As published in Scotsman Guide's Commercial Edition, February 2012.
By the end of 2011, uncertainty over the future of distressed commercial mortgage-backed securities (CMBS) overshadowed positive signs of lower delinquency rates. Defaults declined this past November after two straight monthly increases, which could indicate that CMBS delinquencies might be leveling off. But observers like Trepp, which tracks CMBS-delinquency data, warned that the retreat of defaults might just be the calm before the storm.
The grounds for these concerns may be valid. Many of the loans that were originated in the 2007 commercial real estate bubble will mature this year. Additionally, the second half of this past year witnessed a curtailing of new CMBS issuance, which puts further upward pressure on the delinquency rate, according to Trepp.
Delinquency rates of distressed CMBS seemed to be on track to improve by the end of this past year, declining 26 basis points to 9.51 percent this past November. This was the second biggest drop in ’11, after a drop of 36 basis points in August. The rate had fallen for four out of the first eleven months in this past year, according to Trepp.
This positive change, or the leveling off in CMBS defaults, is unlikely to be sustainable this year. There has been a large amount of resolutions made in the past 18 months that contributed to this apparent leveling-off activity.
Although the aftermath of the last crisis seems to be behind us, the industry is at risk for another giant wave of delinquencies that is likely to hit this year. Commercial mortgage brokers must keep this in mind and remain on top of the changes in the CMBS industry, which can affect the lending environment.
Before addressing the types of resolutions that have been made so far, it is important to get an overall picture of the special servicers because they are responsible for handling and resolving all distressed CMBS loans.
Special servicers are assigned at the securitization by the controlling-class representative (CCR) — that is the owner of the lowest tranche of bond, which are the ones with the first loss and highest risk. It makes sense that the owners of first-loss bonds would want to control the resolution of defaulted loans because that is what will cause their loss.
Nearly 85 percent of the total current CMBS pools were originated and securitized in 2005, 2006 and 2007. When those special servicers were being assigned, there were few defaults in the industry, and special servicers were staffed based on this level of defaults.
When the first wave of defaulted loans came rushing into the special servicing shops in late 2008 and through the first half of 2010, they were not able to handle all the defaults. Accordingly, delinquency rates increased, and so did special-servicer costs. Because of skyrocketing costs and low profits, most special servicers required recapitalization themselves.
The top three special servicers in the industry, which account for nearly 75 percent of all the business, had the following ownership changes in 2010:
LNR was recapitalized by a consortium of five opportunistic buyers of commercial real estate.
Centerline was bought by Island Capital and changed its name to C-III. Island Capital also acquired J.E. Robert Company Inc.
CWCapital was bought by Fortress.
The important point about these ownership changes is that these special servicers are now owned by companies that have more aggressive “real estate like” return targets. They also have alternative investment motivations, which can make a difference in their decisions regarding the resolution of defaulted loans.
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