The commercial mortgage-backed securities market (“CMBS”) has been especially vulnerable to fallout from COVID-19. CMBS represents roughly $490 billion – about 15% of the $3.5 trillion in commercial real estate debt, according to the Mortgage Bankers Association. CMBS is a common financing avenue for commercial real estate projects, typically offering non-recourse provisions – meaning that the borrowers (or “sponsors”) on a loan are not held personally liable for default. The only ‘recourse’ a lender would have in the event of a default is limited to the market value of the collateral property – the borrower will not owe anything personally.
Other popular CMBS features include higher loan proceeds/loan amounts, and less stringent underwriting practices, although this may be more of a matter of opinion, based on the borrower. Unlike a traditional bank loan, CMBS is securitized by the bond market, which provides these benefits by selling off bonds that are backed by the mortgage payments. But the advantages come with a few strings. CMBS borrowers can’t add debt to an existing loan. The loans are subject to oversight by the Securities and Exchange Commission and the Internal Revenue Service – with every dollar from a borrower passing through to those bondholders – most of which are institutional investors – without being taxed.
Once a performing loan is modified, the entire pool of securitized bonds could become taxable. CMBS transactions are handled and managed by a “master servicer,” who collects debt service payments and communicates with the borrowers on the loan (also ‘sponsors’). But a “special servicer” takes over for loans that must be modified, those nearing or in default or those that may be maturing and without appropriate take-out financing in place. In a pre-COVID world, a borrower would never want their otherwise performing loan to be transferred to the special servicer, as special servicers typically are not interested in helping the borrower, but rather separating the owner from the property.
The special service rate for all CMBS loans held relatively steady in 2019 and early 2020, dipping to a low of 2.83 percent in March. Just two short months later, that rate more than doubled, reaching 6.07 percent in May.
The $2 trillion CARES Act was mostly unable to help CMBS borrowers. The $500 billion in small-business loans also could not help, because debt was added. Meanwhile, CMBS borrowers have been trying to stay afloat while waiting for economic recovery, or other continued or extended avenues of relief – mostly from the Federal government.
For the CMBS industry to recover, servicers, regulators, and borrowers may need to work together to come up with a solution. CMBS special servicers should be working with local markets and borrowers while also granting a reasonable level of relief, and for reasonable fees to address that risk. This is one reason why CMBS originations have ebbed and flowed since the industry was created in the mid-1990s and in response to an illiquid market resulting from the savings and loan crisis of 1991. Working together to fix these many issues would result in a far more stable CMBS market for the originators, master and special servicers, and particularly the borrower/sponsors.