Servicers work out business strategies for life after CMBS

The European loan servicing universe is evolving, with servicers diversifying their lines of business ahead of their bread-and-butter CMBS work beginning to dwindle. One investor believes servicing is “one of the main areas of evolution for the CMBS market in Europe”.

Since the financial crisis, servicing teams have been grinding through loan work-outs, with special servicing to the fore. There are still €25.8bn of European CMBS loans to be worked through in the next three years or so, according to Standard & Poor’s, but as they mature – and with few new CMBS deals to replace them – Europe’s main servicers are targeting other areas, such as due diligence and underwriting, new lending businesses and advisory work.

For some, this means entering new geographic areas or pursuing innovative new business lines. Clarence Dixon, European chief operating officer at CBRE Loan Servicing, says: “The typical legacy CMBS servicer is not the servicer of the future, which will have a two-fold profile: helping new debt entrants and helping lenders interested in buying portfolios to manage their debt.”

Chasing due diligence work

With an increase in real estate loan trades last year – Cushman & Wakefield recorded more than €23bn of trades by mid December servicers are trying to get in on the act by providing due diligence work for investors bidding on loan books, hoping to secure the servicing work afterwards. But this is not a definite winning strategy, as there can only be one successful bidder.

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Pursuing new debt entrants with small teams – such as insurance companies, debt funds and private equity lenders – is one way for servicers to build critical mass. Capita has locked in a new mandate to service the loans made by a large UK life company scaling up to lend to commercial real estate. It “makes no sense” for private equity firms to set up in-house servicing arms, as  outsourcing the work can be more cost effective, says Hugo Raworth, Situs’s European head.

One trend has been the demise of bank-captive servicers, as banks, which once had big CMBS businesses, offload non-core operations. Barclays, Deutsche Bank and Morgan Stanley have sold servicing arms to independent, third-party servicers Capita, Situs and Mount Street respectively.

Spanish banks sell servicing arms

This trend can now be seen in Spain, where banks need to raise capital and cut costs, and private equity and hedge funds are gearing up for more non-performing loan sales.

There is a third type of European loan servicer: loan buyers’ own, in-house loan operations. Among this group, Lone Star’s captive servicer, Hudson Advisors, is  expanding in Ireland and is said to be scaling down in the UK and Germany, while Apollo’s Lapithus is also thought to be downsizing.

Key markets are the UK, Ireland and Germany, but firms have different views on the best targets. For Capita, a priority is Ireland, where it already has a strong presence and a lot of work lined up. Last August it won a mandate to manage €41bn of NAMA loans, previously managed for NAMA by IBRC.

Other firms claim they didn’t get a look in on this mandate. “It wasn’t about real estate or documentation; I think they wanted to keep it in Ireland,” says a disappointed competitor.

Other servicers have found Ireland tough to penetrate and some are managing one-off opportunities coming out of Ireland from London. “In Ireland they want people on the ground; it’s difficult to get business otherwise,” notes one servicing head.

The hazards of trying to build up a book were illustrated this month when NAMA said it was cancelling the servicing contract  awarded last August to Irish-based Certus, to provide services on up to €22bn of loans NAMA had planned to acquire from IBRC. The work is being re-tendered because many of the loans are now expected to be sold as the Project Rock, Sand and Salt portfolios, rather than transferred.

CBRELS is targeting Germany, a market it believes could equal the UK in size. It set up a Frankfurt office in October to focus on clients originating, buying or financing German loans and portfolios. Dixon was based in Germany during his previous role at Hatfield Philips, where he was managing director until January 2013.

As loan sales have yet to gather pace in Germany the group is seeking mandates to act as facility agent on syndications or club loans for German banks, which now manage such work themselves. While filling a gap in the market, this approach is unlikely to become mainstream, as this mainly cash- management business provides low fees.

All the servicers recognise that Spain offers big opportunities. “I think the initial opportunity will be residential,” Dixon says. There is fledgling activity on the commercial side, however. CBRELS has recently taken on the servicing of Colony’s €215m Project Alpha Spanish portfolio, which it bought from Lloyds in November.

Spanish market may be too immature

While most servicers are eyeing the market, some feel it may be too immature to set up shop there yet. “Sareb has tended to give short-term, renewable servicing contracts, so continuation of income from that source is a bit fragile,” says Capita director Jim O’Leary, who believes “there is scope for a true third-party servicer. Spain is a market to be watched.”

Situs is among those planning to have a presence in Spain. But as European primary servicing manager Lisa Williams notes: “If you are going to acquire a servicer, you need to have a business that’s capable of looking after itself. You’ve got to [be able to] replace that business if you buy a platform.”

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Loan servicing is a small world and one of the more sensitive areas is transfers of CMBS servicing mandates to a new servicer  by dissatisfied noteholders. In the past two years, market leaders Hatfield Philips and Capita, which have about 75% of the special servicing market, have lost mandates to new entrants Solutus and Mount Street (see chart above and table below).

One servicer says he’s “still getting a phone call per week from noteholders saying ‘I’m not comfortable with my servicer’,” but that he wouldn’t “chase other people’s business” on principal.

Loan servicing transfers became tougher last year after Fitch Ratings stopped giving required Rating Agency Confirmations (RACs) on servicer replacements. This has put up “a brick wall… for a lot of us”, says one servicer.

The only exception is “if you can get the issuer and trustee comfortable with having a RAC from only Standard & Poor’s, rather than the standard two,” notes another. While still limited, new CMBS issuance  is an obvious target for servicers. Few seem to believe it will accrue enough volume to provide a steady source of fee income in the near future, however.

A principal at one of the smaller outfits says of the handful of new issues that have come out, it makes little sense “number crunching for one or two basis points for a massive loan at 60% LTV to a great-covenant sponsor, tenant and collateral, as that’s [essentially] no more than an investor report”.

New deals recast the servicer’s role

But the new deals have allowed servicers to remodel themselves, following previous years’ criticism over their passive behaviour. New deals have prescribed that servicers take more responsibility and there is a general emphasis on improved transparency.

“People are glad to see somebody trying to change the perception of what servicers do badly,” says Paul Lloyd, managing partner at Mount Street, which was established last year with the intention of being liberal and transparent with information, and to maintain a constructive relationship with all parties in a deal.

CBRELS’ Dixon says: “You have to be very client-focused. It’s about how fast you pick up your phone; you must be on top of your game seven days a week. It’s unaccept-able to say ‘I don’t know the answer to your question, I’ll tell you tomorrow’.”

The issue of conflict of interests still dominates talk among servicers. One investor says: “I’m not so worried about this because if it’s a rip off, I’m not going to support it.” Others stress it is down to the client to call the shots about which property manager is appointed, for example.

Most are sceptical about the use of third- party financial advisers at noteholders’ expense; the shared view is that special servicers should have the resources
in-house if they are going to charge the high level of fees that they do.

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