Servicer Beefs: Whats Your Definition of Conflict?

The idea of a brokerage or investment firm owning a special servicing division, or vice-versa, and participating in the same CMBS loan dealings can be a prime example of a conflict of interest, with concerns of sharing information, or tranche holders encouraging their affiliate servicer to make decisions not in the best interest of all the CMBS investors.

The practice isn’t illegal, and is sometimes even preferred by the various parties in a loan. Companies that include New York City-based Fortress Investment Group and investors such as Andrew Farkas and his Island Capital Group are well known for having multiple positions in deals, with the explanation that the more all-property experience will bring the best results in both good years and times of distress.

Of course, the very perception that there could be a conflict is enough for some professionals to argue that potential of misuse should be enough to outlaw the practice, or at least should encourage more servicer transparency. While each deal is different, studies of thousands of CMBS loans by experts such as Brent Ambrose, director of the Institute for Real Estate Studies in the Smeal College of Business at Pennsylvania State University, show that the time a loan remains in default is shorter when servicing rights are concentrated in one firm than when they are held by different firms, and that it’s more likely for a loan to default if the two servicing rights are held by the same firm.

Critics of the conflicts, of course, include those firms that only concentrate on servicing. While these firms can sell themselves as more experienced at the clean-up deals, as the CMBS debt continues to grow, it has been harder to compete with the larger companies. Eric Lindner, an executive managing director at Situs, tells GlobeSt.com that there is an industry perception that servicers with multiple hands in a CMBS deal may focus more on fees than the recovery of assets. Lindner’s firm Helios AMC, based San Francisco, acquired the Houston-based Situs in October “We don’t want any appearance of a conflict,” he says.

Lindner says his firm still engages local and regional brokers, and takes a number of proposals for each deal. “We want the people we’re working with to work to sharpen those pencils,” he says. “We want to make sure the cost we incur related to recoveries are at the best market rates possible.”

Lindner says his firm still engages local and regional brokers, and takes a number of proposals for each deal. “We want the people we’re working with to work to sharpen those pencils,” he says. “We want to make sure the costs we are achieving in these recoveries are at the best market rates possible.”

Robert Lieber, executive managing director at C-III Capital Partners, tells GlobeSt.com that there’s good reasons why his company’s desires to cover multiple parts of a deal. His firm, run by Farkas, completed the purchase of NAI Global in January. Subsidiary C-III Asset Management is the primary servicer for approximately $15 billion and the named special servicer for approximately $146 billion of commercial real estate loans

Lieber says there’s no substitute for having an owners-type eye and owners-type attention on resolution. “The perception is out there that where there’s multiple parts completed/held by the same firm that the trust is being double-charged, that it’s costing twice as much than if done by one party, or that they don’t have the best people. This just isn’t true,” he says. ““For us, we have found we are able to get better execution, a higher price, greater certainty and a shorter timeframe on deals where C-III or one of its affiliates has some kind of involvement.”

While Lieber says there is more that can be done, and that his company plans to do, to provide greater transparency, to convince those who assume the worst that everything is above board, the real issue is whether a company is being consistent with what has been provided for in the contract. “Can they do what they say, are the bondholders getting what they paid for? It’s about the execution,” he says. “If they’re following the pooling service agreements, then everything should be done on market terms.”

Stephanie Petosa, a managing director at New York City-based Fitch Ratings, acknowledges that there can be a high level of distrust between subordinate bondholders and senior bondholders, as their interests are not always aligned. However, she agrees that transparency is key, that as long as everyone’s actions are above board there should be no reason for concern. “Increased disclosure can alleviate some of that distrust -- that's something we focus on in servicer reviews, their attempts at transparency,” she tells GlobeSt.com.

Some of the newer CMBS issues include documents that say the servicer is not allowed to work with an affiliate. A few vocal critics say lawsuits should start flowing if transparency doesn’t. However, Petosa says Fitch advocates that if a servicer is comfortable with its processes and who they’re working with, they should be able to disclose multiple involvement at the end and let investors make their own decisions.

“It’s following pretty simple rules, getting bids and taking the best regardless of ownership interest,” she says. “A servicer shouldn’t be directing work to its brokerage division just to generate fees for a parent company, but servicers who do have an interest in brokerage shouldn’t be penalized just for having that association."

Lindner's and Lieber's respective colleagues, John Maute of Situs and Debra Morgan of C-III Asset Management, will appear as part of a Special Servicers Power Panel at the upcoming RealShare Distressed Assets conference, along with other experts. It's scheduled for May 3 and 4 at the Adolphus Hotel in Dallas.

(Visit the Distressed Assets page on GlobeSt.com.)

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