Special Servicing: the Ultimate Hardball Tactics

An article recently appeared on Syracuse.com. The title of the article was Inside Destiny USA’s Mortgage Emergency… Crisis or Hardball Bargaining? Destiny USA is the 6th largest retail mall in the United States. The journalist who wrote the article, Rick Moriarty, noted that the mall’s lender “took the rare step of transferring the loans to a third‑party special servicer, a company that specializes in handling defaults or renegotiating troubled loans for lenders.”

 

Unfortunately, sending CMBS backed loans to special servicing isn’t that rare. And it represents the ultimate hardball tactics.

 

As noted above, Destiny USA is one of the largest malls in America. Located on the shore of Onondaga Lake in Syracuse, New York, the six story super mall has over 250 stores.

 

According to the article, Destiny USA’s owner, Pyramid Management Company, has not missed a payment. Yet the loan on the mall has been assigned to special servicing.

 

Special Servicing - What Does That Mean and Is That Legal?

 

Under most commercial loan documents, there is both a loan servicer and a special servicer. As long as there are no problems, the servicer simply makes sure the mortgage, taxes and insurance are paid. Banks like US Bank and Wells Fargo often acts as servicers. Although collecting mortgage payments is a big responsibility, the loan documents give them little power to do much else.

 

Most CMBS financed loans (“commercial mortgage backed securities”) have a pooling and servicing agreement. That document is often 1000 pages long and is almost never read by the borrowers. They should read it, however.

 

Under the pooling and servicing agreement, the note can get moved to special servicing if certain triggering events occur. Obviously the most understood of those events is a payment default. If you stop paying your loan, the noteholder can transfer the loan to the special servicer. The special servicer, in turn, can bring a foreclosure action or renegotiate the loan.

 

Special servicers derive their power from the pooling and servicing agreement. That agreement gives them tremendous power.

 

Why? Because one a loan is sold into a CMBS trust, there is no longer a lender. Banks have people, staff and workout specialists. A CMBS loan, however, is owned by a trust. A trust that has no employees. No eyes and ears. The trust holders are institutional investors and not typical lenders.

 

CMBS financed loans usually have several layers called tranches. The senior most tranches – the ones at the top of the payment cascade – get paid first and are therefore the most protected. They also make the least in interest payments. The lower the risk, the lower the payday.

 

The bottom most tranche is the one with the most risk. And under most pooling and servicing agreements, they get to pick the special servicer.

 

Here is where things get interesting. The special servicer has a duty to the noteholders. All of them. But often special servicers act in their own best interest. If the property is valuable enough, they may try to take it for themselves.

 

And unfortunately, that is usually legal.

 

Let’s get back to Destiny USA and the Pyramid Management Group. If the mall never missed a payment, why is the loan suddenly in special servicing?

 

Because the lowest tranches have so much risk, they make sure the Pooling and Servicing Agreement gives them plenty of rights. One of those rights is setting the conditions for when a noteholder can force the borrower into special servicing and into default.

 

We talked about the most obvious reason for moving a loan into special servicing, payment defaults. There are a host of other reasons for moving a loan into special servicing. They include:

 

  • Repeated late payments
  • Unpaid taxes or insurance
  • Impending maturity default
  • Loss of anchor store
  • Occupancy falling below a specified percentage
  • Determination of deteriorating physical plant
  • “anything that makes the noteholder worried”

 

Some of these may not seem real but they are.

 

We don’t know why Destiny USA’s loan was moved into special servicing but we suspect it was the impending maturity.

 

CMBS loans are often interest only. Ultimately there is a date when the loan matures and the principal becomes due. Depending on the economy at the time, maybe the loan gets refinanced or maybe it doesn’t.

 

Unfortunately, many commercial property owners are blindsided when they are assigned to special servicing  for something other than payment and maturity defaults.

 

If a mall is underwater, the special servicer is more likely to work with the owner. When the property is underwater, if the owner simply walks away, the bottom tranches in the trust collect nothing. (Remember, it was the bottom tranche that picked the special servicer.)

 

The special servicer should rejoice when the property remains solvent. Not all react that way. Sometimes the bottom tranche holder or the special servicer look at the borrower like a cash cow. They can string things along for months if not years, all while collecting huge fees and default interest.

 

Media reports indicate that the Destiny USA mall may not be worth more than the total amount of the debt on the project. That actually bodes well for them.

 

Are You Facing a Maturity Default on Your CMBS Loan?

 

It is a tough time for commercial property owners, especially for those that own shopping malls. With so many anchor stores closing, many malls are dying meaning their value is way down.

 

Despite the depressing news about shopping centers, lower property values actually give owners more leverage over the special servicer.

 

Few real estate lawyers deal with CMBS properties. In fact, a few buyers tell us that they are in trouble for never reading the 1000+ page pooling and servicing agreement or asking their lawyers to examine it.

 

We are one of the few firms that understands special servicing and how to maximize leverage in the owner’s favor. Frequently we partner with the borrower’s own local counsel.

 

Want to learn more? Contact attorney Brian Mahany at [hidden email], visit our CMBS loan workout page, contact us online or by phone at 202-800-9791. All inquiries are without obligation a and kept confidential.

 

Mahany Law and Judge, Lang & Katers – Lawyers that Sue Banks!

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