Special Servicing: A Developing Landscape

By Anthony La Malfa

The Role of the Special Servicer
A special servicer is an entity that deals with troubled or delinquent loans within a pool of commercial mortgage loans. Generally, the special servicer, who is often also an owner, or related to the owner, of the lower-rated tranches of commercial mortgage-backed securities (CMBS), is named within the Pooling and Servicing Agreement (PSA) between the investment pool trustee and the master servicer. The PSA outlines the conditions under which the servicing of a loan or pool of loans will be transferred to the special servicer.

The special servicer generally has a broad range of powers conferred on it by the PSA, including extending the loan, restructuring the loan and foreclosing on the loan. The special servicer is required to adhere to the servicing guidelines within the PSA and may also have to comply with Real Estate Mortgage Investment Conduit (REMIC) rules to protect the tax-free status of the trust in which the loan is pooled.

The role of the special servicer is of increasing importance as the risk of loss increases the lower one goes in the tranches of an investment pool since the attentiveness and actions of the special servicer will have a direct impact on any losses incurred.

Special Servicers and the Financial Crisis
During the financial crisis, faced with an unprecedented volume of distressed loans, many special servicers came under pressure for not always acting in all of the bondholders' interests and not having adequate resources to deal with the myriad of issues they were facing.

On April 5, 2010, Arleen Jacobius wrote the following in Pensions and Investments Online. "The current financial crisis is the first test of the CMBS market, which exploded between 2004 and 2007. A total of $1.4 trillion new CMBS's were created in 2007, three times the total issued between 2000 and 2003. Most will not be refinanced, and it is the job of the special servicer to work out the loans or foreclose on the properties. However, some servicers have cash problems. The value of their CMBS investments is falling and the debt financing the investments is coming due."

As the commercial real estate market continued to deteriorate during 2009 and 2010, a number of special servicers became acquisition targets for larger (and more stable) real estate investors. During this time, three of the ten largest special servicers were acquired. The acquisitions were seen more as a way for investors to identify distressed assets rather than as the diversification of their ongoing businesses.

The Changing Landscape
Several changes to the special servicing model are being debated, from ways to ensure the special servicer is independent of the bondholders to the ways they are compensated, all in an effort to improve the securitization model for future investors.

The CRE Finance Council, the industry trade group that controls the reporting standards for CMBS reporting, has developed updated market standards for future CMBS transactions, dubbed "CMBS 2.0." These market standards are intended to result in improvements in three critical areas: loan underwriting, additional disclosure and representations and warranties. One change related to special servicer is that the decision to select the servicer is up to most, if not all, of the investors in the loan by majority vote.

In August 2010, Goldman Sachs offered to give control over the servicing of a new CMBS issuance to the triple-A rated tranche investors rather than the subordinated classes as was usually the case. This change in the control over servicing was a key departure from standard practices as the subordinated-tranche holders (who previously had control over the special servicer) would normally be inclined to extend or modify troubled loans, whereas triple-A rated tranche holders would generally foreclose on the loan and liquidate the property. This shift in control, although it does not achieve the ideal of independence, addresses a significant complaint of the senior bondholders in past transactions and was prevalent in a number of subsequent 2010 CMBS deals.

Although one cannot predict the exact form the role of the special servicer will take in future CMBS issuances, we can be certain the role of the special servicer will continue to be an important step in the loss mitigation process, especially as long as commercial mortgage loan delinquencies remain high and credit continues to be elusive.

Arleen Jacobius' article "Special Servicers' Cure Could Prolong Commercial Real Estate Market's Ills."
Information regarding CMBS 2.0 issued by the CRE Finance Council.

Please This e-mail address is being protected from spambots. You need JavaScript enabled to view it. to discuss any questions you have regarding this topic.