Five things to know about loan servicing

The conventional wisdom in the US commercial real estate market is that distress is coming, with an expected increase in activity as borrowers seek modifications on loans and a rise in delinquencies and defaults. As the financial markets work through the current period of rising interest rates, lower valuations and a significant number of near-term maturities, master and special servicers are expected to have an influx of situations that require them to be more hands-on.

Master and special servicers perform a critical function in the commercial real estate debt markets. While a master servicer makes sure all principal and interest payments are advanced to certificate holders and works to flag and potentially avert problems with loans, a special servicer works with loans once a problem has emerged and offers solutions, which could include modifications or extensions. 

Here are five things to know about what’s going on in the servicing market today – and what to look for coming down the line.

1 Loan maturities are coming

There are approximately $248.8 billion of commercial mortgages set to mature in 2022, a roughly 12 percent increase from the same period in 2021, according to the Mortgage Bankers Association’s Commercial Real Estate/Multifamily Survey of Loan Maturity Volumes. 

Only about 2 percent of these mortgages are guaranteed by Fannie Mae, Freddie Mac or other government-sponsored enterprises. 

About $36.6 billion, or 6 percent, of loans held by life insurance companies will mature this year and $109.6 billion, or about 15 percent, of CMBS loans will be due this year. Another $90.1 billion, or 26 percent, are held by mortgage REITs, debt funds and other investors. 

The loans that are maturing this year and next will be coming due at a time when interest rates are sharply higher than when the loans were originated. The benchmark 10-year Treasury was at roughly 1.6 percent at the start of 2021 and was at 3.37 percent on September 12, just before Real Estate Capital USA went to press. The federal funds rate rose from 0.08 percent at the start of the year to 2.5 percent at the beginning
of September.

2Wanted: Master servicers

An August report from Fitch Ratings expressed concern about the limited number of master servicers to support the US CMBS market. 

Master servicers, in addition to making sure interest and principal payments are passed through to certificate holders, also oversee primary servicers.

Adam Fox, a senior director at New York-based Fitch, cites potential problems, which include constraining the market’s growth, putting upward pressure on transaction costs, and limiting or disrupting service continuity to the point where a master servicer could stop accepting new assignments. Depending on the type of transaction, there are only two to four master servicers, and Fitch does not believe this is sufficient to support a healthy CMBS market. While some of a master servicer’s functions can be supported by a trustee, trustees are unable to take on the functions of a master servicer, Fox adds.

There is another factor to consider: portfolio growth. “I think everyone is seeing portfolios grow as they go over the next couple of years,” Fox says.

3 The hacker in the room

Cybersecurity, already a concern for much of the financial services market, is a major issue for commercial real estate servicers.

“As servicers go more digital, cybersecurity means not only protecting your network and your borrower data, but also guarding against wire fraud,” Fox says. “Servicers have to be particularly diligent in verifying, for example, routing numbers and account numbers for borrowers to guard against fraud attempts.”

4 More complexity

The commercial real estate debt markets have become more complex in recent years, with both securitized and non-securitized debt of many different types overseen by servicers. 

The lack of standardization of the terms of transition from LIBOR to SOFR is reducing the number of available servicers, the agency says in an August report.

Finally, there are three active master servicers for Freddie Mac deals – KeyBank, Wells and PNC. “Freddie Mac transactions are desired by master servicers as they have a higher servicing fee strip of 2 basis points compared with multi-borrower conduit transactions, and benefit from the consistency in loan documents and administration provided by a single-issuer program,” the report stated.

5 The data revolution 

The consensus is that technology will help the servicer market to move forward, with servicers, lenders and rating agency officials citing several areas of improvement including more robust data, a greater amount of real-time information and an increasing ability to paint a picture of what is going on in a portfolio.

“Technology is helping with ingesting and analyzing loan performance at a faster rate than in the past,” Fox says. “Servicers are better able to pull in data around performance, perform stress testing of a portfolio, use analytical tools, and provide more dynamic reporting… We are seeing servicers go in and say, ‘Oh, you have a maturing loan coming off of a 2.5 percent coupon into a something-coupon market’ and ask what is next for that loan, if that loan will be able to refinance. Servicers are better able to use that technology to get in front of problem loans.”

Outlook

Fitch last year sounded the alarm on how commercial mortgage servicers were facing unprecedented turnover levels at a time when the labor markets were very tight, citing concerns over the potential for declines in the quality of servicing. “Turnover is a challenge for servicers, and the labor market is very tight, and that might cause more third-party vendors to supplement their staff to speed up responses during peak times. But we’re also seeing more servicers work to cross-train their staff,” Fox says.