Last month, I discussed the process for getting a modification or restructure on a CMBS loan. There’s a master and special servicer for every pool of CMBS loans. The master servicer can’t discuss a restructure or modification with you—only the special servicer can. You can’t speak to the special servicer until you’re in default or will be in default in the near future (i.e., imminent default).
Read “US Treasury moves to assist distressed property owners.”
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Ann Hambly |
So, the first thing that has to be done when you’re facing a default is to let your master servicer know. Once the master servicer is clear you have a true default situation, it transfers your loan to the special servicer. The Real Estate Mortgage Investment Conduit rules that don’t allow a restructure or modification of a loan allow the special servicer to do whatever is in the best interest of the bond holders once a loan has been declared in default or imminent default. So, once the loan is transferred to the special servicer, any restructure or modification that’s in the best interest of the bond holders can be considered.
Even after a CMBS loan has been transferred to the special servicer, it may be difficult to engage the special servicer in meaningful dialogue about potential modification scenarios. This is due, in large part, to the fact the current real-estate crisis has overwhelmed most special servicers. I’ve said this many times recently, but the special servicers must feel like they’re drinking from a fire hose. The amount of CMBS loans in default went from about US$5 billion a year ago to more than US$20 billion today.
Even with these hurdles, it’s possible to restructure a CMBS loan that has the characteristics described above. Here are the types of modifications that have been done recently:
1. Maturity date extensions. August’s column was devoted solely to this, so I won’t repeat it all other than to say it’s possible to get an extension on a maturing CMBS loan if you can prove you’re not able to obtain sufficient replacement financing to pay your loan off at maturity, which isn’t difficult to do in the current market.
2. Payment modification. The most common type of restructure is one that results in a slight modification of the payment such that the income from the property supports the new payment. If your current payment consists of reserves, principal and interest and tax and insurance escrows, and the current cash flow of the property will support a payment that consists of some components of the previous payment (i.e., interest only), it’s possible the payment can be modified for a period of time so the income from the property satisfies the new payment.
3. Interest rate reduction. If a payment modification, as described above, still doesn’t work with the current property’s cash flow but will cover operating expenses and debt service at a lower interest rate, it’s possible the interest rate can be lowered for a period of time again.
4. Principal balance reduction. This is the most difficult type of modification to achieve and can be considered only in two instances:
- The property cash flow won’t support any other type of payment modification (i.e., interest only, lowered interest rate, et cetera).
- You’re willing to share the pain. Remember the special servicer is almost always the entity that’ll absorb the principal reduction loss. In exchange for granting a principal reduction, it’ll usually require you contribute money to help offset the total amount of principal being reduced.
5. A/B split note. In lieu of outright forgiving some of the principal and incurring a loss today, it might be preferable to split the note into two parts—an A and B. The A note essentially will equal the amount of debt the current property’s cash flow will support today. The B note will be the difference between the original note amount and the A note amount. The B note typically won’t accrue interest and essentially will be due upon final payoff of the debt at the original or extended maturity.
The main benefit to the A/B split note is:
- It doesn’t require the special servicer to actually incur a loss today;
- it allows the special servicer to potentially recoup its entire original debt; and
- the borrower doesn’t have a tax consequence as a result of the debt forgiveness unless and until there’s an actual loss in the future at the original or extended maturity date.
Other type of CMBS loan restructures or modifications that have been done recently, which will be discussed in next month’s article, are:
- discounted payoffs or note sales;
- short sale;
- rescue capital; and
- deed-in-lieu.
Ann Hambly (annhambly@1stservicesolutions.com) is a founding partner, president and CEO of 1st Service Solutions, a commercial real-estate advisory firm in Grapevine, Texas, that assists borrowers who are assuming or modifying securitized mortgages. Hambly has more than 30 years of commercial mortgage servicing experience, with more than 15 years involved with CMBS product.