As the volume of maturing commercial mortgages has spiked, so has the number of loans transferred to special servicing when they fail to pay off.
This is hardly surprising; most loans coming due this year were taken out 10 years ago, at the peak of the real estate bubble, when property value were high and lending standards lax. Also, commercial mortgages are typically structured with large, balloon payments at maturity, and so amortize very little. As a result, a number of properties that were highly leveraged before the financial crisis have not recovered enough value, or are simply not performing well enough, to be easily refinanced.
Fitch Ratings observed 533 securitized loans that transferred to special servicing through mid-July; the original principal balance of these loans was $10 billion and the average was approximately $19 million.
What is surprising, at least to some mortgage bond investors, is the number of securitized loans that are transferred from the master servicer to the special servicer after failing to pay off at maturity, only to pay off a short time later.
This has some investors, as well as master servicers, concerned about the potential for overly aggressive transfers of loans to special servicing.
"If loans pay off shortly after transfer, say within 30 or 60 days, you have to ask, 'was the transfer really necessary'," said Adam Fox, a senior director in Fitch's U.S. CMBS group. "Because there's a cost; regardless of how long loans are in special servicing, the special servicer gets a flat fee equal to 1% of the remaining balance."
After hearing from investors, Fitch decided to review all of the special servicing transfers through mid-July, paying close attention to the number of loans transferred for maturity-related reasons and how quickly those loans paid off as of July remittance dates. It observed that approximately 20% of loans transferred to special servicing for maturity-related default paid off within 120 days, and the majority of those, representing less than 10%, paid off within the first 30 days.
However, the rating agency determined that limited number of instances of quick loan payoffs (54 out of 271 loans) makes it difficult to draw any meaningful conclusions regarding special servicing behavior.
Fox said that the conditions for transferring a loan to special servicing are spelled out the pooling and servicing agreement of a commercial mortgage securitization, though the special servicer "has a lot of influence" over the decision. That's particularly true for deals completed before the financial crisis, because the holder of the most subordinate bonds issued, also known as the controlling class, is often an affiliate of the special servicer. The special servicer is in a position to absorb the first loss in a deal and so has an incentive, and the voting power, to take quick action to work out a loan in order to minimize losses.
At the same time, the master service has no particular incentive to hold on to a mortgage after it matures, unless there is some indication that a refinancing is imminent.
"It's a consultation between the two parties," he said.