Investment Analysis

CMBS Concerns

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 business.

CMBS Backlash?

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.

CMBS Considerations

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 cost.

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 company loan.

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


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