June 30, 2009
By Ann Hambly
 

Some of you might remember the old days when a borrower went to a local bank to receive a loan for commercial real estate? In those days, if you needed anything, you knew exactly to whom to talk. And if the property didn’t perform as you originally projected at the time you got the loan, you could go back to the bank and have a discussion with someone who had your same objective with that property—get out whole.

Well, things sure have changed since then.

To keep up with demand, it has been common practice during the past 10 years for banks and other lender types to get their money for the loan from various sources, such as Fannie Mae, Freddie Mac and other third-party investors. In many of those instances, even though the money came from other sources, your contact at the bank still was the same.

Then along came securitized lending, which is where the bank pools together many loans. The loan pool then is sold to various bond investors in the secondary market. Many of these bond investors buy these because of their yield, not for the real estate. The lowest-rated bonds are called the controlling class certificate holders, and they appoint the special servicer. Often the bank or lender who originated your loan remains your daily contact for payments, property taxes, insurance and other routine daily matters. They’re referred to as the primary or master servicer.

Why is a special servicer important to you, the borrower? If everything is going as you planned when you received the loan, you’ll never need to know who your special servicer is. But if you sell the property and the buyer assumes your loan, the special servicer is the party that approves the transaction, not the primary or master servicer you deal with daily. If your property isn’t performing as you originally planned and you need some relief with your payments, the special servicer is the one who approves your request.

And the ironic thing is that you can’t speak directly to the special servicer until after you’ve defaulted or until you can prove to the master servicer that you’ll be in default soon if you don’t get some relief in your payments.

Once you speak to the special servicer, it’s important to understand what their objective is. Because they’re the lowest rated bonds, they’ll suffer the first loss if there’s a loss on the loan, and they’re charged with making decisions that’ll be the best for all classes of bonds. The most important question to them is whether the losses to all bond holders will be less if foreclosed and the property sold or if the current borrower continues to manage it. This isn’t the same kind of discussion you could have with your portfolio lender.

Here’s a recap of the most common types of commercial real-estate loans made during the past 10 years:

Portfolio loan. Made by banks, life companies, thrifts, etc. The loan stays on the lenders books. The lender retains all approval rights, and the borrower has only one contact throughout the life of the loan.

Fannie Mae. These loans look just like the portfolio loan to the borrower with one exception. Fannie Mae and the lender typically share in the losses, and, hence, Fannie Mae also will need to approve some requests (assumptions, waivers, modifications, restructures). The borrower’s contact throughout the life of the loan still is the lender.

FHA. Federal Housing Administration loans look just like portfolio loans to the borrower as long as the loan is performing. These loans are on the lender’s books just like a portfolio loan; however, the FHA provides mortgage insurance for the loan. If the loan is delinquent, it’s typically assigned to the FHA (just like an insurance claim is made), and the FHA becomes the point of contact.

Securitized loan. Made by typical portfolio lenders and nonportfolio lenders (lenders who make loans and sell them but don’t retain any on their books). The loan is pooled with other loans, and the bonds are sold to investors. This entire structure is governed by IRS regulations known as Real Estate Mortgage Investment Conduit rules. The day-to-day contact on these loans might or might not be the original lender. Various approval authorities (assumptions, modifications, restructures, etc) don’t lie with the day-to-day servicer and the borrower might not have direct contact with the ultimate entity making the decision. This is what causes the black hole feeling—the borrower often doesn’t know who’s making the decisions, and he or she often might not be able to have a dialogue with that entity.

Times have changed.