The CMBS Borrower Experience Is Still Hell

For years now, most participants in the CMBS industry recognize that the borrower experience isn’t what it needs to be if we are to have a thriving CMBS industry. Trade associations, committees and task forces have all tried to find ways to improve the borrower experience. As we are heading to the end of 2019, let’s take a look at the borrower experience in CMBS to see if it is improving or not. I will start out by giving a few examples of some of the most common issues in the industry on fully performing CMBS loans.

One of the most common borrower complaints in CMBS is the handling of cash management accounts for so many reasons. NOT that the loan is in cash management, but the actual handling of the accounts. One particular frustration is when there is a weekend in the middle of the whole process. Servicers typically reach into the cash management account to pull their payment on about the 5th of the month. When the 5th falls on a weekend, the servicer pulls their payment on the Friday BEFORE the weekend; often a day or two before the tenant pays its payment. Often, this results in the borrower being forced to pay the shortfall on that Friday for the payment, or the loan will be in default.

The borrower wires the funds and then the very next business day, the tenant’s payments are posted and now the borrower is out that shortfall until the next month. No big deal you say, but it IS for borrowers that have to wire in hundreds of thousands of dollars just because the servicer pulled its payment the Friday before the 5th instead of the Monday after the 5th.

So, you may now be thinking you can just call the servicer and they will refund the money to you. If so, you are dead wrong. Servicers are unwilling to refund the money.

Often these situations are happening on perfectly performing loans that were arguably never even intended to be in cash management.

The only reason the borrower is in cash management to begin with is because the detailed definitions in the loan agreement allows the servicer to calculate the debt service coverage ratio (DSCR) based on factors that have nothing to do with the actual property. For example, if a property is 90% leased and the loan agreement allows the servicer to use the lesser of (a) property occupancy or (b) market occupancy and the MARKET has an 80% occupancy rate, the DSCR calculation will use an artificial 80% occupancy. This is just one example of the many ways a loan can go into cash management on a perfectly performing property.

Another eye-opening example of this is where Amazon is a single tenant to a property securing a CMBS loan. Amazon’s original lease term expired before the loan matured. Amazon approached the borrower about extending its lease and it all made perfect business sense to do so. As part of the early extension, Amazon asked for a month of free rent every year for a few years. When the first quarterly reports with a month of free rent were sent to the servicer, the DSCR triggered a cash sweep. AND the only way out of the cash sweep was upon TWO quarters of DSCR above the threshold.

What this ultimately meant to the borrower is that he was in a cash sweep for six months of every year on a perfectly performing loan with virtually no tenancy risk.

I often have borrowers call me to see if I can help them understand why they are in special servicing. They didn’t miss any payments, didn’t get any notices they were aware of, and now have been contacted by a company they may not know even existed, the special servicer. Once recent instance was surprising even to me and I think I have seen it all. This property was a well performing hotel that unfortunately, experienced a massive flood that temporarily closed half the hotel. The borrower immediately worked to remedy the situation and the hotel was back up and operational very quickly. Of course, his income suffered during the time a portion of the hotel was shut down. His quality assurance scores also suffered from the guests that stayed at the hotel while it was being repaired. Good news though was that everything was back up and operational and income was now back to what it was before the flood.

The first quarterly financial statements sent in after the flood resulted in a DSCR below the threshold and resulted in a cash sweep. The borrower tried diligently to convince the master servicer that it wasn’t necessary, and all was now good.

Fast forward a few months and the borrower gets a letter from a company he didn’t know existed, his special servicer. The infractions cited by the special servicer were:

• not complying with cash management which was a recourse carve-out violation,
• Low guest scores which resulted in a notice from the franchise, misappropriation of rents, which was also a recourse carve-out violation, because the borrower was not depositing the hotel income into the cash management account (which he hadn’t opened).
• And the need for the borrower to place a significant deposit into a seasonality reserve

For all these infractions, the borrower was now incurring default interest, special servicing fees, legal fees for all the legal letters the servicer was sending to the borrower and he can’t get out of special servicing until he pays all these additional fees, including the significant deposit to the seasonality reserve account.

And remember that all the borrower did here was experience a flood at his property, which he promptly resolved.

Another shocking example of this was for a borrower who was transferred to special servicing and didn’t know why. What we ultimately found out was that there was a small change to the ownership structure about two years prior that required lender consent and the borrower failed to get lender consent. This triggered a technical default and now the loan was in special servicing. The borrower wanted to get everything cleared up as quickly as possible, which he did. BUT, before he could go back to master servicing, he was being required to pay over $2MM of default interest dating back to the date of the initial transfer. The longer he tried to fight the payment of the fee, the larger it became.

Ultimately, sometimes, in CMBS, it is a game of “chicken” to see who caves first, and the servicer is not incentivized too often to cave.

When I reach out to a servicer on behalf of a borrower, I am often told: “Hey, the borrower signed these documents. They should know what’s in them”!

But, let’s think back to all the late fees charged on balloon payments during the maturity wave in 2015 through 2017. Most payoff statements issued during this time included a 5% late fee on the entire balloon payment for loans paid off after the maturity date. The servicer’s argument for doing this was “the loan documents do not exclude it”, so it is due. BUT, we all know that no borrower would willingly sign new loan documents thinking they would have a pay a 5% late fee on their entire balloon payment. This is where there has to be some human element, or element of ‘intent’ applied.

I have spent my entire career in commercial real estate with a significant amount of that trying to improve the borrowers experience with CMBS. I personally think most of the issues can be summarized by the fact that the servicers often do not apply a human element to their decisions. They rely on the literal read of the documents with zero reliance on the intent of the words. Servicers often forget that these are real people trying to run their business too.

Another significant issue in CMBS is the length of time it takes to approve leases. How can a borrower retain an interested tenant in its space when it takes months to get a lease approved? Yet, this is the typical turn-around time for lease approvals. And the reason it takes so long is simply because of the process, which servicers need to find a way around! Here’s the process for getting most leases approved:

• Borrower submits lease request to the master servicer (and typically to a generic mailbox) The request is internally assigned to a person within the master servicing shop
• The master servicer then requests a processing fee from the borrower and won’t start the review until the processing fee is received. Assume for a minute, the fee is mailed. You just lost a week
• Now the master servicer assigns the request to its third party underwriter
• The third party underwriter often has questions about the property and a week is spent answering these questions
• When the third party underwriter is done, the request is then submitted to the master servicer
• The master servicer signs off and obtains committee approval, which can take another week
• The master servicer sends the file to the special servicer
• The special servicer reviews the request and often has additional questions and you have not lost another week
• The special servicer consents and sends the confirmation back to the master servicer
• The master servicer gets its legal counsel to issue a conditional approval letter
• The conditional approval letter is sent to the borrower

Is it now easier to see why it takes so long? Even if the file never sits idle on a desk at any of these shops, the process alone takes a long time. Meanwhile, the borrower is doing its best to hang onto the tenant, even though he cannot tell a tenant when he will be able to approve its lease.

So back to my original question of whether the CMBS borrower experience is improving. The answer is no. I am finding that it is actually going in the other direction.

Ann Hambly is the Founder and CEO of 1st Service Solutions.