The industry (still) needs troubleshooters

Loan servicers were most prominent when dealing with the fallout from the financial crisis, but they can play a valuable long-term role helping lenders avoid fresh problems.

In the European real estate finance markets, loan servicers came into their own in the aftermath of the global financial crisis.

During that period, pre-2008 loans tied up in securitisations needed to be worked out. It was these sentinels of CMBS vehicles that took charge of special servicing mandates. Theirs were active and relatively well-remunerated roles which required them to work-out often complex situations with defaulted borrowers to maximise repayments to bondholders.

In recent years, with Europe’s legacy CMBS special servicing work virtually dried up, debt servicing specialists have looked elsewhere for business. The long-winded deleveraging of Europe’s banks has provided work, as prospective buyers of non-performing loan portfolios entrusted them with underwriting duties as well as working through issues on long-defaulted loans.

As such, the European Commission is aware of the need for credit servicers. Proposals issued in March to help tackle Europe’s NPL mountain included measures to encourage secondary debt trading and to implement a common set of rules for third-party credit servicers to abide by.

Clearing up the last cycle’s problem real estate debt will not last forever, though. There will always be defaulted loans in the sector and market corrections are bound to create work-out situations that require servicers’ skills. However, the volume of such work created by the last crash is unlikely to be repeated soon. Lenders have originated debt at lower leverage, meaning fewer loan-related problems are being stored up for the next downturn.

Loan servicing is the type of practice that goes largely unnoticed until something goes wrong and needs fixing. However, it has an important role to play in the commercial real estate market – even when the loans in need of servicing are performing as they should. Ongoing scrutiny of loans should be seen by lenders as an important measure to prevent issues becoming problems.

Many lenders do not want to take on such day-to-day work. It is time- and resource-consuming and requires a skill set many origination businesses do not have in-house. There are many commercial banks that fulfil such functions in their back offices, but many lenders – including in the alternative lending space – are eager to outsource. It is little wonder Hudson Advisors, previously Lone Star’s captive servicer, is aiming to spread its wings and offer its services to external clients.

Until loans go bad, managing them is not a lucrative profession – meaning it needs to be done at scale to be a viable business. If servicers make more money when loans default, what is their incentive to head off such situations? Simply, earning reputations as reliable custodians of loans – actively monitoring individual loans’ performance, ensuring covenants are being comfortably met and addressing glitches when they first arise – means lenders are more likely to entrust large volumes of performing debt to third parties.

Not that the European loan servicing space is issue-free. Some point to a relative lack of truly independent servicing platforms, with private equity firms buying up businesses in Continental Europe, often from banks, to work through loan portfolios often acquired from those very same banks.

However, the European real estate market needs professionals dedicated to ensuring loans perform and springing into action when they do not. In a series of upcoming features, Real Estate Capital will explore the dynamics of today’s real estate loan servicing industry.

Balancing the costs of running such businesses with the fees on offer is a challenge, but in a market with an increasingly diverse lender base, the function of managing real estate loans will remain in demand.

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