Are securitized loans worth the trouble?
Since becoming popular in the 1980s, commercial mortgage-backed
securitization promised commercial real estate borrowers access to more loan
capital, often at the most competitive interest rates. The trade-off was more
complexity in loan structure and documentation and very little flexibility to
make changes to the loan and the property securing it.
Elaborate Real Estate Mortgage Investment
Conduit rules and rating agency requirements impose extensive and minutely
detailed requirements regarding the loans and the structure and management of
the loan pool. The REMIC rules limit the ability to alter the loan or
collateral, and the rating agency requirements force borrowers to set up
special purpose entities with exhaustive restrictions on the conduct of the borrower’s
Then came the 2007 residential subprime
mortgage crisis, which called into serious question the supposed benefits of
the CMBS structure. The market for mortgage-backed securities abruptly dried
up, and about 20 percent of the commercial loan origination capacity
disappeared in a few months.
That capacity is slowly recovering, but,
unfortunately, originators and rating agencies are responding to the CMBS-led
recession mainly by changes to underwriting, documentation, and rating
practices that tighten the screws on the many largely pointless inconveniences
imposed on borrowers.
This recession has highlighted the fact that,
whatever their drawbacks in good times, CMBS loans can be remarkably
problematic in a down market. While the REMIC rules allow much more flexibility
once a CMBS loan is in default or “imminent risk of default,” the special
servicers appointed to deal with problem loans were simply not prepared to
handle with the volume of bad loans resulting from a real estate recession.
As a result, it has been difficult for
borrowers to locate the person making decisions on their loans, get their
attention to discuss solutions, figure out what the servicer could do if the
conversation could occur, and predict how or when decisions will be made
regarding the loan.
Of greater concern, in our experience, is
that the servicers appear to hold less allegiance to the terms of the
borrower’s loan documents than they do to the pooling and servicing agreements
to which the borrower is not party. In many situations, both ordinary and
distressed, servicers have either refused to allow the exercise of
bargained-for financing, transfer, leasing, improvement, and other rights, or
charged substantial fees for consenting to activities permitted under the loan
documents. And getting there can take months longer and thousands of dollars
more than the loan documents require.
At least in the near term, borrowers should
expect to have a harder time negotiating flexibility and concessions into loan
documentation. Those documents will include stronger and longer nonrecourse
carveout or “bad boy” guarantees, even though the old versions did a good job
of dissuading bankruptcies.
After General Growth Properties’ cunning end
run around the independent director protection, borrowers now may not be
allowed to hire independent directors who serve as independent directors for
affiliates. Borrower’s counsel may also find negotiation of non-consolidation
opinions — already an “Alice in Wonderland” exercise — to be more
time-consuming and contentious.
Based on our recent experience, borrowers
should consider the following thoughts before committing to CMBS loans.
First, borrowers will spend a lot of time and
money on requirements that will do no one but lawyers any good at all, so the
deal size and interest rate must be sufficient to offset a lot of transaction
Second, borrowers should negotiate hard for
the leeway to enter into leases or make changes to the borrower or the
collateral, such as admitting or replacing investors or improving the project.
If it’s not provided for in the loan documents, the servicers are not going to
consent to it later.
Third, borrowers should pay close attention
to the drafting of provisions permitting pre-approved changes so that they are
as automatic as possible, leaving the servicer as little leverage as possible
to resist, impose conditions, or charge fees.
Fourth, notwithstanding successful tough
negotiations, the servicers — understaffed, needing fee income, and mired in
the relationships created by the pooling and servicing agreement — may choose
to ignore a borrower’s bargained-for rights. In that case, there is little a
borrower can do. Even if a servicer honors a borrower’s rights, it is going to
take a lot of time and money to get through the consent process.
Fifth, borrowers should pay very close
attention to new, broader language in bad boy guarantees, especially those
removing the nonrecourse protection.
If all this leaves a borrower a little
uncertain, it’s time to take a good hard look at that “stodgy” bank or life
Clayton B. Gantz, Ellen R. Marshall, and Tom Muller specialize
in real estate and finance at law firm Manatt, Phelps & Phillips LLP. Contact them at www.manatt.com.