Troubled Commercial Mortgage Loan Triage: A Special Servicer Roundtable
With the ebb and flow of 2020 market disruption in the rearview mirror and the vaccine rollout in full swing, MBA NewsLink checked in with a special servicer, a rating agency servicer analyst and Freddie Mac asset management chief to explore what is happening in commercial/multifamily markets, where different parts of the commercial real estate finance ecosystem are today and factors driving the outlook for agency and non-agency CMBS sectors.
Steven Altman is a Senior Director and lead analyst of the North American Commercial Servicer Evaluations team within the Structured Finance Group. He leads S&P Global Ratings’ efforts in analyzing and maintaining relationships with 50 North American commercial servicers ranked by S&P Global.
Sarah Swartzendruber is the Managing Director of Mortgage Loan Special Servicing at Aegon Real Assets. She is responsible for teams who develop strategies to optimize asset values and recoveries for clients holding conventional sub-performing and non-performing mortgage loans. Prior to joining Special Servicing, she managed the Mortgage Loan Servicing department at Aegon Real Assets.
Pamela Dent is the Vice President of Freddie Mac’s Multifamily Asset Management Group where she is responsible for managing Special Servicing, Surveillance, Insurance, Asset Performance & Compliance, Guarantor Risk and External Relations. Prior to joining Freddie Mac in November 2011, she was responsible for Berkadia Commercial Mortgage’s Surveillance and CMBS Asset Management Groups where she managed over $500 million of servicing advances.
MBA NEWSLINK: The COVID-induced recession is dramatically different from the great financial crisis for a variety of reasons. What do you think will be some of the most important implications for special servicers and investors as they navigate working with borrowers and minimizing losses to trusts the represent?
STEVE ALTMAN: Transparency and timeliness of information flow between all affected parties are key so that investors understand potential implications of the resolution strategy partaken by the special servicer. The special servicer should disclose to the investors what sort of workout (forbearance/modifications) are being negotiated. Then, the special servicer should provide updates as to the final terms or if the borrower is unable to meet the terms of the workout. We feel providing ultimate transparency to investors will be key since it will allow them to make investment decisions accordingly.
Separately, during the great financial crisis, investors were, in many cases, clamoring for special servicers to quickly liquidate assets to minimize trust losses. While there appears to be no shortage of capital on the sidelines poised to take advantage of distressed opportunities, I believe that special servicers may be reluctant to liquidate assets at distressed levels (retail assets aside), particularly if a successful vaccine is expected to result in a swift economic recovery, and work with those borrowers that are committed to investing in their properties and have compelling business plans.
NEWSLINK: Hotels are playing are much large role this downturn than the last cycle. What are some of the key variables to understanding how these challenged assets will be ultimately be resolved? In this recession, the softened demand happened much more quickly and sharply even though the asset type is usually the first to react to a bad economy. Do you anticipate this change will impact the timing for resolving portfolios and do COVID-unknowns potentially slow down the process of addressing workouts?
ALTMAN: As of late 2020, roughly one quarter of lodging loans were in or seeking some form of forbearance, not including loans already classified as delinquent. With respect to forbearance, servicers have been granting some combination of debt service relief (three-six months), the ability to use reserves to pay debt service and expenses, waiver of reserve contributions, and waiver of furniture, fixture, and equipment reserve contributions. However, most hotels that were granted short term relief will likely need additional support as depressed occupancy and net cash flow levels continue to persist. It remains to be seen how servicers will respond to the expiration of the initial short-term relief periods that were granted.
Going forward, one of the key variables will be the financial flexibility afforded by the various hotel flag owners related to PIP (i.e. property improvement plans) investments that are traditionally required to maintain the existing flag. To date, the major brands have been flexible in allowing borrowers to defer such investments and/or use reserves designed for such investment to be redeployed to make debt service payments. The loss of a flag can result in value destruction and if hospitality assets are slow to recover, special servicers may have a greater ability than some borrowers to provide the necessary capital (via advances by the master servicer to the trust) in order to satisfy the brand requirements and protect the value of the asset. Another key variable is understanding the extent of COVID-19 containment measures as well as vaccination efforts as they relate to the return to normalcy necessary to result in group and leisure travel demand.
NEWSLINK: Many states jurisdictions are putting in place measures to respond to COVID with evictions moratoriums being the most well-publicized. What impact, if any, do you expect these measures and similar one to have on resolution outcomes?
ALTMAN: Special servicers certainly need to consider state jurisdictions measures such as moratoriums in formulating forbearance/loan modifications with the borrowers in considering the extent and timing of providing payment relief. If a multifamily borrower is affected by a tenant pool that is unable to meet its rent obligations for a sustained period of time and is unable to evict such tenants, I would expect special servicers to also be sympathetic to this plight and refrain from exercising legal remedies of their own. However, I would expect ultimate losses may be more severe in such circumstances as borrowers may be financially constrained to invest in and maintain their properties.
NEWSLINK: Unlike during the first few decades of CMBS issuance, Single Asset Single Borrower (SASB) securitizations have made up a majority of new issuance transactions over the last several years. Sarah, your firm is named special servicer on numerous SASB transactions. Can you share any details about your portfolio and the retail and hospitality performance to date?
SARAH SWARTZENDRUBER: Single-Asset Single-Borrower (SASB) securitizations are generally backed by high-quality properties with strong sponsorship, low leverage, and high debt service coverage. These transactions are less likely to experience the triggers that necessitate transfer to special servicing. However, they are not completely immune. We have seen a few requests for relief and in rare cases, borrowers wanting to hand over the keys on higher leveraged transactions. Retail and hospitality have certainly been among the most impacted property sectors from the Covid-19 pandemic, as one can see if they look at loan delinquency and forbearance statistics by property sector. However, the distress has not been uniform within these sectors and there are a number of idiosyncrasies that will influence the path of each asset going forward.
If we focus on retail for a moment, negative structural influences have been pulled forward with tenancy being the primary differentiator in performance. Neighborhood and community centers that have their tenancy weighted toward need-based consumption have performed relatively well compared to other retail subtypes. On the other hand, regional malls and power centers have performed less favorably as have retail properties that rely on entertainment draws or daytime office employment. In the hospitality sector, we expect the distress to be more cyclical, but recovery prospects will still vary greatly depending on operating leverage, geography, subsector and other variables. Properties that can more easily reduce expenses or have already low expense ratios will have an easier time surviving what will likely be a dark winter and be better positioned as a new normal begins to emerge.
NEWSLINK: The other portion of your special servicing assignments is for Aegon Asset Management’s general account. Any trends or surprises from this year that you would share? Have there been any approaches or responses you have been able to act on for the balance sheet that are not allowed or feasible in a securitized structure?
SWARTZENDRUBER: Like many others, Aegon Asset Management experienced an onslaught of borrower requests for relief in 2020. While the initial requests were primarily retail-oriented, we eventually received requests for relief from borrowers representing office, multifamily and industrial properties. Our approach was consistent across the CMBS portfolio and our clients’ balance sheet loans. While we may have had more flexibility in how we structured relief on balance sheet assets, we took a similar approach across loan types. Generally, any relief granted was short term in nature and was supported by evidence that the property had been impacted by COVID. To the extent possible, we worked to improve the risk profile of a distressed loan through the addition of one or more credit enhancements when granting relief. Depending on the client’s preferences, certain situations provided opportunities to consider deferral and repayment structures that extended a loan’s maturity date as an alternative to deferral repayment within the existing loan term.
NEWSLINK: Certain property types have proved very resilient this year and multifamily is certainly in that category. What have been the most challenging tasks from a servicing perspective from Freddie Mac’s vantage point?
PAMELA DENT: The biggest servicing challenges in 2020 were of course related to the COVID-19 pandemic. Because of this unprecedented financial stress, Freddie Mac led the industry in quickly developing and implementing forbearance programs for our borrowers. The forbearance was made available on both our portfolio loans and, with the cooperation of our securitization parties, on those loans included in our securitization programs. Initially, up to three months of forbearance was offered to those borrowers who demonstrated financial hardship. An additional three months of forbearance and extended repayment terms were options offered to those borrowers that experienced continued financial hardship.
Our forbearance offerings were highly successful, and Freddie Mac was applauded as an industry leader in this regard. A servicing challenge of forbearance is the monthly investor financial reporting that has become much more complicated and tedious given the numerous forbearance options and repayment terms offered.
The pandemic has caused several other servicing challenges. Site inspections have become quite cumbersome. Inspectors are no longer inspecting occupied units and most seniors’ facilities are off limits completely. Also, in some instances, inspection timing has been delayed from the scheduled due date. All of these factors make it more difficult to timely gauge physical risk. In addition, the existence of federal, state and local eviction moratoria means that borrowers may not be able to take action against non-paying tenants, and servicers are working to be sure that borrowers are aware of and comply with these restrictions.
And lastly, Freddie Mac’s policy is that all loans that take forbearance are placed on the watchlist and remain there until full repayment is received, greatly increasing the number of watchlist loans.
NEWSLINK: What are some challenges you anticipate in 2021 and how have items like borrower requests and surveillance changed given all the broader questions around the economy, high unemployment and government stimulus?
DENT: The economic fallout is really difficult to capture as 2020 was very different than any previous recorded economic shocks, and the government stimulus needs to be layered onto an already murky landscape. In short, the rental market has held in there pretty well, relative to early expectations and considering the amount of stress in the market. In estimates from our research team, for a person making the median renter income who lost their job for three months during 2020, the loss of income was minimal given the first two rounds of stimulus, and more government support is likely in the beginning of 2021. That may explain rental markets not reacting as strongly as what was expected at the beginning of the pandemic.
Also, renters have clearly prioritized making rent payments. On the single-family residential side of the market, the expectations were grim as the pandemic hit, but it ended up being a remarkably strong year for single-family housing. Prices are way up. That will have an impact for households who have not yet made the jump to homeownership. They may have higher down payments, and if rates move up, what has been very good single-family ownership affordability may become more challenging. For rental fundamentals, the slowdown in gateway markets has gotten a lot of attention, as it should. However, many markets still had positive rent growth in 2020, and 2021 is expected to be a better year than 2020.
For 2021, we expect continued scrutiny on property performance. We will be watching the impact the pandemic continues to have on rental income collections and how that impacts the overall financial health of the property. As noted above, we will work to assess physical risk timely as well. With respect to borrower requests, we do not anticipate any changes in 2021 but each year always brings surprises!
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