Special Servicers - Operating Without Oversight (LNR, CWCapital C-III)

[Editor’s Note: This post originally appeared on our sister site, MahanyLaw in July of 2014. We have updated and reposted it here.] Special servicers are the folks that take over the handling of loans that are delinquent, in default, or believed to be troubled. In large, commercial mortgages, special servicers are typically given sweeping powers to protect the rights of the noteholders and ensure that all amounts due under the note and mortgage are collected.


A new probe launched by the New York Department of Financial Services suggests that some of these special servicers may be more interested in lining their pockets than protecting the bondholders. According to a story first appearing in Reuters, CWCapital Asset Management, LNR Partners and C-III Asset Management (the nation's largest commercial servicers) are now all the subject of an investigation by New York State regulators for potential conflicts of interest.


[We are involved in several cases involving CWCapital Management and LNR Partners and are seeking information from anyone with knowledge of their practices. Your information will be kept strictly confidential.]


Commercial borrowers normally have no interaction with the special servicer. A trustee or ordinary servicer makes sure insurance and taxes are paid and that the mortgage is paid.


When a commercial loan is originally issued, the borrower deals directly with the lender, typically a bank or private equity lender. Most lenders no longer hold loans, however. They instead sell the loan into a Commercial Mortgage Backed Securities (CMBS) trust.


A document in the CMBS loan papers called the Pooling and Servicing Agreement (PSA) sets out the responsibilities of the servicer, special servicer and others involved in administering the loan. (The PSAs are often 1000 pages in length meaning few lawyers bother reading them.) Worse, the PSA is entered into long after the loan is made meaning borrowers have little say in who administers their loan.


The typical PSA allows a loan to be transferred to special servicing in the event of nonpayment or other default. We often see language that allows the loan to be preemptively transferred to special servicing even in the absent of a default simply because the noteholders perceive the future viability of the loan to be in jeopardy.


When the special servicers get involved, its duty is to protect the property, collect mortgages and insure the noteholders are protected. For those duties, special servicers earn a fee based on the amount of the mortgage, the complexity of the financing deal and the services performed. Typically the fees charged by these servicers are huge.


Regulators say that the three largest commercial servicing firms - CWCapital Asset Management, LNR Partners and C-III Asset Management - also have their own investment arm to acquire distressed properties.


To us, that is a blatant conflict of interest.


Even though special servicers have a duty to the noteholders (the CMBS trust), they still owe a duty of good faith and fair dealing to the borrower. How “fair” can the servicer be, however, if its financial incentive is to keep the borrower in special servicing for as long as possible. Remember, the special servicer only gets paid while the loan remains in special servicing.


And how can the special servicer discharge its duty to the noteholders when the PSA typically allows it to bid on the property for its own account and set the price?


What really happens is that special servicers have a financial incentive to keep a property in special servicing, strip out any equity from the property owners, drive down the value of the property and then acquire it for below market value.


Typically, bondholders will sell a nonperforming loan to the highest bidder. The "troubled asset" is removed from the pool of loans held by bondholders and auctioned for the highest price. What happens if the highest bidder is also the same company that is acting as the servicer? And what happens if the special servicer gets to set the price or artificially push down the price. No wonder New York is investigating.


There are no allegations of wrongdoing by New York State. At this point, the state's investigation is in its infancy. We believe, however, that actual conflicts of interest do exist; conflicts that hurt both the struggling property owner and the note holders.


Google “Who regulates special servicers” and chances are you won’t find much. That is because no one does!


The GAO noted that the “CFPB does not currently have a mechanism to develop a comprehensive list of non-bank servicers and, therefore, does not have a full record of entities under its purview, going as far as to call the Bureau's oversight of non-bank lenders "indirect," stating that even if they did have the capacity to fully supervise all the non-bank servicers in the market, they would not know the full makeup of the market.”


Whether the CFPB can or can’t regulate special servicers, their jurisdiction wouldn’t extend to commercial CMBS trusts.


The Office of the Comptroller of the Currency (OCC) claims it has the authority to regulate servicers who service on behalf of a bank. Because special servicers typically service on behalf of a CMBS trust and not a bank, that means there is no oversight by the OCC either.


A full decade after the 2008 banking meltdown and special servicers remain virtually unregulated. As long as that continues, the abuses probably will as well.


We represent borrowers and property owners who claim they have been the victim of illegal banking or loan servicing practices. We also help borrowers restructure CMBS loans.


Not a borrower but a special servicer insider? We are always looking to speak with insiders. If you have information about practices at CWCapital Asset Management, LNR Partners, C-III Asset Management or any other CMBS servicer, we would like to hear from you. All inquiries are protected by the attorney – client privilege.


To learn more, contact attorney Christopher Katers at [hidden email] or contact the author, Brian Mahany, at [hidden email] or (414) 704-6731 (direct).


Related topics: C-III (8) | CWCapital (16) | LNR Partners (23) | pooling (11) | PSA (6) | servicing agreement (12) | special servicers (30)