It is said that the devil is in the details. If that's true, then investors, who are quite naturally doing all they can to maximize returns, should pay special attention to which firm is servicing the loans in their CMBS transaction. Handled correctly, that detail -- which can affect everything from routine payment of taxes, insurance, principal and interest, to decisions concerning liquidity, workout and foreclosure, in the event a loan goes into default -- might just prove to be the investor's saving grace.
"A good servicer can make a bad deal good, and it can make a good deal a little bit better," says Paul S. Klick, president and CEO of EQ Services Inc., an Atlanta-based subsidiary of Equitable Real Estate. "But a bad servicer can potentially make a good deal bad, and it won't do anything for a bad deal.
To see just how much value loan servicers can bring to a CMBS deal, it's important to understand their role in those transactions.
The servicer's responsibilities include collecting payments every month, keeping the books and records related to that, maintaining escrows, real estate taxes and insurance, and monitoring the underlying collateral of the loan to make sure that, if there are any problems, the servicer and investors are aware of them before they manifest themselves in a default.
"Basically, the servicer collects the payments on a monthly basis, puts them together with a series of reports and transmits those to the trustee, who then takes those moneys, divides them up among the various bondholders and distributes them," explains Stacey M. Berger, executive vice president of Kansas City-based Midland Loan Services,.
Several types of servicers can be involved, but the one heading the team and monitoring the other servicers is called the "master servicer."
"The master servicer is there to oversee the deal, make sure terms of serving agreements are maintained and facilitate timely payment of interest and principal," says Irene Rundblom, group vice president for Duff & Phelps in Chicago.
In some CMBS deals, the master servicer actually farms this type of administration of performing loans out to a "primary servicer" or "subservicer." In other cases, the master servicer may perform all the servicing functions himself.
When a loan goes into default, the master servicer in a CMBS transaction also has the responsibility, typically, of providing servicing advances.
"The servicer advances the principal and interest that would have been due," Berger says, "so the bondholders continue to get what they expect in terms of principal and interest. Then, to fund the property protection expenses -- real estate taxes, insurance, foreclosure and marketing expenses -- the servicer also advances those."
Obviously, it is necessary that the master servicer have the financial resources to allow him to meet this obligation. "The strength of the servicer and the likelihood that the servicer is going to be there for the long run is very, very important," cautions Dan Rudgers, managing director of Bankers Trust, New York.
A "special servicer" may be called in when a loan in a CMBS transaction goes into default.
Berger explains that the special servicer, which also may be the master servicer, is "responsible for evaluating circumstances and then determining what the best alternatives are and implementing those. That may be, if the loan has matured and the borrower can't pay it back, to extend the loan. It may be to do a modification or workout or restructure, or it may be to foreclose and take the collateral back and then sell the collateral."
"The special servicer is probably of more importance to subordinate piece buyers," notes Rundblom. "That's why you find a lot of sub pieces wanting either to be or to control who the special servicer is. They're there to work out any troubled loan, and their abilities -- how fast they move, how well they do their job -- can have an impact on what your ultimate proceeds are, on how the loans are worked out and if they have to be liquidated, what your total proceeds are. All that is important to all the certificate holders, but primarily to the sub piece ones, because the lower you go in the waterfall of classes, the higher your risk is."
As noted, some servicers will handle everything from master servicing to special servicing. That "one-stop-shopping" is another way a servicer can add value to a CMBS deal, according to Rudgers. "Reducing the overall cost of the transaction by reducing the number of players involved is probably, in the end, the most important thing to a lot of the folks in this industry," he says.
"The nature of CMBS deals is different from single-family," notes Jeffrey D. Whitlatch, senior vice president, business development, of EQ Services, "where you have uniform product type and smaller loan balance. You move to commercial deals, you have much larger transactions, different types of product and different geographic locations.
"These transactions have a different set of criteria and obligations because they're in a public arena," Whitlatch continues. "They're complicated transactions: each one's different, they have sophisticated movement of moneys, sophisticated lock-box arrangements that you have to deal with, and, I think, the biggest thing is you have to have an understanding of the viewpoint of the investors."
"It is of paramount importance that people who do commercial servicing have a real strong, in-depth knowledge in the real estate industry -- what we call a full-service, 'cradle-to-the-grave' approach," says EQ's Klick. "They have to have a very good understanding of how real estate works, in addition to all the technical things that are required to service a loan."
"I think the market is beginning to make distinctions between servicers to the extent that good servicers are affecting the subordination levels of the deal and the execution of the deal," Whitlatch adds.
"That (differentiation) is getting partially driven by the rating agencies and their proactive approach on coming in and reviewing the servicing operations and then rating the servicers on how they operate," Klick says. "Some of them spend a lot of time, look at the complete organization from top to bottom and evaluate how they feel you're performing and then give you a ranking to rate your strength."
Whitlatch gives one example where his company brought value to the table for an RTC transaction that ballooned up to 55% delinquency.
"The pool had some concentration issues," he says," and, if you didn't know about them, you would think the pool was going to hell in a hand basket."
A couple of very large loans were affecting the delinquency, and Whitlatch says that, by keeping the rating agencies informed, ultimately, they were able to keep ratings in place and the pool wound back down to around the 8% delinquency level.
A testament to EQ's strength as a servicer is that, as this issue was going to press, AMRESCO Inc., Dallas, entered into a letter of intent to absorb $7.5 billion worth of securitized mortgage servicing business from Equitable.
Having a name that's well-known in the industry can be another benefit in a CMBS deal, Rudgers says. "It allows the issuer to disclose that we're the master servicer, and then they don't need to make as much about the long list of other subservicers who might be involved. Probably this is a marketing benefit when selling bonds, but I think it also does give comfort to rating agencies."
Rundblom of Duff & Phelps agrees that rating agencies do find servicers to be an important part of the CMBS deal.
"Our position is that we have to approve all the entities in a transaction," she says. "We have to feel comfortable with who the underwriters are, who the issuer is and who the servicers are. That's to the extent that, if we don't have a rating on them ourselves or we haven't seen them recently in a very similar type transaction, we'll go out and do a servicer review for that specific transaction."
Two incidents in the past year illustrate the importance Duff & Phelps places on who the servicers are. In one deal, Rundblom says, Duff & Phelps did not approve of the master servicer, and the master servicer had to be replaced. In another case, a special servicer on the deal did not have as extensive experience as the agency felt was needed, so Duff & Phelps gave subordinate levels back to the underwriter both with and without the special servicer -- and with the special servicer, the subordination levels were higher.
"We recognize that's a big effect on a deal to change the subordination level," Rundblom says. "That's an indication of how important we feel the servicers are."