Improving the CMBS Borrower Experience
Stacey Berger, Bob Wright
October 10, 2017
The long term viability of commercial mortgage-backed securities as a major source of funding for commercial real estate finance is at risk--for several reasons.
Borrowers seeking permanent income property loans with higher leverage, lower interest rates and the non-recourse provisions are attracted to CMBS. Unfortunately, certainty of execution has recently become a major trade-off associated with CMBS financing.
This is a result of:
- Capital markets issues including interest rate volatility and inefficient hedging;
- Reduced CMBS investor demand due to decreased secondary market trading and liquidity;
- Increased influence of B-piece investors in shaping loan and portfolio credit exposure; and
- Inconsistent borrower customer service for the life of the loan.
Market and economic forces will continue to influence the first three items. However, borrower customer service is fully under our control as an industry and improvements in the borrower experience must be addressed in order for CMBS to continue to be a sustainable commercial real estate financing alternative. Otherwise, CMBS could become the lender of last resort. CMBS originators and issuers; primary, master and special servicers; and borrowers can all contribute to improving the CMBS borrower/lender experience.
Some of the CMBS servicing issues are inherent in the complex structure, while others can be addressed with better communications, improved processes and responsiveness. Some CMBS servicers do a better job of managing borrower relationships than others. However, borrowers typically don't have a choice in who their servicers are. Unlike CMBS, borrowers can opt for a life of the loan servicing relationship with banks, specialty finance companies, insurance company portfolio lenders and the mortgage bankers that originate for them.
Historically, mortgage bankers originated CMBS loans and maintained the borrower relationship as a subservicer. Yet, mortgage bankers have been disintermediated as securitization transaction economics have made the sale of primary servicing rights to the master servicer more profitable for the issuers. CMBS issuers sell the master servicing rights to a select group of bidders and special servicers are selected by the transaction B-piece investor. To a large extent, borrowers are stuck with the combination of master and special servicers selected by the transaction issuer based primarily on issuance economics rather than quality of service and their servicing experiences may vary widely based on who their servicers are.
Borrower-initiated lender approval requests are one of the most important interactions between the borrower and servicer. These can range from routine to major credit issues, and the servicer's performance in handling these interactions are a major factor in determining borrower satisfaction. Setting appropriate expectations, establishing reasonable timeframes and fees are critical to a successful result.
The CMBS servicing construct is complicated. Primary, master and special servicers administer the loans subject to the loan agreements and the Pooling and Servicing Agreement (PSA), which the borrower is not a party to. Both routine and credit related borrower-initiated asset management requests can require sequential approvals from the primary, master and special servicers and the B-piece investor/controlling classholder. This is an inefficient and time consuming process that can be frustrating and expensive for borrowers.
On recent transactions, servicers and issuers made changes to the PSAs to reduce these sequential approvals. Master servicers can now approve routine borrower requests such as reserve releases and minor lease and budget approvals, while major credit approvals, such as assumptions, change of ownership or property management changes, are directed to the special servicer and controlling classholder for their approval. While this structure is less complex with efficient execution, the servicer is still the key to improving the process.
CMBS originators and issuers and legal counsel have worked with servicers to change loan documents to ease the burden associated with many of the routine lender approval requests, such as reserve releases that frustrate borrowers. These changes have made it easier for servicers to review and approve borrower requests, and are improving the efficiency of the borrower / servicer interaction. Additionally, the number of loan performance covenants could be reduced to the benefit of both the borrower and servicer. Unfortunately, the recent changes to PSAs and CMBS loan documents do not address the existing loans and transactions, many of which have 10-year original terms.
What can be done to improve the CMBS borrower experience for these legacy transactions? Both servicers and borrowers can make a difference. Servicers can improve their internal and external processes to make the borrower request approvals more efficient. Improved efficiency reduces turnaround time and costs. The communication between borrowers and the primary or master servicer is critical in establishing expectations regarding the complete information that's required from the borrower to support the request, the full servicer approval process and timing, and costs and fees.
Borrowers need to understand that servicers can't review and approve requests without the complete information that's required to underwrite the transaction. Servicers need to be specific about what information is required upfront and follow up with the borrower on missing information. Effective communication protocols must be established.
Servicers must be clear in terms of the sequential approval process as well as the time and expense required. In many cases, there are duplicative efforts with the primary, master and special servicer each analyzing the borrower request. Approval by the master servicer does not mean approval of the request if the special servicer and controlling classholder have not also approved. Communications between borrowers and servicers frequently break down in extended email dialogue. Many times a phone call can expedite the resolution of outstanding issues.
Communication between all of servicers involved in the approval process is a critical step and the major servicers have made significant efforts to address this issue. Regularly scheduled calls between primary, master and special servicers help bridge communication gaps and establish priorities. On major credit matters, master servicers frequently reach out to the appropriate special servicer to discuss the borrower request and associated issues prior to underwriting and documenting approval recommendations. This allows the master and special servicers to work with the borrower to successfully negotiate an acceptable approval versus an extended review process ending in a "slow no."
Servicer compensation and economics are important issues in managing borrower requests and the associated experience. Borrower-paid fees are typically divided between the primary, master and special servicer -- who also may have a fee sharing arrangement with the controlling classholder. Fee splits don't necessarily align compensation with the party responsible for the actual review, analysis and underwriting of the request.
Master servicers purchase CMBS mortgage servicing rights and are entitled to their share of ancillary fees associated with borrower-initiated requests, even though the special servicer is responsible for reviewing, underwriting and approving the transaction. This reduces the compensation available to special servicers at a time when other special servicing revenues are at the nadir. In some cases, special servicers have imposed high fees on borrowers in order to secure their consent on major credit matters--creating ill will with CMBS borrowers.
There is a proven market example of how to improve borrower customer service for securitized income property mortgage transactions. Freddie Mac has addressed many of the issues troubling CMBS by building a different servicing construct in its K-Series multifamily securitizations. The structure relies on the originating mortgage seller/servicers retaining the primary servicing as subservicers. The loan originator maintains a life of the loan relationship with the borrower, as primary servicer.
Freddie Mac has established timelines for borrower-requested asset management activities, and monitors and enforces these on their servicers. The servicer approval process is more efficient, with borrower requests directed to the appropriate servicer or controlling classholder instead of a sequential process. Freddie Mac also addressed servicer compensation by providing special servicers with an ongoing surveillance fee to compensate for removing them from the asset management approval process.
Regardless of structural process improvements, making customer service training a priority is an important component of improving the borrower experience. Customer service representatives and asset managers can be taught how to improve communications and effectively set borrower expectations regarding the review and approval of their requests. Additionally, process improvements can improve efficiency for servicers in handling borrower requests. Tracking is a critical component to allow managers to review the approval process and resolve issues that slow down individual approvals. The establishment of an ombudsman to provide borrowers with a resource to assist them in delays is also an effective mechanism to improve communications and escalate the resolution of outstanding issues.
One particularly effective mechanism for servicers to improve the borrower experience is through regular satisfaction surveys. CMBS borrower surveys can provide important feedback regarding their new loan onboarding process and borrower-initiated asset management requests to improve both of these critical processes.
These surveys can help establish performance benchmarks that allow servicing managers to evaluate performance trends. Borrower customer service representatives and asset managers can be evaluated on their performance based on survey metrics. Borrower survey scores may improve significantly as a result of feedback from borrowers, which provides quantitative measures of areas for process improvement and provides managers with tools to improve oversight, training and incentive compensation.
The CMBS industry would significantly benefit from industry-wide borrower surveys to identify which primary, master and special servicers provide the best customer service. The high performance servicers should be rewarded, and those providing less than the best service should be called out for improvement. This would provide CMBS issuers with qualitative measures to select the best servicers for their borrowers, improve the overall borrower experience, and allow CMBS to remain a viable financing option for the long term.
This article was reposted with permission from MBA Insights/Mortgage Bankers Association.
Stacey Berger is an Executive Vice President and Bob Wright is a Senior Vice President of Midland Loan Services, a PNC Real Estate business, a provider of loan servicing, asset management and technology for the commercial real estate finance industry, including commercial mortgage-backed securities servicing. The views expressed by the authors are their own. This article was prepared for general informational purposes only and does not purport to be comprehensive. The information and views in this publication do not constitute legal, tax, financial or accounting advice or recommendations to engage in any transaction. The views expressed in this publication are subject to change due to market conditions and other factors.
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Executive Vice President