Loan servicers are probably best thought of as the backstage crew keeping the show going for lenders in the real estate market.
Their day-to-day focus has changed in the post-crisis real estate finance market. While managing CMBS used to put servicers in decision-making roles, today they are employed more as administrators of large-scale portfolios – largely mandated as facility and security agents on performing, balance sheet loans.
Loan servicers’ work varies by jurisdiction, depending on where a market is in its cycle. “Much of what we do in the UK on the commercial real estate side relates to facility agency roles wherein our mandate tends to be restricted,” explains Peter Walker, director of banking and credit management at Link Asset Services.
“In Ireland, where banks are still deleveraging, a lot of business takes place in the portfolio sector, in which case we are working those portfolios out through refinancing and recovery processes on behalf of private equity funds and investment banks,” Walker adds.
Facility agents’ jobs are to oversee loans during their lives, acting as a conduit between borrower and lender. In certain cases, for example, if a borrower requires a valuation or consent for a lease renewal, it will approach the servicer, which liaises with the lender, or lenders. “This comes into play on loans that are syndicated to several lenders because a borrower doesn’t want to go to 15 lenders to get approvals,” says Clarence Dixon, CBRE’s global head of loan servicing.
In addition, facility agents collect interest and amortisation, of which they distribute the appropriate share to lenders.
Security agents are responsible for matters relating to the assets securing loan facilities. That means handling documentation associated with substituting or disposing of properties relating to a loan, for instance.
Many lenders have outsourced facility and security agent functions after selling off captive servicers or rebuilding origination teams in the most efficient way, post-crisis. Fees for such activities were incorporated into loan margins before, whereas now these functions are delivered by third-party providers and borrowers tend to foot the bill. Often, however, lenders will ask servicers to make recommendations on matters including lease consents or rent adjustments, as well as providing enhanced reporting such as covenant surveillance for an additional fee.
Typically, servicers act for three types of clients: those buying loan portfolios without servicing operations of their own; start-up loan originators or established lenders that do not want to take on servicing functions themselves; and existing lenders that want to syndicate loans and outsource loan facility agent functions.
One real estate banker, who declined to be named, says the investment bank he formerly worked for had internal capacity for facility and security functions but was “really terrible at it”, down to the way information was communicated by fax rather than being scanned into an email.
By contrast, third-party servicers represent “good value for money”, according to the banker. The bank’s facility agent group might cover 50 products, which is “not what you want in commercial real estate. Knowing that people understand the asset class is super helpful”, the banker says.
“At headline level, the service we provide spans due diligence around a loan and the underlying property; cash management and payment functions as well as loan and asset management; and helping a client work things out if necessary,” explains Walker. Due diligence at loan level involves capturing all relevant data a client might need, including information about the sponsor, maturity date and how interest should be calculated.
“In essence, it is understanding what a client is trying to achieve: what the loan product is they’re wanting to originate or buy, so we understand the loans as well as they do because we’re the ones that have to operate them,” Walker says.
A servicer will then ‘board’ a loan onto its system, as part of which cash management and payment functions are set up. This involves collecting money from a borrowers on the date it is owed in the manner it is due to be paid – whether by direct debit or bank transfer – or ad hoc payments in the case of non-performing loans, reconciling this and passing the funds on to a client.
Loan management thereafter involves ensuring the scheduled repayments of principal and interest are collected, making sure covenants are being observed and, if they are not, what action should be taken.
As part of the asset management function, a servicer must understand what the cash flows are from a property so it can monitor and manage the risk that a cash flow might be broken in some way – if a tenant vacates, for example.
Servicers must maintain updated data associated with the loan as well as the property throughout the life of a loan. “There is a lot of data to assimilate. From a reporting point of view, we aggregate data from different systems to generate a standard report for clients at intervals that are agreed at the start of an assignment. Often, clients also want data tapes and ad hoc reports to manage risks or loan delinquency,” says Walker.
“Quality of data is very important. In the past, up-to-date information has been difficult to get hold of, although this has improved,” says one CMBS investor.
While there is a reporting format servicers follow when it comes to public CMBS, there is little standardisation with regard to bilateral agreements with clients.
“We have service-level agreements within all our contracts which set out what we are going to provide, ensuring we hit our reporting targets and that we are accurate with our data,” Walker points out.
In line with the scope of its mandate, a servicer will help find a resolution between the lender and borrower should anything go wrong. This may involve simply telling a client that a borrower has not paid on the due date and asking what action it would like the servicer to take. Or it could be that a servicer has a mandate set out under a CMBS servicing agreement which means it will follow through as if it were the lender.
“When a loan defaults, generally we have a conversation with the borrower to make sure we understand what the problem is. We then assess all the various options that could put a loan back on track or if that’s not possible, ensure maximum recovery for investors,” says Walker.
Whether a servicer pursues a work-out or foreclosure varies depending on the individual circumstances. Sometimes, issues surrounding the asset can make it undesirable to liquidate. “If it’s a particularly complex operating asset, like a care home, matters must be dealt with carefully,” Walker says.
The more effort a servicer is required to put in, the higher its fees can be. Work-out situations can command a margin up to 15 basis points higher than performing loans (at 3bps to 5bps per year). If it is necessary to engage lawyers and other advisors to recover a loan, a range of costs are incurred. These are wrapped into special servicing fees, though not pocketed in full by the servicer.
Work-out situations might provide the most lucrative jobs for servicers, but helping clients avoid problems in their loan portfolios is in servicers’ interests, those in the industry argue.
“It is the servicers’ job to support the lender in managing risk exposure,” says CBRE’s Dixon. “To do this, the servicer needs to be proactive in identifying risk indicators. While special servicing offers higher revenue potential, the servicer should support the lender in ensuring the potential of a default is avoided.”
“If you don’t as a servicer invest in technology and processes that prove to your clients you know as much about their loans as they do, they won’t keep coming back,” he adds.
When something appears in the press relating to a company voluntary arrangement, which allows insolvent companies to pay creditors over a fixed period, CBRE runs that company through its system to find out if it manages loans where the firm is a tenant, immediately sending out a notice to its client if it is a potential area of concern. “This is not something we are required to do but it lets our clients know we are on top of things,” Dixon explains.
Servicers are being appointed for their operational expertise plus extra support they can provide lenders. Clients are also asking trusted servicers to follow them into new jurisdictions to help with distressed loan purchases, as per Link’s launch of an Italian branch at the end of last year. Their day job may require less decision making than it once did, but loan servicers remain a valuable resource for lenders.