[Update 1: Corrects CMBS delinquency rate measured by Morningstar]
Distrust between commercial mortgage bond investors and special servicers, due to perceived conflicts, could remain for another year and even amplify as more loans fall into trouble.
The delinquency rate on commercial loans backing these bonds ticked down slightly in April to less than 8.2%, according to Michael Merriam, senior vice president of operational risk assessment at Morningstar Credit Ratings.
But take out CMBS issued by Fannie Mae and Freddie Mac, and the delinquency rate spikes. Even more trouble could be coming as loans originated during the housing bubble mature in the next few years.
Roughly 45% of the commercial loans originated between 2005 and 2008 will likely not qualify for refinancing at their maturity in the next year, said Richard Parkus, who heads CMBS research at Morgan Stanley ($26.11 0%). He said that could reach higher than 50% as more loans mature in 2015 and beyond.
Both Merriam and Parkus sparred with CMBS special servicers while on a panel at the Mortgage Bankers Association commercial real estate and technology conference Tuesday. The issue was that as more of the loans will transfer from the master servicer to the special servicer, investors want more disclosure from the new special servicer about any potential conflicts of interest.
Investors want more disclosures on special servicer actions. They want to know if principal will be reduced and what assets are being bought out of pools, and how the fair values of those assets are determined.
Merriam said a lot of large special servicers recapitalized post-crisis and were often acquired by large parent companies. As a result, many are now affiliated with brokerages and larger parents looking to buy assets on the cheap. Because of consolidation, many special servicers are now affiliated with the CMBS b-piece investor, leaving questions on motivations.
Earlier this year, credit ratings agency Fitch Ratings called out a troubling trend in the commercial mortgage-backed securities industry. Fitch said special servicers, firms brought in to resolve distressed CMBS, are charging shadow fees, in a potentially irresponsible manner.
"It's a huge, huge issue. There is a mammoth information gap," Parkus said. "When there is a lack of clarity and investors have a lot of money on the line, the imagination runs wild."
Lea Land, director of special servicing for Wells Fargo ($40.66 0%), who sat on the MBA panel, said she simply would not disclose such information especially if the outcome of a loan was in litigation or if she was preparing for litigation.
"The trustee gets the business plans of the special servicer, but we're not getting into all of the nitty-gritty details, and that's exactly what investors say they want," Land said.
Merriam complained of an instance last year in which the special servicer agreed to a discounted payoff on two Michigan properties. But it was later found out the borrower had a lease about to close with an affiliated brokerage of the special servicer and the principal of the borrower's company had a debt with the parent company of the special servicer.
Investors were outraged, he said. Morningstar analysts released a special report on the issue to calm the market. They found there was no real way for the special servicer to know about these potential conflicts of interest.
"There was no smoking gun. It was just perception. We had to put closure on that, but are we really going to have to do a report every time one transaction is rumored to have a problem?" he asked.
Parkus said a lot of these problems are being addressed in the pooling and servicing agreements in newer vintages of CMBS 2.0.
Clark Rogers, senior vice president of another large special servicer KeyBank Real Estate Capital, who also participated in the panel discussion, said he took part in a meeting recently where investors and servicers discussed the best way to provide information without violating the PSAs or securities law.
"There's a breakdown," he admitted, "and we're going to fix it."
Merriam, too, said, a solution could still take time.
"I think you're going to see a lot of progress over the next year as this issue comes into the light," he said.
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