The market needs to address some key issues to encourage investors back to CMBS, a product that was unprepared for the scale of the downturn and that has been slow to address its shortcomings. As a servicer, I am concerned about the lack of servicer scrutiny. Scrutiny would have led to more servicers being replaced and better primary management of loans, led by market competition.
With few loans falling into special servicing, it is hard for investors to know if one servicer is better than its peers. But special servicing track records are emerging – as are extra costs of third- party advisers appointed to support the servicer. How can we rebuild lost confidence in CMBS to help re-ignite the market? First, it is worth noting that the armageddon predicted has not material-ised. We have shown (admittedly ahead of a wall of maturities) that CMBS is not as rigid a structure as had been feared. Investments can be exited and, with an experienced servicer, you can extend and enforce loans looking after creditors’ interests.
Fees are a contentious issue. Many smaller loans in special servicing command smaller fees, often for as much work as a ‘big-ticket’ mandate. Likewise, fee structures on larger loans do not represent good value for investors. The answer may be a minimum fee or hourly charge agreed up-front between all parties; or a single fee for primary and special servicing. The latter would remove the incentive to put loans into special servicing, encourage better discipline and quality of service by primary servicers and prevent the need for special servicing in all but the worst cases.
The ability to replace underperforming primary servicers is paramount for transparency and accountability, but most CMBS documents do not allow this to happen, except in cases of negligence, and the replacement process is often complicated. For CMBS 2.0, this process could be governed by independent, non-investor monitoring agents, authorised to find a replacement for the servicer with lower thresholds of noteholder consent. This would promote all parties’ interests, not just those of the controlling class, and would be more cost-effective, as the monitor would only be called in when needed. Agents could represent noteholders, encouraging better reporting and data provision.
Banks’ right to receive full entitlement to the coupon offered by X-class or other notes, even in the event of a default, has been questioned. But there must be an incentive for banks to securitise, otherwise why would they promote CMBS? In the event of a default, the answer could be to put a percentage of the coupon back into the structure at the point where the value currently breaks, for capital spending or other deal-related expenses.
US issuers can sell their positions and typically don’t retain equity in deals. In Europe, at the top of the market, prepayments made it hard to sell these pieces at attractive prices – and if borrowers sold or refinanced, the value of this position was often instantly cut. So changes must be considered to protect noteholders, but also remunerate banks sufficiently for them to re-enter this market.
What view will investors take of the requirement for issuers to retain 5% of the credit risk on new issues when deals are handled by banks with in- house servicers? Is their role segregated enough to protect the interests of everyone? Surely third-party servicers would be more efficient and independent. Transparency and consistency has to improve across the board. CREFC Europe has made a start by promoting new reporting package E-IRP version 2.0, which has harmonised standards in line with ECB requirements and will enable the promotion of more standardised reporting across Europe.
There are other difficult questions. Should hedging caps be encouraged instead of fixed-rate loans? Should borrowers pay for this, or should the premium cost be imbedded in the loan? Either way, long-dated swaps in some deals have clearly reduced servicers’ options in work-out situations. Many complex issues must be addressed for a robust, sustainable CMBS market to re-emerge, with the confidence of investors, issuing banks and advisers. These matters cannot be speedily resolved.