Thursday, April 1, 2010

Losses to CMBS Deals Could Shift Control


April 2, 2010

The increasing losses hitting most CMBS transactions could soon result in a shift in the control of the special servicing rights for many deals. So far, the sector has not seen many, if any, changes in deals’ so-called controlling classes, which provide their owners with the authority to name special servicers. But most observers expect big changes this year and next, especially if predictions of continued increases in loan delinquencies bear fruit and special servicers start liquidating loans more actively.

As it is, 173 CMBS transactions with a combined balance of $70.5 billion have seen losses of at least 1 percent of their original balance. While many were issued during the 1990s and have little collateral left, a total of 83 deals with a balance of $56.8 billion were issued since 2000. Those include 16 deals with a balance of $19.6 billion that were issued since 2005, according to data compiled by Bloomberg for CMBS. That latter group could be at greatest risk of seeing changes to their special servicers, since they are backed by loans that were written during the market’s headiest days. When those sour, they have a high likelihood of suffering substantial losses.

A CMBS deal’s controlling class, also known as its B-piece, is generally comprised of bonds rated BB+ and lower, down to its unrated class. During the market’s frothiest days, CMBS deals were regularly issued with B-pieces totaling roughly 2.5 percent to 3.25 percent of a deal’s total balance. The transactions are structured so losses stemming from any loan liquidations hit a deal’s unrated bond class first, until it’s wiped out. Losses then crawl up a deal, hitting what typically would be the class rated B-, then B and so forth. When losses wipe out all the bonds in the B-piece, control of the transaction moves to holders of the next more senior bonds. Those bondholders can name a new special servicer.

Because B-pieces have historically come with special servicing rights, most firms in that sector had developed investment capabilities in order to build up their servicing portfolios. Indeed, LNR Partners, the most-active player in the B-piece market, had acquired the B-pieces of 22 percent of all the fixedrate CMBS deals that priced between 2005 and 2007. Centerline Holding Co. was the most active buyer in 2007, investing in 19 deals with a balance of $48.2 billion, or 25.1 percent of that year’s conduit issuance.

Needless to say, many of the players that were most active during the market’s runup have run into financial difficulties as the value of their investments have plummeted. Others, however, have not invested in bonds and instead have long relied on being hired as third-party servicers. Those firms, which include Crown Northcorp, Helios AMC and Midland Loan Services, could benefit from the potential musical chairs.

Centerline recently agreed to a recapitalization that gives Island Capital Group a 40 percent stake, while LNR is said to have hired advisers to help it develop strategic alternatives, which some say might include a bankruptcy filing.

Despite their difficulties, their servicing portfolios remain extremely valuable because of the ongoing cash flow they generate.