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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   March 2017

Options Are Few When a CMBS Note Is Due

Borrowers can pay off the loan, make a deal with the servicer or return the deed

For a nonrecourse commercial mortgage-backed securities (CMBS) loan, there are only three options for an owner at the maturity date of the loan.

The owner can pay off the loan, strike a deal with the servicer or return the deed to the property to the lender/trust. Of course, the first option is one everyone is clear on and, if at all possible, it is the option the owner should choose.

For the more than $40 billion of overleveraged CMBS loans maturing this year alone, however, paying the loan off at maturity is not an option to pursue lightly. For commercial mortgage brokers dealing with clients who are coping with or affected by a maturing overleveraged CMBS loan, it’s important to understand the choices available, as well as the consequences.

Payoff or a deal

Let’s say a property owner owes $50 million on a CMBS loan maturing in 2017, and the property value is only $30 million at the time of maturity. To pay off the $50 million CMBS loan, the owner could sell the property — hopefully for at least $30 million — and then pay the remaining $20 million out of pocket. Alternatively, the owner could get a new loan for about $22.5 million (assuming a 75 percent loan-to-value ratio on the $30 million property) and then come out of pocket for the additional $27.5 million to pay off the loan. Neither of those options will be attractive to most owners.

Doing a “deal” with the loan servicer is much more complex, because the owner would first need to figure out what kind of “deal” is necessary. A simple extension of the $50 million loan would likely not be a deal the owner would want to pursue, unless there is a clear method to recover $20 million or more of value from the property during the extension period — typically not more than three years. If the value of the property is only $30 million and the loan is $50 million, it is unlikely the property income could even support the monthly payments on the $50 million loan.

Another important factor to consider is that the owner would need to be willing to invest significant new money to make the deal happen. New “skin in the game” is almost always a requirement for doing a deal with the servicer. So, ultimately, the owner would need to be willing to put more money into an already overleveraged property to have any chance of making a deal with the servicer. 

Return the deed

Handing the deed to the property back to the lender/trust may seem like the easiest fall-back position of the three options available. If a deal can’t be struck with the servicer that makes sense for the owner, and the loan can’t be paid off, then the property can just be handed back.

There was a time when we called this process “jingle mail” (a reference to actual keys being mailed to the servicer). Unfortunately, for nonrecourse CMBS loans, the typical carve-out guarantee prevents the owner from just mailing the keys back — at least, not without significant consequences. Carve-out guarantees are meant to protect the lender against actions by the borrower that could erode the value of the loan collateral.

In any event, the servicer has to agree to accept a deed in lieu of foreclosure or some form of “friendly foreclosure,” and they are not always willing to do so. It may seem the owner has the upper hand when wanting to hand back a property on a nonrecourse loan, but that is not so.

Borrowers can’t simply send ‘jingle mail’ and wash their hands of over-leveraged CMBS loans, or they risk carve-out violations.

Let’s assume the $30 million property in our scenario is a struggling mall with many vacancies. Remember that the loan is $50 million in our example. The owner approaches the servicer with a request to hand the property back and the servicer agrees. 

The owner is anxious to make this happen sooner rather than later to get the pain over with. Keep in mind, however, the servicer will not be in a rush to make this happen and, in fact, will want to be sure all of its ducks are in a row — for example, ensuring there are no environmental issues with the property, that the property value is fully understood and that full approval has been received from everyone involved.

That means before the servicer will do anything to actually take the property back, they will first order an appraisal, a property-condition assessment, a survey, a Phase I environmental site assessment, and a title report. At best, it is likely to take 90-plus days before the servicer gets all the necessary approvals to move forward with taking back the property.

Laws of the land

During the property-review process, the servicer also will determine whether they would prefer to take a deed in lieu of foreclosure from the borrower, which the borrower would always prefer, or to go through the formal foreclosure process, which is the preference of the servicer. That decision is partly driven by the foreclosure laws of a given state.

In Texas, for example, the process from filing notice to conducting the actual sale can take as little as 41 days. In other states, that process can take longer than a year because of foreclosure laws and backlogs of legal-notice filings. In a state where the process takes a long time before servicers can get to properties, they may be more willing to consider a deed in lieu of foreclosure.

While this process is going on, the servicer may act to have a receiver appointed, or they may not. If a servicer doesn’t move for a receiver, guess who is stuck continuing to ensure the property is cared for in accordance with the loan documents? You guessed it, the borrower. Remember, borrowers can’t simply send “jingle mail” and wash their hands of overleveraged CMBS loans, or they risk carve-out violations.

Environmental effects

Now, imagine this multifaceted process compounded by the possibility of a report revealing environmental contamination on the property that is securing the CMBS loan. Maybe the contamination isn’t even the result of something done by a property tenant. It could have been the result of a groundwater pollutant seeping into the soil of the property.

The servicer will not move to put its name in the chain of title to an environmentally contaminated property until the contamination is fully remediated. That could take months, even years, depending on the nature of the contamination. All the while, the borrower is quite possibly stuck in the same position of liability unless the servicer decides to pursue appointment of a receiver.

Now, clearly, this is an extreme scenario that rarely happens. It is much more common that the servicer will decide to take back the property from the borrower — in their own time.

The most important thing a borrower can do once a decision has been made to give a property back to a servicer is to guard against the potential of a nonrecourse carve-out guarantee violation. That means the borrower will likely need to be willing to trade speed for security.

•  •  •

In the long run, when attempting to make a deal with a servicer, it is prudent to bite the bullet and let the loan- and collateral-review process run its course, even though it may take much longer than hoped to resolve a maturing overleveraged CMBS loan. That’s still a better option for the borrower than simply pitching the keys back to the servicer and running the risk of a costly legal battle over nonrecourse carve-out violations. 

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