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Servicing issues, the surprise cost of conduit loans

According to the Federal Reserve Board over 1/4 of all outstanding multifamily debt is securitized (conduit) loans.  Conduit loans are the best option for many properties, they often can lend more funds than other lenders and are usually willing to lend on older properties. However, before closing a conduit loan it is important to understand some of the negative points of this type of lender. 

Conduit loans are mortgages that are made with the intent of placing that mortgage in a pool with other loans and selling that pool of loans.  These pools are sold on Wall Street as commercial mortgage backed securities (CMBS).  The payments under these mortgages are usually divided with certain investors getting a preferred payment and thus a higher rated portion of the pool or security.  After securitization the owner of the loan is not the lender who made you the loan, but a trust created solely for the purpose of collecting payments and passing these through to owners of the CMBS securities.  Since the loan is in a trust the servicing agent for the loan (the person you make payments to) has restrictions as to how they can deal with you and your loan. 

In my opinion the restrictions on servicing that the conduit structure creates is the cause of most of the problems and complaints about a conduit loan.  With a traditional life company or agency loan there is one servicing agent who deals with the lender and on a traditional bank loan you work directly with the lender.  You are usually dealing with the group that made you the loan in the first place and with whom you have some sort of relationship.  With a conduit loan there is not one servicer, but many.  There can be as many as three servicing agents, including a sub, master and special servicer.  Additionally there may be an “operating advisor”, a bondholder representing the lowest ranked class of securities, who may have a say in servicing matters.  You usually have no ongoing relationship with any of these groups.   These groups are solely focused on the documents; your relationship is not important, they are driven by their responsibilities to the bondholders.

Since there is no real lender, just a trust, the servicing agents must service the loan in accordance with the loan documents and the bond documents (the CMBS Pooling and security agreement).  If the documents say you must do something like submit quarterly reports be assured you will be asked to submit such reports.  This also means that any special request, even if it is logical and beneficial to the lender, doesn’t have to be approved.  If the documents don’t address the issue the servicer may just decide to say no.  Finally, if there is any cost associated with the analyzing or evaluating your request, be assured you will pay for that analysis.  The person doing the work has no financial I interest in the loan so they won’t do any real work without someone (the borrower) paying the tab.

In my opinion there are six main servicing problems that are created by this structure.

1)      Reporting - Most agency and life company loans call for an annual submission of property income and expense statements, however, most CMBS documents ask for this information quarterly.  Be assured that you will be asked (and asked, and asked) for this information and will be required to submit it.  You may even be asked to submit it in a specific format or even electronically.

2)      Collateral - Once you put a CMBS loan on your property the legal structure of the collateral (the property) must remain the same.  If you want to grant an easement on your property including a cross easement with an additional (new) phase of the property you must ask permission.  This is also, true if you plan on selling or developing a vacant part of the property.  Obtaining permission is often difficult or impossible.  The lender does not have to agree to your request and unless there is a compelling reason that is beneficial to the lender, they may just say no.

3)      Assumptions - Most CMBS documents allow for a one time transfer or assumption of the loan by a qualified buyer with the consent of the lender, in this case the master servicer.  However obtaining that consent is likely to be somewhat expensive and time consuming.  The new borrower will have to be approved by the lender and will usually have to have, at least as much, experience and financial wherewithal as the current borrower.   Even if the new borrower is an experienced owner he may not be able to assume your loan if he does not have your level of experience or financial wherewithal.   Additionally, all costs of reviewing the assumption will be your responsibility.  This may include fees to the servicer, rating agencies and various third party vendors.

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