MBA NewsLink Roundtable: Top Commercial Mortgage Servicing Issues to Watch in 2024
(Illustration: Miami, Fla. Photo credit Antonio Cuellar via Unsplash)
Introduction By Andrew Foster, CRE, Director of CMBS Surveillance with KBRA, Dresher, Pa.
Commercial and multifamily mortgage loan originations were 49% lower in the third quarter of 2023 compared to a year ago and decreased 7% from the second quarter, according to the Mortgage Bankers Association’s Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations. While a full-year 2023 view will not be available for a little while, it was a down year.
With the logjam in the commercial real estate transaction market top of mind for many, loan servicing and asset management professionals entered the new year with a fresh set of opportunities and challenges defined not by a flood of new originations but the expectation of a growing supply of troubled loans. While 2023 was defined by the Federal Reserve’s flurry of interest rate hikes, 2024 promises to be defined by the continuing impacts of those 2023 interest rate hikes and any subsequent actions.
Kroll Bond Rating Agency’s (KBRA) 2024 CMBS Sector Outlook describes the industry dynamics as follows: commercial real estate continues to face interest rate headwinds. With the federal funds rate at 22-year highs and expectations that it will stay higher for longer, borrowing costs will remain elevated. However, property fundamentals across most property types, with the exception of office, remain positive to neutral which will help push up origination volume and CRE securitizations.
For a pulse-check on commercial/multifamily servicing and asset management trends, MBA Newslink interviewed executives at Mount Street, Freddie Mac, KBRA and Seyfarth Shaw LLP about top issues impacting servicing: asset management challenges, CRE market stress, loan maturities, valuation issues and technology.
MBA Newslink: What asset management challenges are your team focused on?
Pamela Dent, Vice President, Asset Management, Freddie Mac Multifamily: Freddie Mac works with partners to advance our mission, including our common goal of promoting property and tenant safety. This work has resulted in the update of several of our standards.
These updates reinforce that for Freddie Mac, a performing loan is not simply a loan that is current on its payments, but one secured by a property that meets all contractual obligations, including that it is safe and healthy for tenants who reside there.
As Freddie Mac has worked with stakeholders to ensure properties meet our requirements, we have enhanced our property inspection protocols with new standards around timely reporting, quality reporting and replacement reserves.
Specifically, Freddie Mac now requires that the most experienced inspectors be utilized for all properties securing affordable housing loans and for those properties that are more than 40 years old. Where a HUD inspection exists, the servicer must reconcile it to the Freddie Mac inspection in detail. Freddie Mac staff will inspect all properties rated Below Average or Poor in addition to a random selection of loans with a rating of Average. If there are past due repairs, or if the inspection indicates Below Average or Poor condition, the collection of any previously deferred replacement reserves will be triggered. Where inspections are of poor quality due to underreporting, incomplete information or inaccuracies related to early warning signs, servicers will be assessed a significant penalty and be subject to additional requirements, and Freddie Mac will enforce late fees. While this is not an exhaustive list, it represents some noteworthy changes that will be in place commencing January 2024.
MBA Newslink: Where are you experiencing CRE market stress in Mount Street’s portfolio?
Steve Luther, Executive Director, Special Servicing, Mount Street: While we are observing distress in all sectors due to the impact of inflationary pressures, the majority of our recent servicing transfers continue to reflect escalating distress associated with the ongoing disruption and dislocation in the office sector. Landlords are still struggling with the inherent challenges of return to office patterns, the inflationary impact on capital requirements, and the elevated leverage that both prospective and existing tenants have in negotiating lease terms.
The aggregation of these factors has led to such a negative impact on value that we are observing an increase in borrowers simply wanting to effectuate a consensual transition of collateral back to the noteholder. This is especially evident when the fact pattern includes older vintage buildings in secondary markets.
Newslink: What are some growth areas for your practice and how do you foresee supporting loan servicers with issues that may arise?
Katie Schwarting, Partner, Servicing & Special Servicing, Seyfarth Shaw LLP: At Seyfarth Shaw LLP, we are focused on growth in two areas of our practice. First, is asset administration and special servicing, particularly as the commercial mortgage industry experiences an increase in the number of loans in default.
We are assisting our special servicing and directing certificate holder (B-Piece investors) clients in interpretation of the special servicer obligations, along with the limitations, when working with borrowers on default issues. We are assisting our primary and master servicer clients on identifying potential loan defaults and understanding the importance of clear communication with borrowers, to ensure that the servicer preserves the lender’s rights under the related borrower loan documents.
Second is assisting clients with interpretation and implementation of new laws and regulations on our industry. Servicers are being impacted by the multiple jurisdictional anti-corruption laws, data privacy laws (including cyber security threats), the new Corporate Transparency Act going into effect in January 2024 and other regulations, including the new Securities and Exchange Commission Conflicts of Interest in Securitization rule.
I think servicers are wonderfully adaptable and the servicing practice has continued to evolve and grow. We think this is an area where we can assist clients with valuable intel on what we are seeing across the market and how servicers can comply.
MBA Newslink: From a rating agency perspective, what are the hot topics currently impacting master servicers?
Gretel Braverman, Senior Director, CMBS Surveillance, KBRA: From KBRA’s perspective, as a rating agency we are particularly interested in servicing decisions that can impact CMBS certificate holders and influence our ratings. The focus is heightened in an environment where there are higher levels of distressed loans. These decisions include, but are not limited to, servicer advances, the terms of modifications and extensions and disposition decisions. For example, a master servicer decision to continue to advance P&I payments or make a non-recoverable decision will have a direct and immediate impact to the cashflows available to distribute to the securities of a transaction. In the face of uncertain or declining property values, this can be a challenging decision.
As post-pandemic values continue to decline, particularly in certain asset classes such as Class B office, non-recoverability determinations can lead to interest shortfalls that climb higher in the capital stack. Because we consider timely payment of interest in our ratings, we may downgrade the ratings of securities that are impacted by the shortfalls even though we may believe that the likelihood of full recovery is higher than the ratings would suggest. According to the master servicers which KBRA reviews, some strategies for determining advancing on loans in a stressed environment include more frequent communication with special servicers to better understand the disposition plan and the risks. Others employ advanced modeling which evaluates various recovery outcome scenarios.
In the same vein, the terms of a modification effectuated by a special servicer can influence our ratings. Even if the modification may not change our expectations of the likely recovery on collateral, terms of the changes can have an impact on our ratings if they delay timely interest or cause WODRAs. An example of this is the deferral of some portion of the monthly interest payments due from the borrower out to the maturity of the loan. These deferrals are not advanced by the master servicer and cause interest shortfalls to the bonds. To better understand how these decisions are made, KBRA generally includes a discussion of various modification and workout scenarios it its periodic meetings and reviews of CMBS master and special servicers.
MBA Newslink: How are you viewing maturing loan portfolio and do you expect this area will drive transfers for the year?
Steve Luther: It is anticipated that maturity defaults will continue to be the fundamental driver of servicing transfers in 2024. It is also anticipated that the availability of capital in 2024 will continue to be at a reduced level, historically speaking. The refinance efforts of borrowers will continue to be hindered by declining property values resulting in a lower new loan sizing and as such will require material new equity contributions for a loan to be paid off at its scheduled maturity date. Maturity defaults are of such a concern that our loss mitigation efforts include proactively conducting an elevated level of surveillance across the entire servicing portfolio.
MBA Newslink: What are your expectations for special servicing transfers in the next few years?
Katie Schwarting: I believe we will continue to see an uptick in the number of loans in special servicing. This first wave of loan defaults has mostly been as a result of maturity defaults, but we are already seeing the impact of market softness in the office and retail sectors, which may lead to more loans potentially going into special servicing for payment defaults. I also think floating loans that have a shorter maturity timeframe will continue to be vulnerable to finding an exit strategy (through refinancing or loan sales) at maturity.
Special servicers are looking for creative, yet permissible under the related servicing agreements, solutions for modifications and workouts. For example, we are working with servicers to review proposals from various sponsors to recapitalize assets that are in distress, including options for new equity investors, adding preferred equity or restructuring for layered or mezzanine debt to existing loans.
MBA Newslink: Technology is a perennial challenge. What technology initiatives are important for Freddie Mac Multifamily Asset Management going forward?
Pamela Dent: We are striving to adopt innovative technologies to expedite information gathering and analysis for improved risk assessments. Key initiatives are focused on simplifying data submission and consumption, while enhancing the information review processes to ensure swift and efficient risk determination.
From a surveillance perspective, our goal is to access data earlier and more rapidly. We are exploring methods to acquire property information sooner, which is crucial to identifying issues and risks promptly. Indicators of potential property condition issues extend beyond the property inspection itself. Examples include municipal violations, calls to 311, and other information from the broader environment. We are actively working on technology that will provide alerts if any of the 30,000+ properties with which we are involved with have red flags. Early identification of these issues allows us to mitigate risks more effectively and, as importantly, take action to ensure that property conditions remain stable.
From a special servicing and borrower transactions standpoint, organizing data efficiently enables us to devote less time to information consolidation and more time to analyzing borrower requests and managing ongoing situations. Our technology initiatives are designed to streamline our operations and enhance our ability to manage risk effectively in a timely manner.
(Views expressed in this article do not necessarily reflect policies 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 Editor Michael Tucker or Editorial Manager Anneliese Mahoney.)
