CMBS B-Piece Bondholder & Special Servicer - Conflict of Interest?
I'm attempting to better understand the special servicer's role when a borrower of a commercial loan defaults. Typically, in a CMBS, the junior-most bondholder has the ability (per the pooling & servicing agreement) to appoint and manage the special servicer--the entity charged to work with the borrower in default to arrange a solution that will maximize returns to all bondholders. The special servicer can typically choose to modify the loan to some extent, sell the CMBS note, or foreclose on the secured property. At the same time, the junior-most bondholder has a "purchase option" (or, some variation of a right of first refusal) to purchase either the note or the secured property, where the special servicer proceeds with either selling the note or foreclosing on the property.
Scenario #1--
Let's say the special servicer chooses to sell the CMBS note, and the junior-most bondholder exercises its purchase option. The special servicer would have priced the note based on the "fair value determination" of the borrower's loan (which is in default), NOT on the value of the property secured by the loan.
Question #1--
Since the borrower has already defaulted, can the junior-most bondholder (who exercised the option to purchase the note) immediately initiate foreclosure proceedings on the property?
The concern is the CMBS note may be worth substantially less than the secured property, particularly where the borrower put equity into the property (for example, by making a 20% down-payment and borrowing 80% to finance the rest). If the purchaser of the note was a junior-tranche bondholder who exercised a purchase option at the “fair value determination” of the defaulted loan, then that purchaser can foreclose and gain title to the property well below market value.
If the special servicer and the junior-most bondholder are co-owned (or affiliated in some way), it seems there is a serious conflict of interest at play. The special servicer can make a "fair value determination" of the note (which may be worth much less than the underlying property), the junior-most bondholder can exercise its purchase option on the note, and then the junior-most bondholder can foreclose on the property. This conflict of interest could prevent special servicers from working with borrowers in default to modify the loan terms, even where modifying the loan terms would be in the best interest of all bondholders.
Question #2--
Does that reasoning make sense? And is that conflict of interest quite real?
If you're a borrower, don't default on your loan. Problem solved.
tldr, but yes, there is a huge conflict of interest in that business, and everybody knows it
The idea is that the B-piece buyer has the most to lose in a default situation and should have the most input in the workout.
There is a absolutely a conflict. In an attempt to address this most Pooling and Servicing Agreements state that if the note is going to be purchased by the special servicer, or some affiliate of the SS, the fair market value option price must be confirmed by a third party.
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