Just so we are all on the same page: Special servicers effectively serve as middlemen to troubled loans. A special servicer services loans that are delinquent in repayment, matured without pay off, or are current but have some sort of existing credit issues with the tenants or borrowers. Loans enter special servicing when they are more than 60 days behind in payments, have matured, or a default has occurred or is imminent. Depending on the situation, the special servicer has leeway to modify/extend the loan, agree to a forbearance/workout, or they can choose to foreclose. The special servicer is contractually bound to act so as to maximize recovery for the lender/note holder.
According to Morningstar & Fitch Credit Ratings the following asset categories all are in the midst of massive oversight and control by special servicers:
1) CMBS: CMBS loans in special servicing at the end of January 2012 totaled $82.3 Billion, with another $5.3 Billion added in February alone. Add to this, another $140 billion of loans on the “Watchlist.”
2) US Commercial Banks: At the end of 2011, U.S. banks held on to $27.9 billion in foreclosed loans as REO properties and continued to hold $91.7 billion in seriously delinquent loans. Of those delinquencies, $19 billion had already been restructured at least once before!
3) Fannie Mae: Published reports claim that at the end of 2011, Fannie Mae reported having 385 seriously delinquent multifamily loans on its books with unpaid loan balance of about $1.1 Billion. Additionally, Fannie is holding 260 REO properties at a value of approximately $575 Million. It is generally believed that Fannie Mae’s level of distress is far higher than is being publically disclosed.
4) Freddie Mac: At the end of 2011 Freddie reported $129.2 million in nonperforming loan assets. It held 19 multifamily REO properties valued at $20 million at the end of 2011.
As significantly daunting as these numbers are, there remains a considerable mystery surrounding what roles these special servicer firms play and the full extent of their rights. Also, what are the real factors which motivate special servicers? Is it their fees? Affiliation with certain bondholders? Or is it a desire to purchase and hold the collateral for their own account?
We are clearly seeing that each servicer is different and it is impossible to predict how each servicer will react and why. For that reason, it is best to be prepared. Here are a few suggested steps in your process of negotiating with special servicers:
Step #1 – Get Organized: It is critically important that you fully understand the position you AND your property are in. A good special servicer will know the loan documents, including whether there are payment guaranties or whether recourse has been triggered under a non-recourse carve-out guaranty. They will know what reporting they are entitled to and what remedies they have at their disposal. It is important that you, too, understand the documents and what rights the lenders have and what rights they don’t have. In addition, take time to analyze the performance of the property and look to strategies to improve your property. Arm yourself with a sound and compelling business plan to present to the Servicer that shows you understand how to financially stabilize your asset.
Step #2 – Know the Beast: You must find out everything you can about the servicer. Clearly, the first step is to identify the asset manager and potentially their chain of command. Also, you must understand the roll of your servicer because they are under a servicing agreement with the note holder. This servicing agreement clearly dictates the “servicing standard” by which they must adhere.
Step #3 – First Impressions are Everything: If you are going to make discussions work to your advantage, you must fall over yourself to be friendly. Let’s face it, we’ve all had many successes in the real estate world and maybe you deserve some recognition of your years of experience, but that means nothing now. There is a really strong chance that the first and primary point of contact will be a junior asset manager who doesn’t care about your track record. This asset manager is also probably completely overwhelmed and time is extremely valuable to them. Every effort needs to be taken to establish a respectful relationship no matter what you think of their qualifications or desire to make a deal.
Step #4 – Put it in Writing: The servicer must have a physical written plan in order to respond to you. The plan must be clear, well thought through and stand on its own merits. Importantly, the plan must be respectful of the servicer’s own guidelines which require them to maximize the recovery to their bondholders. If your plan is too far outside these guidelines, ultimately you will be wasting your time…more importantly, wasting THEIR time. Don’t be discouraged as these servicers do have a certain depth of flexibility to resolve your situation.
Step #5 – Beware of Motivating Interests: Special servicers are required to act in the best interest of their bondholders, but they also can be motivated by other factors. These other factors can create a conflict of interest that could constitute a breach of the servicing agreement. These factors include servicers being in direct contact with the controlling note holder or the affiliation with another group with an interest or influence on the note. Specifically, with four of the five largest special servicers having been acquired by real estate investors in the past two years, there is likely a motivation on the part of special servicers to acquire real property collateral for their own account. Understanding these motivating factors and determining which of them exist in your case will help you formulate the best proposal that is most likely to be approved.
Step #6 – You Can’t Predict a Response…or Can You? Gain some leverage: Although you priority is to be respectful, organized and conciliatory to the servicer, you do have some rights to protect yourself with. You need to be knowledgeable of those rights and prepared to use them as necessary. Servicers are very cautious of impinging on your rights because they do not want to be sued for breaching the terms of their servicing agreement. Also, it is important to consult with an attorney regarding any possible lender liability claim.
So what does this all mean? Special Servicers have become the new major “players” in real estate. With traditional capital (for the most part) exiting the business, and securitization available for only “A” assets, banks undercapitalized and over regulated, it is the private capital providers who will be the winners, along with the Special Servicers. For years to come, transactions involving Special Servicers will be common-place driving more opportunities for private capital players.
The firm David B. Norton has encountered all of the challenges inherent in a vast portfolio of distressed real estate assets and has crafted strategies and solutions to maximize the value of these investments while providing these services to its clients.