CMBS special servicers – they are responsible for tens of billions of troubled commercial real estate projects. Until very recently they escaped all media and regulatory scrutiny. Because of their expansive powers, they have the ability to dramatically impact the future of the commercial real estate market and maybe even the entire economy. They are that powerful. And some say they have misused their power.
During my time working for the Maine Senate, someone gave me a gift; a small placard. It’s inscription, “Power Corrupts and Absolute Power Corrupts Absolutely.” We think there is truth to that statement, especially when it comes to CMBS special servicers.
CMBS is short for Commercial Mortgage Back Securities. The loan servicing industry is divided between residential and commercial. (The residential servicers currently have their own set of problems.) Commercial loans are often packaged into pools, securitized and then placed in trusts. Those trust documents typically specify a trustee, servicer and a special servicer.
Ordinary servicers are responsible for collecting payments, making sure the mortgage is paid and insuring other essential bills are paid such as maintenance, taxes and insurance. When a borrower defaults or there are signs of trouble, the normal servicing function is turned over to special servicers.
Special servicers have broad powers. Once a loan is turned over to special servicing, the goal becomes to preserve the asset and collect as much money for the note holders as possible. At least that is the theory.
Earlier this summer the New York’s banking superintendent, Benjamin Lasky, announced that New York was concerned about possible conflicts of interest caused when a servicer decides to acquire a troubled property. Although they have a fiduciary duty to the lenders / note holders to collect the most money as possible, that appears to be in direct conflict with their desire to acquire properties for the cheapest possible price. You can’t do both.
It’s not just New York state that is getting interested in what the CMBS special servicers are doing. The IRS and Congress are asking questions too.
The three largest CMBS special servicers are CWCapital, C-III Asset Management and LNR Partners. Earlier this year CW Capital was sued for its handling of the billion dollar Stuy Town Village in New York. And that isn’t the only lawsuit.
An estimated 10% of CMBS loans are currently delinquent or in default. One research firm says this is the highest delinquency rate since the real estate market collapsed in 2008.
Theoretically, special servicers must determine whether troubled properties should be liquidated or go through a workout process. The determining factor is what is best for the note holders, not the delinquent borrowers. New evidence and our own experience suggests that some CMBS special servicers are actively working in their own best interests.
What does that mean? Special servicers get paid first and they get paid well. The longer a troubled property stays in limbo, the more special servicers get paid.
More ominously, we believe that some of these companies are working to buy the properties for their own portfolio. Think about it, they have the best information about rent rolls and loans. They also have the power to greatly influence the manner of sale and the price.
Several experts in the field share our same concerns.
Litigating against special servicers is difficult. Typically only larger law firms have the experience to litigate these sophisticated claims. And inevitably, those firms have conflicts of interest galore and are precluded from taking these cases for borrowers.
Unless the bond holders seek to litigate against the servicers for breach of fiduciary duty, the borrowers – who are already in trouble as evidenced by the special servicing requirement – can’t afford the legal fees to litigate these claims.
Is there hope? As regulators start to shine on a light on the practices of CMBS special servicers like CWCapital, C-II and LNR, conflicts should diminish. Until now, however, the industry has operated below the radar with little scrutiny.
There are also a handful of boutique law firms willing to take these claims on behalf of bondholders or borrowers. Most charge affordable fees much less than those of the larger firms.
Mahany & Ertl is a boutique law firm headquartered in Milwaukee. We handle CMBS fraud and special servicer fraud cases across the United States for both borrowers and bond holders. For more information, contact attorney Brian Mahany at or by telephone at (direct).