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A Major Challenge To Distressed CMBS Debt Sales

Pricing remains the biggest stumbling block in the sale of assets backed by commercial mortgage loans, according to panelists at SourceMedia’s Buying and Selling Distressed Mortgage Portfolios Conference in New York.

The CMBS market is hot, said Jon Winick, president, Clark Street Capital, a receivership firm that started out buying properties 15 years ago. “I’ve never seen this, it’s billions a month.”

Winick argued that millions in CMBS deals are from the past years and getting close to maturity, so as a wave of five-year deals mature, “a tremendous amount of volume,” especially pools of loans valued at $10 million or under are about to hit the marketplace. He expects “a huge increase in the percentage of defaults” along with new opportunity.

The challenge in taking advantage of the current market opportunities, however, is pricing.

It is a problem for investors in the primary market as well as for firms that are buying distressed debt in the secondary market, said William O’Connor, partner, Thomson & Knight LLP, as most buyers are bidding against servicers who do not provide all the loan information.

If loan information is insufficient, said Salman Khan, managing principal, Stabilis Capital Management LP, “you have to get out.”

The trick is knowing when.

Clark Street Capital is a receivership business adapting to these market changes, Winick said. Because “everything is a workout,” the only way to access the market is through a loan. “I’m on the receiver’s end, and I’ve seen many of them transfer from the CMBS special servicer to loan-to-own buyers.” And at least during the initial wave this type of seller would bid too high “because they think they own the property” and then they fail, he said.

Trade venues such as auction.com have been quite busy in the past few years even though buyers bidding on a loan do not have access to a loan representative. “There’s no reps,” he said. “Whatever due diligence you can do you do, and that’s what you get. And that’s the biggest problem.”

According to Winick, it is much more difficult to deal with loan-to-own buyers than with the servicers. They often are not familiar with the role of the receiver.

The receiver can help the loan-to-own buyer or loan acquirer by providing information about the loan if the lender grants permission to allow it, he said. The receiver may serve as an intermediary for one year or more.

If the information is not available or if the loan seller refuses to take due diligence action and does not give any guarantees, “bid accordingly,” he said. “If you think there’s a problem, bid less.” It is a crucial learning curb. Everyone needs to learn about foreclosures, how they differ in every state, how the court systems work, how does the pricing process work in the secondary market, or how servicer disposition fees range, he said.

The process matters, said Khan, since the servicer has the option to bid, and it could be they are still learning how, but if the servicer is bidding against a buyer “and there’s imperfect information” to begin with, in this market buyers are better off if they just opt out.

Winick has a different view. Communication and exchange of available data between buyers and sellers, such as fiduciaries, can help frame what the value is and improve asset pricing, he said. “If you are a fiduciary the last thing you want to do is sell an asset and then they flip it and make $2 million.”

According to Darrell Wheeler, senior managing director, Amherst Securities Group, since about $40 billion of mortgages are maturing this year, and roughly $15 billion of that volume has a 15% debt yield, an estimated $25 billion of distressed loans will not qualify for refinancing.

Before the crisis “when things were tough these servicers wouldn’t put it out,” he recalled. Instead, they developed the technology to delay foreclosures and would hold distressed assets for a long period of time or, depending on size, dispose of certain assets through venues like auction.com. As the pool pays down and the CMBS servicer loses control of the bottom class of transactions rated BB+ and lower, severities increase, so there is no economic interest in holding these assets in their books.

Servicers may sell distressed assets in an open market, argued Wheeler. A glance at the fees charged at auction sites like auction.com, indicate buyers may pay a 5% fee, which is split between the servicer and the trust. “But have you ever seen a disclosure on that? I will tell you what’s the BB class severity when it gets liquidated: It goes from 67% to 87%.”

Yet again there might be bargains to be had, he added, it is a matter of perspective, particularly when dealing with large to midsize assets because nobody wants to compete if they do not have the upper hand.

Plus, the crisis has changed servicers’ perspectives. As a result, Wheeler said, some servicers “have become less institutional and more real estate oriented.”

Even some pension funds and insurance companies are becoming “real estate opportunistic” following the steps of real estate investors and REITs. “You sort of have that midlevel competition there also,” he said. It all depends on what type of real estate one is shopping for.

A positive development is that demand is up. At the same time, Khan said, “there’s lack of sophistication and that guy is not going to be around anymore."