Pre-lease IssuesSuperior Interests

A watch-list, a special servicing event, and maximizing NPV recovery all have this in common.

Question: “What is a landlord with a troubled CMBS loan?”

Back in the day, a landlord may have had a loan with a life insurance company in Iowa or a pension fund in California that retained the loan through maturity.

Then smart money came along and structured a secondary market for the trading of commercial mortgage backed securities (CMBS). 

Now, mortgage bankers could transfer loans to a tax-advantaged trust.  The trustee, with promissory notes in hand and an expectation of receiving regular interest payments on the pool of loans, could issue a series of bonds varying in yield and risk.  Rating agencies could come in and assign ratings to the various bond classes: from the most secure AAA down through the below-investment grade and unrated bonds.  Bankers could underwrite and sell the securities to investors.  Bond investors could select from the tranche matching their credit risk, yield, and term preferences.  Meanwhile, down in the boiler-room, a master servicer, engaged by the trustee to service the loans, would collect mortgage payments, release disbursements from escrow, and handle other routine loan matters, all so long as a loan performs as expected.

However, a wheel or two came off the truck during the last few years and some loans have not performed as expected.  

And rating agencies expect more troubled CMBS loans to surface, despite the gradual improvement in the economy. 

Fitch Ratings, in its Dec 10, 2010 U.S. CMBS newsletter, maintained “a negative outlook on CMBS loans in the office sector due to anticipated income declines….” Managing Director Mary MacNeill states that, “Office and retail properties fared well during the recession due to generally longer-term lease agreements, but they are now most vulnerable to…performance declines for the same reason.  As office leases originated at the peak of the market come up for renewal, they will be marked down to lower market rents, pressuring operating income.”  http://www.businesswire.com/news/home/20101210005413/en/Fitch-U.S.-CMBS-Newsletter-Delinquencies-Resume-Climb

Watch-list, special servicing event, and maximizing NPV recovery

When crossing paths with a landlord having a troubled CMBS loan, the following terms/concepts may be part of the story:

Watch-list:  A list of “at-risk” loans monitored by the master servicer.  A loan could be put on the watch-list because an anchor tenant’s lease is rolling, the building’s occupancy level has declined, the Debt Service Coverage Ratio is below the threshold required by the loan documents, or perhaps the loan is simply approaching maturity. 

Special servicing event:  Usually a monetary or maturity default on the loan, triggering the transfer of the loan servicing responsibilities to a special servicer.  The special servicer is appointed by the first-loss bond-holder(s) and, in fact, is often an affiliate of the first-loss investor. 

Maximizing NPV recovery:  The special servicer is mandated to maximize the NPV of the bondholders’ recovery when evaluating alternatives.  These alternatives include restructuring the loan, a negotiated payoff, a sale of the defaulted loan, foreclosure, and a deed-in-lieu of foreclosure.    

What’s a tenant to do?

While undoubtedly the prudent tenant will have done its homework in evaluating a prospective landlord, the future is nonetheless unknowable.  A longstanding anchor tenant may go bankrupt.  A seemingly solid landlord may be unable to refinance its loan.

Consequently, the prudent tenant will also have worked during negotiations to protect its interests in case of lender foreclosure as well as against a landlord’s monetary default or failure to perform under the lease.  In such cases, the SNDA language, self-help rights, set-off rights, termination rights, escrow and LOC requirements contained in the lease are no longer mere boilerplate, but key rights.          

The prudent tenant will also recognize that the special servicer’s directive to maximize NPV recovery might present the well-positioned, credit tenant with an opportunity to improve its deal.  This opportunity stems from the fact that any refinancing of the loan or any sale of the property will be predicated on the value of the property.  The credit tenant whose rent payments account for a meaningful percentage of the property’s cash-flow may find that it has some cards to play.

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