CMBS Loan "Triggers' Causing Headaches
Complaints are rising about confusion and red tape surrounding bondholder-protection provisions that authorize commercial MBS servicers to take direct control of rent payments when property performance slips.
Borrower advocates and other industry pros contend that the confusion stems from the wide variety of such “lockbox” provisions and inconsistency about how they are being implemented — problems they say have contributed to driving some property owners away from securitization lenders.
Meanwhile, many servicing pros are also unhappy, arguing that poor implementation procedures and a lack of clarity in loan and securitization documents often complicate their enforcement of the provisions, causing both higher operating costs and more disputes with borrowers. While the complaints aren’t new, they’ve been increasing as deals floated since the market crash age and the provisions are triggered more frequently. The gripes come at a time when the CMBS industry is already trying to address complaints from some borrowers about poor customer service.
The lockbox provisions are aimed at protecting bondholders from potential losses on loans collateralizing CMBS transactions. They are triggered when a property fails to meet certain performance hurdles. When that happens, all rent payments and other property cashflows fall directly under the control of the primary, master or special servicer, bypassing the borrower. That process, called a “cash trap” or a “cash sweep,” is aimed at preventing owners from taking cash out of properties while loan performance is in doubt.
For loans of $20 million or more, a cash-management bank account, dubbed a lockbox, is typically set up at origination. Tenants are instructed to send rent payments to the account, which the borrower controls initially. If a lockbox provision is triggered, control of the account shifts to a servicer.
For smaller loans, lenders frequently don’t set up lockboxes at origination because owners of small properties balk at incurring the associated administrative fees. In those cases, a “springing” lockbox is established upon a triggering event. Once a provision is triggered, the servicer will continue to forward monthly payments to bondholders and also disburse money to the borrower to cover property operating costs. However, any excess funds are retained in a reserve account to protect bondholders against potential losses, meaning that the borrower is delayed from capturing any profits.
If a lockbox is implemented at origination, a servicer can quickly take control of property cashflows upon a triggering event. But when it isn’t, the creation of a springing lockbox can be time-consuming, taking up to four months, servicers said. That delays the build-up of a reserve account and increases a servicer’s operating expenses. Servicers have become increasingly sensitive to higher expenses because servicing fees and portfolios overall have been declining in recent years amid the contraction of outstanding CMBS.
Traditionally, cash traps were triggered when a basic performance metric, such as the debt-service-coverage ratio or occupancy rate, fell below a prescribed level. But other metrics have been added in the current generation of deals, including ones pegged to a loan sponsor’s net worth, tenant bankruptcies and the pending expiration of a major lease.
“The amount of performance covenants in loans has grown dramatically since the crisis,” said one servicing pro. “Some are appropriate, but some don’t really provide any benefit from a credit-quality perspective. They’re just hard for the servicers to administer and painful for the borrower.”
Servicers noted that borrower net-worth requirements are particularly difficult to track on a timely basis.
Meanwhile, borrowers complain about a lack of standardization in calculating metrics. “The definitions of occupancy and underwritten revenue and expenses are trending toward a much more complex calculation,” said managing director Kevin Duty of 1st Service Solutions, a borrower advisory shop in Dallas.
Borrowers might dispute the calculation of a debt-service-coverage ratio if, for example, a servicer decides not to count rent payments that an anchor tenant continues to make while its space in a shopping center is closed during renovations, on the basis that the dark space will undermine the property’s performance.
Borrowers have also been surprised to learn that servicers sometimes discount a property’s actual rent receipts if the average occupancy rate in the surrounding market is lower.
“We get lots of calls from borrowers on newer-vintage loans who don’t know why they’re being put into cash management,” said Ann Hambly, 1st Service’s founder and chief executive. “The borrowers believe they understand how the cash-management sweeps work in the beginning, but it’s not until it happens that they realize just how tough it is.”
Some industry pros have called on CMBS lenders to craft a standardized format for loan triggers. But the idea hasn’t gained much traction because securitization shops want to preserve the flexibility to adjust lockbox provisions as needed to satisfy the demands of B-piece investors and other bond buyers. When investor demand softens, buyers have leverage to force lenders to stiffen the provisions.
Some pros maintain that CMBS lawyers could do a better job of drafting loan documents to spell out how triggers work and that borrowers should be more diligent about reviewing the details before closing on a loan.
“There’s room for improvement on both sides,” said Gerard Keegan, a partner at law firm Alston & Bird. But he warned any attempt at quick-fix changes could be counterproductive. “We shouldn’t let the borrower-convenience factor impact the credit quality of CMBS loans,” he said. “Cash-management triggers are here to stay. People just have to embrace that and focus on the practical aspects of how they’re going to work.” ?