this by ordering an MAI appraisal and a few brokers’ opinions. The special servicer had determined that the value of this property was less than $7 million; they had a property worth about $7 million and a loan of $17 million. Since the loan was originated in 2007, there was sufficient term left on the loan to possibly conclude that the value of the property could increase to the loan amount by the maturity date in 2017. The restructure they agreed to was known as an AB structure and it was structured like this:

•They bifurcated the existing note into two parts — an A and a B.

•The A note is typically equal to the property’s value and will be the new debt that is serviced by the property’s income. In this case, the A note was $8 million.

•The borrower was going to contribute $3 million of new capital that would be held by the trust and could be used for future tenant improvement, leasing commissions and other capital expenditure needs.

•The B note was the difference between the original note and the A note — or $9 million.

•At sale or refinance of the property at maturity, the funds would be distributed in this order (known as a waterfall):

• First to pay off the A note;

• Second to pay back the borrowers new capital, plus a preferred rate of return on that money;

• Then, all remaining proceeds would be split 50/50 between the borrower and the B note (and only to the extent that the B note is satisfied).

That seemed like a good resolution for all. Upon final approval of the deal, the borrower wired his legal retainer to the special servicer’s lawyer and the deal was documented. There were various versions of the modification document that circulated and then everyone was eventually ready to close. And then, out of nowhere, things went silent. The borrower was having a difficult time getting a straight answer about what had happened to his deal. He became frustrated and desperate. Then, the answer came.

The pool his loan was in had suffered a significant amount of losses. Unbeknownst to the borrower, many other loans in the same pool as his were being resolved daily and losses were being passed through the pool. Losses are all borne by the lowest class of bond holders first — the CCR. The CCR is also the group that selects the special servicer. So, at some point in the process of documenting his AB structure, enough losses passed through the pool to wipe out the current CCR.

The new CCR in the pool decided to appoint another, completely different special servicer.

So, we all assumed that the new special servicer would pick up the file and continue with the deal as was previously structured. We were wrong.

This special servicer decided to take a totally different course of action and would not agree to continue with the AB structure at all. This special servicer decided to put the loan in an upcoming note auction, which put the future of the borrower and his property completely at risk to the winner at an auction. The borrower was told that he was welcome to bid on the note, of course, if he so wanted.

The borrower had owned this center for a long time and had every intention of continuing to own it and that is why they had agreed to fund $3 million of new capital to get the modification done. They were not interested at all in just participating in a note auction and hope that they win the deal. They had too much on the line.

Ultimately, after much negotiation, the special servicer agreed to sell the note directly to the borrower for under $10 million. However, the borrower had 5 days to agree to the new deal and wire the entire $10 million, or he would possibly lose his deal at the auction.

So, one day this borrower had an AB structure all ready to close with an A note of $8 million, $3 million of new capital and then a 50 percent split of proceeds after that to the trust. The next day, he wired a sum of money and owned his whole note and all for less money than he would have had to pay under the AB structure, all because the special servicer and CCR changed during the process.

Now, rest assured that special servicers do have a servicing standard that they all must operate under. We, as human beings are all supposed to abide by the 10 commandments too, but I can assure you that there is a ton of wiggle room within all those standards.

Ann Hambly is the founder and co-CEO of 1st Service Solutions, a borrower advocacy firm based in Grapevine.

©2012 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 553-9037.