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CMBS (Commercial Mortgage Backed Securities) Basics
What is the (PSA) Pooling and Servicing Agreement?
A pool of mortgages that constitute the collateral for CMBS is serviced under the terms of a Pooling and Servicing Agreement (PSA). The PSA describes in detail how the loans are serviced. The PSA is an incredibly detailed and complex document. A typical PSA can exceed 500 pages in length. The PSA is not generally made available to borrowers or others although many PSAs are filed with the SEC. Each CMBS pool has its own PSA document which, while similar to other PSAs, will have its own specific deal terms. The PSA typically requires all CMBS servicers to act in accordance with a “servicing standard” that is no less rigorous than the standard they use to service their own loans. The PSA also requires the servicers to meet REMIC requirements and to protect the bondholders.
What is a Servicer?
 A mortgage servicer is an entity involved in collecting the monthly payments from the borrower, verifying compliance with the mortgage’s ongoing requirements and dealing with loan payoff at maturity. In the world of CMBS loans there is more than one “Servicer”. There can be a Primary Servicer, a Master Servicer, and a Special Servicer. The various servicers perform their responsibilities under the terms of the PSA – the pooling and Servicing Agreement.
What is a PRIMARY Servicer?
The Primary Servicer is the servicer that has direct on-going contact with the borrower. If the loan was originated through a mortgage banking organization it is very common for them to also be designated the Primary Servicer for that particular loan. The Primary Servicer may also act as a Sub-Servicer for the Master Servicer, in which case, it may collect the monthly payment from the borrower and may also collect and analyze rent rolls, operating statements and other financial and property information. The Primary Servicer reports to the Master Servicer for the CMBS Trust. The Primary Servicer has very limited discretionary authority and must secure the approval of the Master Servicer and/or Special Servicer for many borrower requests.
What is a MASTER Servicer?
The Master Servicer’s is responsible for the servicing of all the loans in the pool. Many different Primary Servicers may report to the Master Servicer. The Master Servicer manages the flow of information regarding all loans in the pool. The Master Servicer is generally required to process all borrower requests related to consents, waivers and modifications related to performing loans. The Master Servicer’s ability to waive, consent or modify terms of any mortgage loan is governed by the PSA. Many servicing requests will also require the consent of the Special Servicer. In some cases those decisions are further subject to approval by the Directing Certificateholder or review by Rating Agencies.
What is a SPECIAL Servicer?
Upon the occurrence of a loan default and selected other events the servicing of the loan is transferred to a Special Servicer. Additionally, the Special Servicer must approve many important borrower requests such as a loan assumption or modification. The Special Servicer is often affiliated with the entity that owns the B-Piece.
The Special Servicer has substantial experience in dealing with non-performing loans. Many Special Servicers got their start in the early 1990s buying and servicing defaulted loans from the FDIC and RTC. The Special Servicer generally uses a net present value (NPV) methodology for determining which work-out strategy to pursue. They will consider various loan alternatives, including: loan modification, foreclosure, deed-in-lieu and a discounted payoff (DPO). In certain circumstances the Special Servicer will sell the loan rather than continue trying to reach an accommodation with the borrower.
What is an Operating Advisor?
In the past several years a new role has been created within the CMBS trust structure. The Operating Advisor (OA) is a firm, generally a small one, that does not own any bond classes. They function in an oversight role reviewing certain actions of the Special Servicer. The role was created to deal with the perception that some Special Servicers took actions that benefited them as holders of the B-piece but at the expense of the top rated bond classes. In certain situations the OA might wield great power over the Special Servicer. However, they are paid only a modest amount, – less than $50,000 annually on a one billion dollar plus CMBS pool. Therefore, some people in the CMBS industry do not feel they will have the resources to exert a significant influence on the operation of the trust.
Who is the B-Piece Investor?
The investor in the most subordinate CMBS bond classes is commonly referred to as the “B-piece Buyer”. B-piece Buyers generally purchase the lowest rated and the very bottom of the bond classes - the unrated class. The most subordinate bond class is usually the Controlling Class Certificateholder. Because losses come out of the lowest rated bonds the CMBS servicing structure affords them the right to play an active role in making decisions on important issues that can affect the value of the loan or the collateral.
Who (or what) is the Trustee?
The Trustee’s role is to hold all the loan documents and distribute payments received from the Master Servicer to the bondholders. The Trustee is generally a large financial institution. Borrowers rarely have any dealings with the Trustee.
What is a Rating Agency?
Rating agencies establish bond ratings for each bond class at the time the CMBS securities are issued. They evaluate the major properties that are the pool’s collateral and they analyze the subordination levels. Subordination levels basically mean the amount of bonds that are below any particular bond class – where the lower bonds will suffer losses before the upper bonds.
Rating agencies also continue to monitor the pool's loan performance and they can change ratings for the CMBS bond classes throughout the trust's life. This is referred to as “surveillance”.
The major Rating Agencies are: Standard and Poors (S&P), Moody’s, Fitch, Morningstar and Kroll. There are typically more than one agency involved with the rating of each particular CMBS deal.
Borrower loan documents may require that some loan requests be submitted to the rating agencies for confirmation that the agency will not downgrade of any of the CMBS bond ratings as a result of the requested change. This confirmation is frequently required with respect to actions on the largest loans in the pool. However, loan documents often require this for Mezz financing and other matters even for small loans. The borrower does not deal directly with the Agencies but will have to interface with them through the Servicer. This whole process can add cost, time and complexity to the borrower’s request.
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