Last week, Fitch Ratings warned CMBS special servicers against engaging in opportunistic servicing.
The release said that Fitch is concerned when a special servicer, based on its role in the deal, makes use of "self-serving opportunities through excessive litigation, and/or opportunistic servicing by unnecessarily transferring assets into special servicing." Fitch added that the consequences happen when bondholders are not made whole on their investment because of the unwarranted costs related to this type of servicing.
"The main reason that we put this out is that through the course of this year there has been a lot of discussion regarding the frequency of questionable special servicer actions," said Stephanie Petosa, an analyst at Fitch. "It's Fitch's position to listen to the whole market and to comment when appropriate. We decided to comment in such a situation to let the market know that we are aware of these issues and that we'll take action if necessary."
Petosa said that their servicer ratings include the type of issues that were discussed in the press release, and said that a servicer's ratings may be in jeopardy if that servicer continues to engage in opportunistic servicing. However, before taking any action, Fitch would work closely with these special servicers. As stated in the documents, servicers are usually given a cure period. The press release should act as a first type of warning. "There will be many discussions with the servicer if the opportunistic behavior continues," said Petosa "We will continue to monitor and to take action if we need to."
Analysts say that most special servicers perform their jobs very well and are able to manage competing interests by sticking to what they are supposed to do - which is to work for the benefit of the trust, and not toward the interest of specific security holders. However, there may be some potential conflicts of interests in which a specific security holder's interests are favored, and not the interest of the trust as a whole.
For instance, in the case of B-piece holders who are also the special servicers on the deal, which was an instance cited in the Fitch release, there is the potential that the special servicer's interest as a certificate holder might influence its choice of workout and thereby put its own interest as a certificate holder ahead of the interests of the trust.
"The special servicer is supposed to work for the benefit of the trust, which means all certificates without favoring any class over another," said Mary Stuart Freydberg, an analyst at Merrill Lynch. But for special servicers who own the bottom piece, there is that potential to work out a loan in a way that would benefit them and end up not favoring senior certificate holders. "This introduces an element of working on a securities basis as opposed to a loan basis as they are charged to do," said Freydberg.
Fitch also mentioned the aspect of excessive litigation in their release. In this case, special servicers should still focus on maximizing the net present value of the loan.
"With respect to litigation, the special servicer should determine whether litigation is necessary,"
Though certain litigation may have the potential to prevent investors from taking a principal loss, this may not be the most effective route to maximize the net present value on a particular property if the litigation efforts and legal expenses erode recovery beyond what would have been recovered on a discounted payoff. "Special servicers are charged with maximizing the net present value of a loan, as oppose to maximizing current cash flow or avoiding the recognition of a principal loss," said Freydberg. "The goals of individual certificate holders don't necessarily align or match with what is best for the trust as a whole."
Investors' point of view
One investor says that though there are inherent conflicts of interest between parties in a CMBS transaction, as long as buysiders understand that there is a potential for conflict, they can make an assessment of the credit under consideration.
Currently, the CMBS market is experiencing an increase in delinquencies as well as loss severity in deals. Consequently, there have also been more workouts in the sector - thus the more prominent role of servicers in deals. Since the frequency of workouts is a relatively new development, CMBS deals have not been priced according to who are the master servicer and special servicer in these deals, but ultimately the market will, said the investor, who declined to be quoted by name. Thus, eventually, deals with the better servicer should get better pricing. As the market matures and workouts become more common, the good special servicers will rise to the surface.
Though there have been some very self-serving workouts whether an investor is impacted depends on where that investor is on the capital structure. A triple-A buyer, for instance, may be adversely affected if a borrower comes in and makes a par payoff. If, in this instance, the special servicer waives the prepayment penalty, he benefits from the transaction because he bought discount securities and he is getting par back. Aside from this, subordination on the deal increases. Meanwhile, the front-pay triple-A buyer gets par back but he is sitting on a 105 bond. He should have gotten a commensurate amount of yield maintenance to make up for that early prepayment.
It's important to ask whether or not a special servicer is meant to maximize recoveries for the benefit of the trust. What does this mean for a triple-A buyer who also has to maximize yield? These issues need to be addressed so that the steps that should be taken become more clear, the investor said.