In today’s commercial real estate market, commercial loans are often pooled together to create commercial mortgage backed securities (CMBS). These loan pools typically have several tranches. Each varies in credit quality and payment priority.
The first-to-be paid tranches of bondholders usually possess investment grade securities. These are the A class bondholders. The last bondholder to be paid is the one most at risk. This is the “B piece” bondholder.
Because they are last to be paid, they are most at risk. To compensate for that higher risk, they receive a higher rate of return that that of the senior or A grade bondholders. The B piece buyer also have more rights which will be explained below.
Pooling and Servicing Agreements and B Piece Holders
When a CMBS loan pool is created, a document called the pooling and serving agreement is created. It sets forth the rights of the various bondholders. Most borrowers who use CMBS financing focus on the note and mortgage terms. Few borrowers read the pooling and servicing agreement but they should. (These agreements typically are between 500 and 1000 pages long!)
One of the rights common to B piece holders is the right to approve any loan modification. Since they are most at risk, they have the right to approve any change in terms.
Unlike a typical bank loan, CMBS trusts have no office and no employees. Although a bank may have issued your loan, its involvement was extinguished when that loan was sold and pooled into the CMBS trust.
If a CMBS trust has no employees and only exists on paper, who makes decisions or speaks for the trust?
Typically, a servicer is designated in the pooling documents. That company, often a bank, collects payments, pays the bondholders according to the waterfall (A pieces first) and ensures taxes and insurances are up-to-date.
If the borrower is in trouble, authority to make modifications falls to a special servicer. And those are usually controlled by the B piece holder.
While the B piece holder has significant power when loans are in trouble, its power is not absolute.
First, its influence is directly controlled by the pooling and servicing agreement. The first step in knowing what a special servicer can do and can’t do is too read that agreement.
B piece holders can lose their ability to approve modifications and appoint the special servicer if it transfers its ownership interest. Recent rules spurred by the Dodd Frank Act, require CMBS lenders keep at least 5% of a loan on their books, and also require that B piece buyers hold onto their investment for a minimum of 5 years.
If the B piece holds the controlling class as a third-party purchaser, it is prohibited from transferring its certificates to an unaffiliated buyer, except for a single transfer to an unaffiliated buyer at least five years after the securitization closing date. Anything else and it loses its control abilities.
B piece buyers can also lose their control if it is affiliated with a borrower party, property manager or the holder of a mezzanine loan where there has been a default.
Why does all of this matter?
In a traditional bank loan, the bank has a strong incentive to ensure the loan is successfully repaid. Special COVID-19 pandemic inspired rules give the banks greater leeway in working with troubled borrowers without declaring a default. (Defaults trigger larger loss reserve requirements for banks.)
The real power in a CMBS loan rests with the B piece holder and special servicer. Banks cannot acquire properties for their own portfolio but special servicers and B piece holders have no such restrictions. Pooling and servicing agreements often give the special servicer the right to acquire the property at a fair price. That’s a lot different from the best price.
Special servicers also only get paid when a loan is in trouble. Unlike a traditional bank which has an incentive to firm up a troubled loan, special servicers have the opposite incentive.
We have represented many savvy business owners who were completely unprepared when they attempted to renegotiate with a special servicer. (Negotiations must go through the special servicer in most CMBS loan documents.)
In 2019, the biggest B piece buyers were Rialto capital Advisors, followed by KKR Real Estate Credit, Eightfold Real Estate Capital, Prime Finance and LNR Securities. Together these five buyers represent 79% of the B piece market share. Several are affiliated with special servicers and all are sharks.
Holding on to Your CMBS Financed Property in the Midst of a Pandemic
We have re-written this post in light of the pandemic. The rules of the game are changing on a daily basis. As we await a new administration, a bipartisan relief package for CMBS borrowers remains stalled in Congress.
What can you do? The most important thing is finding good counsel and not panicking. Thousands of property owners (many of the office buildings, hotels and shopping centers) are in the same boat.
Although special servicers have a fiduciary duty to the bondholders (not borrowers), that doesn’t mean they can do whatever what they want. They will do so, however, unless the borrower has strong counsel that knows how to fight back successfully.
Special servicers may be controlled by the B piece holder but they do have a duty of fair dealing and good faith.
We stand ready to step in and defend borrowers. More importantly, we are often able to turn the tables and place the servicer on the defense.
To learn more, contact us online, by email [hidden email] or [hidden email] or by phone at 877.858.8018. We also invite you to visit our CMBS loan modification page.
We accept cases anywhere in the United States and welcome the opportunity to work with your existing counsel.