CMBS Servicing: What Borrowers Need to Know
Unlike traditional bank loans, CMBS loans are not serviced by the lenders that issue them. Instead, after conduit loans are securitized and sold as commercial mortgage backed securities, they are serviced by third-party companies. In general, borrowers do not have any say in the companies that service their loans; this is decided by the lender.
CMBS Servicing: The Basics
Unlike traditional bank loans, CMBS loans are not serviced by the lenders that issue them. Instead, after conduit loans are securitized and sold as commercial mortgage backed securities, they are serviced by third-party companies. In general, borrowers do not have any say in the companies that service their loans; this is decided by the lender.
In most cases, multiple loan servicing companies will be assigned to a CMBS loan. Day-to-day servicing is typically taken care of by a master servicer. However, if a borrower defaults on their loan, servicing will be shifted to special servicer, who will either attempt to help the borrower become current, or, alternately, will decide to foreclose on the property.
CMBS Pooling and Servicing Agreements (PSAs)
Potential CMBS borrowers should understand that conduit loans are governed by lengthy and complex contracts, known as Pooling and Servicing Agreements, or PSAs. A PSA will lay out the various rights and responsibilities of a master servicer, a special servicer, the investors, and any other relevant parties. On average, PSAs are often 400- 500+ pages long and sometimes contain hundreds of definitions. This can make them difficult to understand, especially as their definitions and rules can sometimes differ from the definitions in the actual loan agreement. However, it is still important for borrowers to read (or have an attorney or advisor read) through their loan’s Pooling and Servicing Agreement, in order to understand exactly what will be expected from them.
The Role of the Master Servicer
Master servicers are generally responsible for handling everyday issues, such as collecting and receiving collecting monthly mortgage payments and required escrows, paying insurance premiums and real estate taxes, maintaining books and records related a borrower’s loan, and keeping tabs on a borrower to prevent issues that could lead to a loan default. While master servicers can usually handle small borrower requests, such as lease approvals and minor credit issues, for larger issues, such as loan assumptions, they will often need approval of the special servicer, as well as the investors. In some scenarios, a master servicer may actually assign a secondary servicer, known as a primary servicer, to execute many of the everyday functions that they are responsible for.
The Role of the Special Servicer
If a conduit loan goes into default, a special servicer will take over the servicing of the loan. In most cases, this is a separate firm, but some situations, one servicer will carry out the functions of both a master servicer and a special servicer. In an ideal situation, the special servicer will do everything they can to help the borrower get current on their loan, avoiding a foreclosure. However, the special servicer’s responsibility is to the investors, not to the borrower. In fact, in most CMBS deals, the b-piece buyers (the bondholders with the riskiest class of CMBS) actually get to choose the special servicer. Since they are the last group of bondholders to get paid if the borrower defaults on their loan, b-piece investors often want to be able to choose a special servicer they believe will work diligently in their best interests.
Unfortunately, some special servicers have a reputation for putting their own needs before that of both investors and borrowers. Due to the fact that special servicers often have the right to acquire a foreclosed property at a discount, some firms will intentionally foreclose on a property simply in order to purchase it. However, it should be noted that b-piece investors can replace a special servicer at any time if they believe the firm is not acting in their best interests.
It’s important to keep in mind that borrowers generally do not have any control over which servicing companies work on their loans; however, they may be able to find out which ones are assigned before signing a loan agreement. If a deal has a special servicer with a particularly bad reputation, a borrower may want to think twice before signing on the dotted line.
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Related Questions
What is CMBS servicing and how does it work?
CMBS servicing is the process of managing a CMBS loan after it has been sold on the secondary market. It is typically handled by a third-party loan servicing firm, known as a master servicer. The master servicer will handle a borrower’s payments and any additional paperwork that is required after the loan closes. They will also generally be responsible for answering any questions that a borrower has during the term of the loan. If a borrower defaults on their loan, servicing will be shifted to a special servicer, who will either attempt to help the borrower become current, or, alternately, will decide to foreclose on the property.
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What are the benefits of CMBS servicing for borrowers?
CMBS loans can provide the highest leverage loan a borrower can get for properties in secondary and tertiary markets. Additionally, if a borrower has difficulty making payments, the loan may be sent to a special servicer, which may be able to modify loan terms, forgiving or deferring a certain amount of interest or fees in order to help the borrower get current on their payments.
Source: The Pros and Cons of CMBS Loans: A Guide and CMBS Loans for Commercial Real Estate
What are the risks associated with CMBS servicing?
CMBS loans may provide a poor loan servicing experience due to the fact that they are not serviced by the initial CMBS lender, but instead are hired out to a third-party servicer. This third-party servicer may not have the borrower’s best interests in mind. Additionally, borrowers may be required to conduct either yield maintenance or defeasance in order to repay their loan. Furthermore, borrowers who have trouble repaying their loans are unlikely to get any form of forbearance or foreclosure/default prevention assistance, and instead may default on the loan relatively quickly. Lastly, CMBS financing may also have strict enforcement of prepayment penalties, higher closing costs, and dishonest tranche ratings which can have serious negative effects for borrowers and investors.
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What are the key considerations for borrowers when selecting a CMBS servicer?
When selecting a CMBS servicer, potential borrowers should understand that they will not be dealing directly with their lender after their loan has been securitized and sold to investors. Instead, they will work with a master servicer, a company which specifically works to administer conduit loans. In addition to collecting payments, a master servicer (or a company they have contracted) is responsible for inspecting the property and taking care of other administrative functions. Source
Potential CMBS borrowers should always make sure to hire highly experienced counsel to review all their loan documents before they sign anything. Of particular importance is the loan’s Pooling and Servicing Agreement (PSA), which identifies the names, rights, and responsibilities of the special servicer and the master servicer. As some of these agreements are 500+ pages long, borrowers will want a qualified attorney experienced with CMBS financing to review them and point out any potential concerns before they move forward with the closing process. Source
A potential downside for conduit borrowers is the fact that these loans are not generally serviced by the lenders themselves. Instead, they’re assigned to a master servicer, which is a company specifically tasked with servicing loans. These companies may not have a borrower’s best interests in mind. Their sole remit is typically to work to further the interests of the CMBS investors. Source
In summary, key considerations for borrowers when selecting a CMBS servicer include understanding that they will not be dealing directly with their lender after their loan has been securitized and sold to investors, hiring highly experienced counsel to review all their loan documents, and understanding that the master servicer may not have the borrower's best interests in mind.
What are the most important terms and conditions to consider when negotiating a CMBS loan?
When negotiating a CMBS loan, the most important terms and conditions to consider are:
- Non-recourse
- Competitive rates for long-term financing
- Relatively high leverage
- Flexible loan sizes
- Cash-out refinancing options available
- Borrowers with credit and legal issues may qualify
- Relatively relaxed borrower net worth requirements
- Mezzanine financing and preferred equity may be arranged in some scenarios
- Difficulty releasing collateral
- Expensive to exit (long lock-out periods may require defeasance in order to exit the loan early)
- Dealing with a master servicer may be challenging for borrowers
- Reserves required
- Secondary financing is sometimes prohibited
- Loans are fully assumable
- Legal fees can be particularly expensive
For more information, please visit www.commercialrealestate.loans/cmbs-loans and cmbs.loans/blog/cmbs-primer.