Special interest in special services

These are busy times for the usually obscure companies that specialize in distressed commercial loans.
With investors defaulting on billions of dollars of debt nationwide, so-called special servicers are gaining new prominence. The companies — which handle securitized loans on the verge of default to ensure that bond holders can be paid off — are not only raking in lucrative fees, they’re also being courted and, in some cases, acquired by high-profile investors looking to cash in on the credit crunch.

“Everybody is trying to buy one of these,” said Stephen Emery of Mission Capital, a loan sale advisory firm with offices in Lower Manhattan.

Last month, Fortress Investment Group paid $300 million, beating out Vornado Realty Trust, and the private equity firms Apollo Global Management, Centerbridge Capital Partners and Starwood Capital Group to acquire the nation’s second-largest special servicer, CW Financial Services.

CW’s business involves servicing more than 13,000 asset-backed mortgages worth $144 billion, including more than $3 billion in securitized senior debt handed over by Tishman Speyer and Blackrock Realty after they defaulted on payments at Stuyvesant Town and Peter Cooper Village.

Undaunted, Vornado, headed by Steven Roth, appears poised to secure partial ownership in the nation’s largest special servicer, LNR Partners. LNR, which is based in Miami Beach, reportedly represents $195 billion in loans.

Those two deals follow months of frenzied jockeying for smaller servicers.

In March, Island Capital Group, run by Andrew Farkas, who made a name for himself buying up distressed properties in the 1990s, closed on a deal to acquire the nation’s third-largest servicer, Centerline Holding Corp., which is servicing $113 billion in mortgages. In February, Warren Buffett’s Berkshire Hathaway and Leucadia National Corp. formed a joint venture called Berkadia to acquire the commercial servicing business of the troubled Capmark Financial Group for $468 million.

While a few years ago many of these special servicers were operating under the radar, they have quickly become investors’ favorites — even though some of them are teetering on the edge of bankruptcy.

Many of the firms are in financial distress themselves because when times were good, they were encouraged by the stakeholders in their deals to purchase subordinate pieces of the securitized debt. Since they owned the riskiest portion of the debt and would be the last to get paid off if something went wrong, they had an extra incentive to resolve any problems, which helped the stakeholders.

Today, investors clamoring to get a piece of these special servicers see myriad advantages. For one, they generate a steady revenue stream, and can provide a solid hedge for a company that owns other properties, which may be losing value in a weakened market.

“For somebody like Fortress who owns real estate-related assets, owning a special servicer is a good thing,” said Malay Bansal of the Midtown firm NewOak Capital. “When the markets go down, the value of assets goes down. [But] the value of special servicers in some ways goes up because more loans will go into default and they will collect more fees.”

Of CW’s $144 billion of loans, for instance, about $18 billion are currently in distress, according to Bansal. CW, he said, collects about 2.5 percent, or 25 basis points, on every loan that requires servicing. That means the company is probably earning about $45 million in fees on the $18 billion. In addition, they receive 1 percent of all loan resolutions.

But the fees are only one advantage to owning or investing in a special servicer. Perhaps even more appealing is that companies can also provide an edge to those looking to snap up distressed debt and assets, several observers said.

The companies come with valuable information that can give investors a leg up when vying for deals, Bansal said.

“Owning one of these servicers gives you a great courtside seat to the action,” Bansal said. “You’re looking at how many loans are troubled and how they are getting dissolved, where the values are.”

Dan Fasulo, managing director of research at Real Capital Analytics, doesn’t see investing in special servicers as a wise investment at the moment, but said that “whoever acquires these special servicers will have unique access to information on many distressed properties around the country, and access to all these situations almost before they go down the foreclosure path, with a unique look at all the dynamics at play.”

One source close to Fortress, who asked not to be identified, said the pieces of troubled debt owned by some of the special servicers can actually be an asset in the right buyer’s hands. That’s because the riskiest debt holders with the most subordinate pieces are often empowered by provisions in loans to make key decisions when the debt goes bad.

“My sense of the [Fortress] deal and others like it is that people are buying into these companies to get control of the most subordinate piece of these deals, which puts you in a position to make a lot of decisions,” he said.

None of the special servicers or their buyers, including LNR, CW and Fortress, returned calls for comment.
Speaking at a recent REIT conference, however, Michael Fascitelli, Vornado’s CEO, noted that “we expect there to be a great source of opportunities coming out of the CMBS and special services market.

“We’re looking for assets anywhere we can find them,” he said. “In New York, the game really hasn’t started yet.”

But Fasulo sees these investments as a sign of desperation.

“It’s clear to me that investors are having trouble getting access to distressed properties, and they are looking for creative ways of getting exposure to the sector,” he said. But “given how quickly values have recovered for the best assets, the clock is ticking as far as opportunities go.”

“I think we are approaching a high-water mark, [and] unless the economic recovery stalls in its tracks, I think we’re out of the woods,” he said. If that happens, the fees generated by the special servicers can only go down — as fewer properties fall into distress. Should that occur, the value of the special servicers will plummet.