Commercial mortgage-back securities servicers are not lenders. They are investors who used their money to buy the junior piece—the B piece—as an investment. Under CMBS procedure, the most junior piece, which is the one with the highest risk, gets the “control” position, and so gets to be the servicer in most cases. This makes sense because they are most at risk they want to control the risk. Under other CMBS rules servicers have a fiduciary obligation to do what is best for all classes of bonds, not just themselves. That is defined as maximizing the net present value of the asset so that the most cash is available to repay the most possible to the bondholders.
The problem is the servicer has a different view than the AAA holders. AAA holders are fine to foreclose because they are generally money good or close to it. The servicer gets wiped out in most cases in a foreclosure, and he loses the servicing fees. Because the servicer really is an equity investor in bondholder clothes, he looks at the loan in a different way. Now the servicers are saying, if someone wants to buy the note and foreclose, and they will earn a 20-percent+ return, then I will hold the asset and make that return instead of selling it. The servicers, not being lenders in the first place, often have the cash to be able to do this.
Other lenders who are not regulated, and banks whose capital is in good condition, are also able to do this. So, in one case an unregulated lender still has a functioning CDO (collateralized debt obligation) with excess capital. If a loan buyer offers a price that is clearly one which makes the deal minimal risk to the note buyer and gives him a 20-percent+ return, the lender instead of selling will put the loan into his CDO and make that return himself. Some banks will simply extend or find a way to hold the loan or the REO until the market improves, and then sell so they can book a profit, having written it down earlier against reserves. This is the game going on now, and what some lenders did in the early nineties.
Tishman-CMBS loans
Without going into great detail, there was a US$3 billion CMBS loan on an 11,000-unit middle income residential project in New York City made about three years ago. It was under rent stabilization, which means the city controls rents which can be raised only under certain conditions. The highest court in New York just ruled that the rent increases put through by real-estate owner/manager Tishman Speyer Properties over the past three years are illegal because they were done while the project was receiving certain tax abatements under J-51. The court held they can’t raise rents while getting J-51 benefits. They ignored that everyone in New York had been doing this for over ten years and almost all lawyers think Tishman was in the right.
This will cause Tishman Speyer to have to pay back US$200 million of rent to the tenants. More important is the default on the US$3 billion CMBS loan. There will be at least a US$1 billion loss to bondholders and maybe more. The ruling affects all apartments in New York operating under the same J-51 tax abatement that was in place in this deal. There are 5,000 of them and several had large CMBS loans. This means a lot more defaults of size and terrible problems in the New York City residential market. The US$3 billion Tishman Speyer CMBS loan was in several different CMBS pools. The other loans on other affected buildings are in other pools. In short, the ripple affect to the CMBS market is possibly extensive as several pools of loans will now have serious problems, as will several major developers who might have to repay rent increases going back several years. It could possibly cause them to default on other loans. Nobody yet knows.
This will further affect any effort to restart the CMBS market. It is things like this, the Extended StayAmerica loans, and other legal issues which will be playing out over the next year that has caused me to take the position that CMBS is not coming back for a long time, and when it does it will look different than it did in 1993. The full affects of the Tishman Speyer decision—known as the Stuyvesant Town case because that’s the name of one of the apartment complexes involved—are just starting to play out, but everyone needs to pay close attention to it as it will deeply impact lending and CMBS in the future.
Joel Ross is principal of Citadel Realty Advisors, successor to Ross Properties, the investment banking and real-estate financing firm he launched in 1981. A pioneer in commercial mortgage-backed securities, Ross, along with Lexington Mortgage and in conjunction with Nomura, effectively reopened Wall Street to the hotel industry. A member of Urban Land Institute, Ross conceived and co-authored with PricewaterhouseCoopers The Hotel Mortgage Performance Report. Ross is also the author of Ross Rant, a commentary on the economy, financial markets and politics that’s available through his website.
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