03/16/2012

Continuing Trend, LNR Aligns With Brokerage

LNR Partners has acquired a stake in Auction.com’s commercial real estate unit, becoming the third major special servicer to align itself with a loan brokerage.

Last May, CWCapital bought Rockwood Real Estate Advisors. Meanwhile, C-III Capital entered the brokerage arena by forming an affiliate, C-III Realty Services, in 2010. And just last month, C-III also acquired brokerage NAI Global.

The maneuvers enable the three servicers to sell distressed loans and foreclosed properties via the affiliates, thereby capturing fees that otherwise would go to third-party brokerages.

While CMBS deals issued since the market’s revival usually have provisions that restrict special servicers from using affiliates as brokers, the practice doesn’t violate the rules governing seasoned CMBS trusts. But it has raised the hackles of CMBS investors, who see a conflict of interest.

Bond buyers fear that a servicer has motivation to use its own affiliate in order to garner fees, even if an independent firm might recover more money for the trust. They worry, too, that an affiliated broker could set a depressed valuation on a loan that is being sold to another affiliate, thus short-circuiting the “fair-market value” process that is supposed to protect the bondholders.

The complaints have gained traction with the buy side because LNR, CWCapital and C-III handle more than four-fifths of the $70 billion-plus of CMBS loans in special servicing, according to J.P. Morgan. LNR has a 33.6% share, followed by CWCapital (29.4%) and C-III (20.2%).

Fitch is calling on servicers to publicly disclose when any affiliates participate in loan workouts as part of a move toward greater transparency (see article on Page 3).

For their part, the servicers defend the practice, saying that it gives them greater control over liquidations, enabling them to maximize returns for bondholders. The use of an affiliate as broker could ensure an honest auction, potentially preventing a third-party broker from bypassing the high bid to curry favor with a lower bidder, said one special-servicing pro.

“Yes, we charge fees,” he said. “Yes, we get paid. But the question bondholders should be asking is what is the best way to get the best outcome. And this gives us control to do that.”

Added another servicer: “In the traditional model, you have brokers who want to build relationships with big firms, so they may have an incentive to direct a sale to a large player.”

Auction.com, which is 50% owned by private equity firm Stone Point Capital of Greenwich, Conn., was formed 23 years ago under the name REDC, with a focus on brokering residential loans. In 2007, the firm established an “eBay style” online platform in which all participants can see competing bids, with the highest offer winning. In 2010, the firm launched its commercial division, which soon attracted a number of CMBS special servicers as clients, including LNR.

Late last year, LNR agreed to fold its Archetype Advisors unit into Auction.com Commercial in return for a noncontrolling stake in that operation. The transaction closed early this year. LNR had set up Archetype Advisors to handle preparatory work on CMBS loan sales before awarding sales assignments to brokerages.

Loan buyers typically pay a fee equal to a percentage of the purchase price. Auction.com Commercial charges a flat 5% fee, which it splits with the seller — the CMBS trust, in the case of securitized loans.

The split is determined by a sliding scale, based on the price, according to Jeff Frieden, chief executive of Auction.com. If a loan sells for less than $5 million, for example, the brokerage keeps most of the fee. But the split moves in favor of the seller as the price increases. For sales exceeding $15 million, the seller gets 70% of the fee. The seller’s split peaks at 86% on loans that exceed $35 million. “We use the same split with all of the special servicers we work with,” Frieden said.

The fact that Auction.com Commercial always selects the highest bidder should allay CMBS investors’ concerns about getting the best deal, he added.

By aligning with a brokerage, a special servicer can supplement the fee it is paid directly by the trust for liquidating an asset. With loan sales booming, servicers have a clear incentive to line up brokerage affiliates.

Concerns about the affiliates have added to the friction over loan workouts that has built up between senior bondholders and special servicers for several years. Senior investors contend that special servicers sometimes negotiate workouts with the goal of maximizing their fees or protecting their investments in junior bonds, rather than seeking to maximize the amount recovered by securitization trusts.

Some investors worry that questionable special-servicer practices are creating a stigma for the CMBS industry. “There is no question this is having an impact on the rebound of CMBS,” said one major investor. “This could permanently keep this industry smaller than it would otherwise be. We won’t recover as much as we otherwise would.”

To help allay investor worries, LNR recently embarked on a campaign to demonstrate its willingness to be more transparent, providing detailed post-mortem reports on its loan workouts from the past two years to a number of industry analysts. “Our disclosure was much greater than any regulators require,” said LNR co-chief executive Toby Cobb.

In touting the “open kimono” approach, Cobb said the reports demonstrate that LNR has done a good job for investors. “The bondholders should look at how much they are getting back, and how fast,” he said. “We are doing the best job for the trust that we can do.”

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