Bloomberg News

Real-Estate Investors Owning Servicers Prompt CMBS Scrutiny

November 22, 2011

Nov. 22 -- Bondholders may suffer bigger losses amid a shift in ownership among firms that oversee troubled commercial mortgages packaged into securities, according to Amherst Securities Group LP.

“Investors are concerned that in some instances liquidations aren’t being appropriately handled,” Darrell Wheeler, a commercial mortgage bond analyst at Amherst in New York said today in an interview. Special servicers have been sold to new owners that may have more aggressive real estate- like return targets or alternative motivations beyond simply servicing the pool, he said.

So-called special servicers are charged with determining the best outcome for commercial-mortgage bond holders when a borrower is struggling to make payments, thrusting them into the spotlights as defaults climb. Island Capital Group LLC, a New York-based firm run by Andrew Farkas, is among real-estate investors that have snapped up the companies in the past two years, raising concern that special servicers may act to the detriment of bondholders.

“Potential conflicts of interest for special servicers between their obligations to bondholders and their own self dealings are a huge issue for investors and one that multiple parties are watching very closely,” Andrew Solomon, a managing director in New York at Angelo Gordon & Co., which oversees $23 billion, said in a telephone interview. “Investors are frequently asking trustees for these deals for information to justify the special servicers’ actions.”

Island Capital’s C-III Capital Partners acquired Centerline Holding Co.’s special servicing business in March 2010. The firm has attracted recent scrutiny through office loans in Livonia, Michigan, said Wheeler.

Booking Losses

Two loans booked losses of 85.5 percent and 89.3 percent in August after the borrower, a real-estate company owned by Grubb & Ellis Co. chairman Michael Kojaian, negotiated with C-III to pay the debt back at a discount, Amherst wrote in a Nov. 18 report. Quicken Loans, the tenant, had vacated the properties that month.

A C-III affiliate agreed to invest $10 million into Grubb & Ellis by expanding the company’s credit facility, becoming a “significant stakeholder,” according to an Oct. 17 statement from the Santa Ana, California-based firm.

Appraisals used to determine the discount on the debt valued the buildings as empty properties at $3.9 million and $4.5 million, according to Amherst. The mortgages, taken out in 2001, were for $24.2 million and $22.6 million.

‘No Connection’

Trinity Health, a Catholic health care organization, said in a statement it was moving its headquarters to the buildings on Oct. 19. The new tenant means the properties are worth significantly more than the appraisals, and the steep losses for bondholders may have been unnecessary, said Wheeler, who previously ran securitized strategy at Citigroup Inc.

“There is no connection between the Livonia, Michigan property workouts and C-III’s role as a lender to Grubb & Ellis,” Andrea Calise, a spokeswoman for C-III said in an e- mail. “At the time of the loan resolution, we did not know that the owner was in advanced discussions with a major tenant. In fact, we first learned of the negotiations when we read the reports in the press.”

Kojaian, of Grubb & Ellis, didn’t return calls seeking comment.

Standard & Poor’s cut the ratings yesterday on the lower ranked portions of a Bank of America Corp. deal arranged in 2002 that contains the two loans. S&P cited $41.9 million in principal losses resulting from the liquidation of loans by C- III, including the Livonia properties, for the downgrade, according to a statement yesterday.

‘Daunting Idea’

Market vacancy in that area is 25 percent and tenants have numerous alternative office buildings to choose from, Calise said.

“Owning and leasing empty office buildings in suburban Detroit is more than just a daunting idea,” she said. Adding to the challenge of leasing the space was the physical condition of the properties, with deferred maintenance costs estimated to exceed $10 million based on recommendations from engineers, she said.

“Combined with the cost to carry the loan in the trust, the significant leasing costs as well as operating expenses, insurance and real-estate taxes led us to conclude that the best economic outcome to the trust was a settlement with the borrower, rather than assume ownership, responsibility and incur the substantial capital outlays for the asset,” Calise said.

Choosing to take losses quickly rather than modifying loan terms can be the right decision when borrowers are in ”hopeless situations,” Amherst analysts wrote in the report. Liquidating a loan before other options have been exhausted can lead to severe losses, they wrote.

Amherst is continuing to gather commercial mortgage loan resolution data to determine patterns between servicer ownership and debt recoveries, Wheeler said.

“The volatile economy makes it difficult to judge servicer performance based upon a few examples,” he said.

--Editors: Pierre Paulden, John Parry

To contact the reporter on this story: Sarah Mulholland in New York at smulholland3@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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