What to Expect When Expecting Distress: A CMBS Servicer Roundtable

Market participants expected a record year for commercial/multifamily originations in 2020. But by March, these expectations were managed down as production teams shifted to assisting with portfolio management tasks in a marketplace which, in some respects, shut down with the economy.

As COVID-19 and government responses continue to drive uncertainty around outcomes and outlooks, MBA Newslink interviewed senior professionals from a credit rating agency and several highly rated servicers to get their perspective on forbearance, loan workouts and portfolio management challenges for agency and non-agency CMBS. 

Alex Killick is the Head of CWCapital’s Special Servicing business. He oversees a team of veteran loan workout and REO operations professionals as they develop and implement business plans for the ultimate resolution of non-performing loans. His key direct responsibilities also include negotiating and structuring workouts on commercial loans, aggressively managing the exercise of lenders’ contractual and legal remedies and protecting CMBS Trust investors through setting legal strategies in CMBS-borrower bankruptcy proceedings. As a member of the firm’s Credit Committee, he reviews business plans on a weekly basis to quantify recovery projections and manage the approval of proposed workout or disposition strategies.

Gina Sullivan is a Senior Vice President of KeyBank Real Estate Capital’s Loan Servicing and Asset Management division. She is also a member of the Freddie Mac Advisory Council and the Key Executive Women’s Network Leadership Team. She manages the loan servicing activities for the CMBS, Agency and HUD portfolios totaling approximately $225 billion. As a core executive of LSAM’s leadership team, Sullivan’s additional responsibilities include driving strategic directives, business expansion and talent management.

Adam Fox is a Senior Director in Fitch Ratings’ U.S. CMBS group. His primary areas of expertise are commercial mortgage servicing and U.S. CMBS. He is responsible for Fitch’s North American commercial mortgage servicing group and leads a team of three analysts covering approximately 45 commercial mortgage servicers. In addition, he maintains an active role in new issuance and surveillance CMBS rating reviews as well as European servicer evaluations. 

MBA NEWSLINK: Adam, what trends are you seeing among commercial real estate servicers because of the coronavirus pandemic?

ADAM FOX, FITCH RATINGS: Beginning in March all servicers began to see a large influx of requests from borrowers for debt relief across all lending products. North American servicers responded by reallocating existing staff and, to a lesser extent, hiring new staff to increase resources to customer service to deal with the record levels of increased requests.

In some cases, servicers tried to programmatically resolve loans using standardized approaches; however, commercial real estate assets are idiosyncratic operating businesses, so debt relief or loan workouts ultimately need to be tailored to the individual property and loan sponsor. As a result, we’ve have also seen special servicers increase their ranks of asset managers, again largely pulling experienced workout talent from other business lines, in order to analyze each loan individually and identify the best workout or debt relief plan.

NEWSLINK: Adam, is the pandemic and associated responses likely to change the way servicers do business in the future? Are there any early lessons to take from this or areas you’re monitoring from an operational risk perspective?

FOX: The pandemic has brought several changes to how servicers operate, the largest being remote working, and demonstrated the importance of robust business continuity procedures. For loan servicing specifically, if a servicer was not paperless pre-pandemic, it is now and likely will be going forward.

Servicers have also now seen the importance of investing in web portals to communicate with borrowers and provide them tools to manage their loan without having to pick up a phone. Document management systems and digital signatures have now become key tools for servicing that the industry was not always quick to adopt.

Lastly, the importance of cross training and creating a deep bench of staff able to react and respond to borrowers has been key. All these measures, however, have shown the important of the need to constantly evaluate efficiencies through processes and technology which will ultimately make servicers better and improve the borrower experience.

NEWSLINK: Gina, what has the pandemic impact been like for commercial real estate borrowers and how are you responding as a servicer?

GINA SULLIVAN, KEYBANK REAL ESTATE CAPITAL: Unfortunately, the pandemic spared no geographic location or property. Most properties, regardless of type, were impacted in some way. Beginning in March, we started to receive a high volume of debt relief and loan modification inquiries. 

Initially, the unknown of the impact of a pandemic across different industries contributed to the high volume of inquiries. Borrowers sought to understand the pandemic’s implications to their properties and tenants as shutdowns commenced and unemployment numbers accelerated. Questions around the government stimulus packages and regulations pertaining to owners and landlords’ operational processes also increased anxiety. Hospitality properties have suffered the most as the travel industry was hit hard from the beginning, with retail following closely behind. 

KeyBank responded immediately by adjusting its staffing resources to ensure a timely response to all borrower inquiries. We wanted to make sure our borrowers had accurate information on what their loan documents would allow, and what specific programs were available to them. Effective and timely communication continues to be critical to provide support and direction during these unprecedented times.

NEWSLINK: Gina, have the number of COVID-19 requests from commercial real estate borrowers dropped dramatically over the summer, what do you expect for the rest of 2020?

SULLIVAN: To date, we have seen COVID-19 related requests for nearly 15 percent of our portfolio, and of that nearly 10 percent have formally requested relief. We have seen a dramatic decrease in the number of COVID-19 requests over the summer. More than 90 percent of our inquiries and requests were received prior to the beginning of June. This is primarily due to the timely responses and the temporary debt relief options provided to borrowers, as well a slowly healing market. It is hard to predict how the rest of 2020 and 2021 will play out as we wait for a vaccine and workers begin to return to their offices.  We will continue to watch our hospitality and retail properties, but we are also focused on renters’ preferences and migration patterns within multifamily. Longer-term, there will be a heightened focus on student housing and office properties as major tenants renew or define new space requirements based on more permanent remote workforces. 

NEWSLINK: Alex, if a borrower’s loan is transferred to special servicing for potential relief, what are your first steps, what should borrowers be prepared for when their loan goes to special servicing? Whether it be an agency loan or private-label CMBS?

ALEX KILLICK, CWCAPITAL: Private-label CMBS loans that transfer largely do so for delinquency with a process that is unchanged from those loans that transferred pre-COVID-19. Agency CMBS on the other hand has a specific set of forbearance/relief terms set up by the agencies which is mostly managed by the master and primary servicers. 

In the non-agency space, we have been performing a daily triage process to review relief requests received by master servicers to determine what relief can be accommodated without requiring a special servicing transfer. These non-transfer accommodations largely revolve around the use of funds from reserve accounts to provide short term relief. For loans that do transfer to special servicing, either because of uncured delinquency or other critical factors, borrowers should be prepared for the following:

• A pre-negotiation agreement will absolutely be required in advance of any substantive negotiations regarding the terms of the loan.
• Borrowers should be ready to provide recent property financials, forecasts and projections. These should be based on their thorough understanding of underlying market conditions and discussions with tenants. Examples of info that will help special servicer include individual tenant aged delinquencies and details of aged payables, which while beyond the requirements of a performing loan’s reporting package,  are necessary to review if a special servicer decides to recommend material relief on a loan. 
• A recent property inspection and other third-party reports such as an appraisal will be needed in most cases, so borrowers need to provide access and information to these professionals.
• The borrower should present a detailed relief request.  However, I want to caution that is this not an opportunity to “go big.” On most of the COVID-related special servicing transfers, we are trying to evaluate the need for short- and medium-term relief related to a cash flow disruption or elevated tenant delinquency. Accordingly, requests for discounted payoffs, waivers of prepayment premiums, or permanent changes to the interest rate, come off as opportunistic and are not in line with what the bondholder community is willing to approve.

As to first steps, they are essentially the same as on traditional loan defaults:

• Understand the current operating status of the property
• Understand the use of cash flow since default and ensure no misappropriation
• Evaluate the borrower’s request in light of the above

The big change brought about by COVID-19 is that we are much more focused on property-level expenses, accounts payable and critical items such as payroll/utilities. While we have dealt with abandoned or closed assets in the past, it has never been this widespread. We are finding that a good barometer of whether a forbearance/workout can get done is whether property payables/expenses are being kept under control while the loan is in default.  If borrowers are not willing/able to cover operating expenses, and aged payables grow while the loan is in default, then this is a strong indicator that we will end up on the remedies track. 

NEWSLINK: Alex, what are ways a trust may structure any debt relief, is there a standard playbook for non-agency loans?

KILLICK: The agency space benefits both from a relatively homogenous collateral base and strong central actors who can drive policy. Private-label conduit, on the other hand, has a wider set of actors. Similarly, the wide range of collateral in the conduit space (think long-term NNN industrial vs limited-service hotel vs. suburban office) limits the ability to apply a standard playbook.  We need to see a sustained and demonstrated impact to revenue to justify a recommendation of granting concessions. 

Obviously, hotel performance is easy to prove out. On retail, we need to see sustained aged delinquency along with borrower’s efforts to collect from tenants rather than just waive rent and pass the hit on to the lender. The goal of this process is to separate short-term rent interruption (missed April/May rent, repaid later in the summer) from long-term loss of revenue (tenant bankruptcies and business failures). Relief options are focused on the following, in order of severity of distress:

• The potential for P&I forbearance for a period, with future repayment of forborne amounts. This could be combined with the use or reallocation of reserve funds subject to property-specific circumstances. Initially we were targeting 3 months of forbearance with repayment of the forborne amounts commencing immediately thereafter. Recognizing the length of the impact of COVID-19, we are now looking at a longer-term repayment structure such as over the course of 2021, along with potentially more upfront forbearance. 

That said, we are generally not willing to “just deal with it at maturity” when it comes to repayment. Borrowers should expect a requirement to take no distributions (including payments to insider vendors) until any forborne amounts have been repaid.

• Adding periods of interest-only, or, in cases of severe distress such as retail assets that have permanently lost multiple anchors (fitness, cinema), evaluating a “pay and accrue” structure where a portion of the interest rate is deferred until either maturity or until property cash flow supports it being paid.
• In many cases, we are requiring credit enhancements such as cash management (if not already in place), partial recourse on forborne amounts or amounts used from reserve accounts. If we are doing significant modifications to loans where we expect the asset to need TI/LC dollars, borrowers should still expect to be required to post new equity into reserve accounts. 

All of the above is caveated by the fact that every asset is different, different controlling bondholders have their own expectations, and there is no “form” CMBS loan workout. We have had to invest a lot of time countering the narrative of certain parties in the market who are sending in form requests or claiming that they know the secret code for unlocking relief.

NEWSLINK: So, a question for everyone: Given we are now months into the pandemic, have primary and special servicers been successful in their efforts to provide relief for agency and private-label CMBS borrowers? Do you anticipate the effects of COVID-19 carry through to 2021?

SULLIVAN: Primary and special servicers have collaborated to assist borrowers in navigating temporary debt relief opportunities. This quick action has resulted in short-term relief to qualifying borrowers and has helped to provide stability in delinquency rates. As expected, we witnessed delinquency rates increase earlier this year, but we have seen delinquency rates retreat over the last couple months. It is hard to determine how long we will see effects from Covid-19 and the severity of its impact into 2021.

FOX: Servicers have made progress in responding to borrowers more efficiently and in many instances the temporary debt relief provided has mitigated the increase in commercial loan delinquencies.

SULLIVAN: There continues to be a lot of uncertainty and we anticipate a potentially volatile Q4 2020 and 2021. If and how much will carry through to 2021 will be determined by COVID-19 trends influencing on-going remote work forces, multifamily rent collections, travel restrictions and lodging recoveries. That said, we are hopeful to find a new normalcy in 2021.

FOX: Carryover into 2021 will be dictated by the ongoing impact of COVID-19 to retail and the travel industries, the potential long-term shift to more remote working and less need for office space, and expiration of government support and eviction moratorium for multifamily properties. Today, servicers are paying close attention to property performance for loans that received some form of debt relief. So far there hasn’t been a tidal wave of defaults or requests for additional relief, but it remains to be seen how much liquidity will be available for maturing hotel and retail assets.

(Views expressed in this article do not necessarily reflect policy of the Mortgage Bankers Association, nor do they connote an MBA endorsement of a specific company, product or service. MBA NewsLink welcomes your submissions. Inquiries can be sent to Mike Sorohan, editor, at msorohan@mba.org; or Michael Tucker, editorial manager, at mtucker@mba.org.)