Secondary Mortgage Market


Posted on Monday, December 20, 2010

The real-estate firms managing the swelling volume of distressed commercial mortgages that were sliced and diced on Wall Street are blazing new trails as they pick up the pace of working through bad loans.
The firms, known as special servicers, are dealing with an influx of souring loans backed by commercial-mortgage-backed securities, or CMBS: a total of $90.9 billion as of the end of September, compared with $73.8 billion at the end of last year, according to credit-rating firm Fitch Ratings. But the pace at which those loans have been resolved has picked up at an even faster rate, with $27.9 billion recovered by special servicers from bad loans in the third quarter, compared with $8.9 billion in the first quarter, according to Fitch.
Many of those bad loans are simply getting modified and extended, pushing the borrower's day of reckoning to a day into the future when, both sides hope, the market will improve to a point at which the property owner can refinance. But in other cases, servicers are trying more unusual methods to dispose of properties through sales or other means as they work through a volume of distressed loans that is testing the legal apparatus built up by Wall Street's boom-time securitization binge.
The creative approaches that are emerging could be good news for the multitude of buyers waiting at the sidelines of the commercial real-estate market hoping to see bargains. Up until now, there have been far fewer properties on the block than many investors were expecting when the recession hit.
Some of the new twists allow the special servicer to avoid the time-consuming and expensive foreclosure process. For example, a judge in Orange County, Calif., last month authorized the $213 million sale of Pacific Arts Plaza, a four-building office complex owned by MPG Office Trust Inc., which had defaulted on its securitized mortgage loan. But the buyer, local real-estate giant Irvine Co., didn't pick up the property out of foreclosure. Instead, the seller and the bondholders—represented by special servicer LNR Partners Inc.—agreed to have the property sold by the court-appointed receiver, avoiding a drawn-out foreclosure process and letting potential buyers assume the loan already in place.
"Special servicers are getting creative with how they're working out the assets in this environment," says Frank Innaurato, an analyst at Realpoint. "Rather than foreclosing on an asset, they are placing more properties in receivership and giving the receiver the right to sell the asset directly."
Avoiding foreclosure offers an additional advantage: Special servicers can sell properties with modified CMBS debt already in place. Take the case of an Arizona court's decision in August to let a portfolio of distressed apartments be sold by a receiver for $133 million. Bill Hoffman, president of the receiver, San Diego-based Trigild, said the move allowed the buyer to assume existing financing, delivering a higher price than if the portfolio had been sold out of foreclosure.
Meanwhile, MPG Office Trust reached agreements with special servicers on two other mortgages on which it defaulted to let them sell off the properties without a foreclosure, according to a person familiar with the matter.
"There's been a lot of money on the sidelines, waiting for opportunity to invest," said Mike Gerdes, a Moody's analyst who tracks CMBS. "Special servicers are understanding that there's a healthy market out there to dispose of some of the properties."
Special servicers have emerged as key players in the commercial-real-estate market's rocky recovery, making them attractive takeover candidates themselves. The companies—the most active firms include LNR, CW Capital Asset Management and C-III Asset Management—are bound by a complex web of rules because they are supposed to serve a diverse group of bondholders, often with diverging interests.
Commercial-mortgage-backed securities were popular with investors during the economic boom because they offered better yields than many other investments. CMBS issuance helped drive the real-estate boom, and how top-of-the-market loans get resolved will play a key role in how the real-estate market's recovery plays out. About $170 billion in CMBS loans come due in the next three years, according to data firm Trepp LLC.
CW Capital has told tenants and potential investors that it will likely move ahead next year with a co-op or condo conversion of the property, a move that could involve CW bringing in a third party to invest and lead the conversion—or one that CW could manage by itself, according to people familiar with the matter.
In New York City, CW Capital this fall took control of the 11,200-unit Stuyvesant Town and Peter Cooper Village rental-apartment complex. The property's $3 billion first mortgage is the largest in-default CMBS loan in the country.

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