Academy Securities warns on impact of servicer replacements in CMBS workouts

The firm cited concerns over the workouts of New York’s 1740 Broadway, which has seen its servicer replaced twice since entering special servicing. 

An Academy Securities report released last week raised concerns over the potential impact of special servicer replacements for distressed commercial mortgage-backed securities loans, with analyst Stav Gaon noting this phenomenon is expected to rise as more loans come up against performance or maturity issues.  

While special servicers are assigned to CMBS deals at the time of securitization, bondholders can vote to replace the special servicer on a troubled loan as it proceeds through a workout, Gaon noted. This scenario is being seen with a $308 million loan on New York’s 1740 Broadway, a class B office building which was securitized in BWAY 2015-1740 and was transferred into special servicing after New York-based manager Blackstone ceased making payments in March 2022.  

Since the loan was transferred into special servicing, the loan servicer has changed from Green Loan Services in March 2022 to Midland Loan Services in February 2023. In August 2023, CW Capital replaced Midland and, at that point, hired Dallas-based advisory CBRE to sell the loan.  

But earlier this month, Midland was re-hired to service the loan – and it is no longer clear if the loan will be sold, Gaon said. The loan, which had been posted for sale on the R Marketplace auction website, is no longer there and according to published servicer commentary, Midland said it was working to figure out the best approach to the loan, he added. 

“We expect a rising frequency of special servicer replacements, as the rights terminate servicers and appoint new ones shift across the capital structure,” Gaon added. 

The frequency of servicer replacements stems in part from 1740 Broadway’s declining appraised value. At the time of acquisition in 2014, 1740 Broadway was valued at $605 million. But its valuation was pegged at $175 million in April 2023, with Gaon noting declines in valuations have an impact on which group of bondholders is the controlling class of the deal. And as the controlling class changes, this can also lead to changes in the special servicer or the workout strategy.

The situation is not a unique one, with Gaon underscoring replacing servicers makes it difficult to understand where a loan is in the workout process or determine which party is handling the workout.  

“To be sure, the complexity of the 1740 Broadway workout, and limited availability of public documents on the note sale, make it hard to conclusively tie the special replacement to the note sale cancellation. But the rapid replacements of the specials in recent months and the varying classes that directed those replacements, underscore investors should not expect continuity or clarity on handling troubled loans as specials change over,” Gaon added.  

Officials at CBRE and Midland respectively declined to comment on a potential loan sale, citing client obligations. A spokesperson for Blackstone responded via a written statement, noting “[Blackstone] wrote this property off two years ago, and in the event a buyer is identified, we will work collaboratively to transfer the ownership.” Blackstone is not involved in the note sale, the spokesperson added. 

Special servicing expected to rise 

With elevated interest rates and a difficult refinancing market, CMBS loan transfers to special servicing are expected to rise in the coming months. New York-based data provider Trepp found that the CMBS special servicing rate increased by 20 basis points in September to 6.87 percent, according to a report published in early October. The office sector, with a 62-basis point increase, saw the largest rise in transfers. 

Ed Weil, co-leader of the national law firm Dykema’s CMBS practice, noted that loan transfers have been lower than expected. 

“We have not seen as much volume increase in the main for transfers to special servicers in the US as was originally forecast, but that’s not because we’re out of the woods,” Weil said. “It’s because servicers and lenders tend to be kicking the can down the road with respect to exercising their remedies in hopes that interest rates will go down.” 

Maximizing recoveries 

The role of the special servicer is intended to maximize recoveries to bondholders and the note sale of 1740 Broadway was intended to be an important step in maximizing recoveries for bondholders, Gaon said. He added, however, that the best approach is not always clear. 

“[Loans] being transferred to special servicing is certainly not a good thing, but many times that’s the first step to deal with the situation,” Gaon said. “The question is, ‘What is the best approach?’” 

Special servicers in situations like this have several options, including liquidating a loan as quickly as possible through a note sale or foreclosing and transferring the ownership back to the CMBS trust with the aim of stabilizing the property and preparing for sale when the market is in a better place, Gaon said. 

“Do we want to liquidate distressed commercial properties in such a distressed market?” Gaon said. Factors such as depressed valuations, interest rate volatility and unstable occupancy make it more complicated for servicers to calculate the best path forward for loans in distressed situations, he added. 

There are also less drastic methods a servicer can pursue, including loan modifications. 

“If you have a committed sponsor interested in sticking around and working on the property, usually that would be a preferred approach [rather than a note sale],” Academy Securities’ Gaon said. He added special servicers are usually not interested in taking over distressed properties, so they would be inclined to negotiate with borrowers on loan modifications. 

Furthermore, if there’s no monetary default, the lender will often enter into a forbearance agreement or a short-term loan extension agreement with borrowers and will not pursue legal remedies of foreclosure or collect outstanding debt from the guarantors. 

When negotiating forbearance agreements with borrowers, lenders and servicers want to see a series of documents that substantiate borrowers’ financial circumstances and their business plan for the property, which include but aren’t limited to updated verifiable financials for the property, current income statement certified by an accounting firm, current rent rolls and a current personal financial statement from the sponsor, according to Weil. 

“The lender obviously needs to evaluate those data points [as to] how solvent and liquid the sponsor is,” Weil said. 

He continued: “Then the lender will want to talk to the sponsor to get a sense for what their business plan is for the property. What’s their plan to renovate or reposition the property? What’s their leasing plan? What’s the tenant improvements and leasing commission allowance?”  

A final reason why loans are being transferred to special servicing is related to expiring interest rate caps. Borrowers typically have acquired interest rate caps on floating-rate loans to hedge against interest rates volatility. However, as the SOFR rate has continuously spiked in the past 12 to 18 months, the interest rate cap expenses surged accordingly, making some borrowers go into “strategic defaults” to avoid these payments.  

“When we refer to strategic defaults, it’s more about the borrower being interested in initiating negotiation with the servicer about loan modification, and in CMBS, the only way to do that is [to] get transferred to a special service,” Gaon said.