The firms responsible for figuring out the best solution to troubled commercial real estate loans might end up extending the market's problems.
With an estimated $1 trillion in commercial mortgage-backed securities coming due over the next five years, these firms — known as special servicers — are facing extreme financial pressure, which many fear could lead them to extend the loans backing the CMBS instead of defaulting on them.
That's a problem for institutional investors because until CMBS and other commercial real estate distressed debt are allowed to default and be flushed out of the system, there is little hope of recovery.
There are few transactions now because buyers expect that commercial real estate values are still going down and sellers are unwilling to sell at rock-bottom prices.
“Special servicers have a Herculean task. There's an onslaught of bad loans,” said Joseph B. Rubin, principal, transaction advisory unit of Ernst & Young LLC, New York. “It's not only a tidal wave that hits you, but it keeps coming.”
The current financial crisis is the first test of the CMBS market, which exploded between 2004 and 2007. There were $1.4 trillion new CMBS issued in 2007, three times the total issued between 2000 and 2003. Most of the CMBS debt will not be refinanced, and it's up to the special servicer to work out the loans or foreclose on the properties.
But a number of the servicers have cash problems. The value of their CMBS investments is falling and the debt financing those investments is coming due.
LNR Partners, the nation's largest special servicer with $191.7 billion in loans as of Dec. 31, is preparing for a possible bankruptcy, sources said. LNR executives could not be reached for comment by deadline.
LNR and CW Capital Asset Management LLC handle more than 50% of all loans in special servicing, according to corporate finance adviser Navigant Capital Advisors, which analyzed Mortgage Bankers Association data.
The volume of loans in special servicing ballooned to $66.9 billion at the end of 2009, up from $12.8 billion at the end of 2008, according to a Navigant report.
Plus, the newer the loans, the more complex they're likely to be and more likely they are to default or require special servicing, according to a Feb. 8 report by Standard & Poor's. Newer loans — those originated between 2004 and 2009, the period when CMBS issuance exploded — are performing “notably worse than those issued seven or eight years ago. Indeed, newer vintages performed for an average of 2.3 years before defaulting or triggering transfer to a special servicer, compared to an average of eight years for older CMBS,” the S&P report noted.
The test is whether the CMBS investment infrastructure will survive the massive real estate downturn, Ernst & Young's Mr. Rubin said.
Special servicers have a tough job. They are charged with analyzing each bundle of loans, figuring out the strategy to work out the loans and complying with servicing standards, which includes maximizing recovery of defaulted loans, Mr. Rubin said.