Presented By: Kasowitz Benson Torres LLP
High Level of Loan Maturations Could Have Significant Ramifications for Investors
This year is shaping up to be significant for commercial loan maturities. Partner Insights spoke to Michael A. Hanin and Uri A. Itkin, leaders of the structured finance litigation practice at the law firm Kasowitz Benson Torres, about the commercial mortgage-backed securities (CMBS) market, and the ramifications arising from the quarter of a trillion dollars’ worth of commercial loans set to mature in 2022.
Commercial Observer: There’s a significant increase in mortgages set to mature in 2022. What does this mean for CMBS investors, and more generally investors in retail and office markets?
Mike Hanin: In 2020, approximately $163 billion in CMBS loans came to maturity, and in 2022 it’s going to be close to $250 billion. A majority of those maturities are in the retail or office space — 38 percent in retail and 24 percent in office. Given the stressors in those sectors, we’re expecting a significant increase in special servicing activity in 2022, along with increased risk, and potential reward, for CMBS investors.
CO: Approximately $270 million in loans are being transferred on a monthly basis to special servicing this year, which so far have been heavily made up of office properties. How will those loans be resolved, and when?
Uri Itkin: An important point to keep in mind is that when CMBS loans are transferred to special servicing, certain investors — often the most junior investors — have considerably more say in what happens with those loans.
Hanin: That said, most special servicers must adhere to a contractual standard of care, the “Servicing Standard,” that requires the servicer to maximize recoveries for investors in the CMBS structure as a collective whole. This means that when a special servicer makes a decision with respect to a delinquent loan — for example, whether to do a modification, a discounted payoff, a liquidation or take the loan as real estate owned (REO) — that decision must be guided by the best interests of all certificate holders, not solely the most junior investor in the first loss position.
CO: What do you expect to happen if and when delinquencies and loans in special servicing rise? Will special servicers take enforcement actions?
Itkin: Generally, over the past several years, there’s been a trend of special servicers trying to preserve the status quo and keeping the loans in place, rather than pursuing more aggressive options like foreclosure. My sense is that will continue to be the case in the short to medium term. Of course, this calculus might change in light of macroeconomic factors, such as if the Fed continues to raise interest rates.
CO: What can investors do about the increase in delinquencies and loans that we’re already seeing?
Hanin: To Uri’s point, there’s been an unfortunate history of special servicers delaying tough decisions with respect to CMBS loans held in trust — what’s often referred to as an “extend and pretend” mentality. That mentality can avoid losses to the most junior certificate holders in the short term but can, and has, resulted in far more significant losses to CMBS investors on the whole over the long term.
Rehabilitations, modifications or extensions can be consistent with the servicing standard. But when loans or properties are beyond salvation — for example, what we’re seeing with respect to certain loans secured by retail malls that are never coming back, or are secured by abandoned or “zombie” properties — special servicers, consistent with their contractual obligations, may need to take actions that result in some short-term loss to avoid a greater loss in the future.
Many market participants believe that this myopic decision-making is, at least in part, the byproduct of influence by investors in the CMBS derivatives market interested in avoiding or delaying losses in certain CMBS trusts. To the extent that’s true, and there are reasons to believe that it is, that’s obviously a problem for the integrity of the CMBS market as a whole.
CO: How can CMBS investors take a more proactive approach with their investments?
Hanin: CMBS investors should carefully monitor trustee reports — particularly when significant assets are in special servicing — and should be aware of their rights in the individual underlying real estate transactions.
Itkin: As I mentioned before, when delinquencies in CMBS transactions rise, investors have additional rights and opportunities for control. Unfortunately, to Mike’s point, investors often are not aware of these rights. We see this when the deals start to rack up losses, and we hear from investors looking for answers and solutions. While negotiations with the deal parties, particularly special servicers, can be fruitful, litigation — or just the threat of litigation — can be a valuable tool for investors seeking to have their voice heard.
CO: What about investors outside of the CMBS arena? How might they benefit from the large amount of loans coming due?
Itkin: There are quite a few “ifs,” especially for a litigator. But if the fears about rising CMBS delinquencies materialize, and if special servicers cave to pressure to make the tough decisions and pursue foreclosure and other liquidation options, the confluence of those factors would result in an increase of properties being sold out of CMBS deals. This may be an opportunity for any real estate investors, not just those with holdings in CMBS.