Restructuring CMBS Loans, Part 2

By Jay Maddox, Principal, Avison Young

As discussed in Part 1 of this series, CMBS borrowers with maturing, underwater loans are facing potential loss of their property unless they can modify their mortgages. CMBS loan modifications, while difficult, can be accomplished—provided that the borrower understands the practical realities of dealing with special servicers.

Getting Started

The master servicer has no authority to make loan modifications, but it does have discretion to transfer the loan to the special servicer, who can make decisions.  If a default is imminent, the first step for a borrower is to formally request a transfer to the special servicer. This request must convey the urgency of the situation, and must be carefully worded in order to potentially avoid triggering the non-recourse “carve-out” guarantee provisions of the loan. In many cases, the transfer can occur before an actual default occurs, providing important lead time while avoiding excessive late charges and default interest.

Initial Action Steps

Once the loan is transferred, the special servicer will typically order a property inspection and an appraisal, and in some cases an environmental report.  The borrower will be required to remit all net cash flow from the property and/or rents may be swept into a cash control account. The special servicer will authorize and make disbursements of reserves for property- or tenant-related costs, and may also advance funds in order to preserve and protect the property value.  The special servicer would also have the right to approve all leases and capital expenditures.

In some cases, the special servicer may wish to appoint an independent receiver to manage the property; however, this does not preclude a loan modification. The receiver may have the power to market and sell the property. The rights available to receivers vary state by state.

Pre-Negotiation Agreements

The borrower will be required to enter into a pre-negotiation agreement that permits both parties to engage in confidential settlement discussions and exchange information, which cannot be used in any future litigation should loan modification discussions fail. Under the PNA, the borrower must waive any claims it may have against the lender. The special servicer may elect to delay commencing foreclosure proceedings if there is a signed PNA and negotiations are proceeding in good faith. In other cases, foreclosure actions will be initiated in order to avoid losing valuable time should negotiations fail.

The special servicer will compare the borrower’s restructuring proposal to its next best alternative, which is usually a foreclosure or a loan sale. A loan sale may also make sense if the property is special use, if there is environmental contamination or if there is a need for significant repairs and replacements. A deed in lieu of foreclosure may be accepted in cases where foreclosure is a long and difficult process. Other options include short sales and discounted payoffs (DPO); however, these are rare.

Conclusion

While the odds are clearly not in the borrower’s favor, CMBS restructurings are possible, and in fact they are on the rise as the volume of defaulted loans has begun to increase. Part 3 of this series will address the various types of loan modifications that may be available.