And while LNR has yet to make a formal announcement of itsplans, industry observers believe any decision may have farreaching implications for commercial real estate. After all, thecompany's special servicing arm, LNR Partners, manages a quarter ofall loans in special servicing.

|

LNR's booming special servicing business, which according toFitch Ratings has more than doubled in the past year, may indeed becontributing to its current woes.

|

"They may be attempting to get out from underneath theirobligations to advance interest payments to the unsubordinatedsenior tranches," says Greg E. Schecher, managing member ofLexington Capital Advisors LLC in Boca Raton, FL.

|

LNR's land and residential holdings may also be sinking thecompany. "They are, unfortunately, involved in one of the mostvolatile property niches in the market, land," says Dan Fasulo,managing director of Real Capital Analytics. "Given the propertyvalue decline in that sector, it's not surprising at this pointthat they are looking at bankruptcy protection as a way to moveforward."

|

In January, Bloomberg reported that LNR enlisted Lazard Ltd. and lawfirm Dewey LeBoeuf LLP to help restructure nearly $1 billion ofdebt and prepare for a possible bankruptcy filing. Calls placed toDewey LeBoeuf were not returned, while representatives from Lazardand LNR declined to comment.

|

According to Bloomberg, Oaktree Capital Management, LNR'slargest creditor, is also seeking advice on restructuring thefirm's debt. Oaktree Capital and a handful of LNR's otherbondholders are considering a takeover, sources tell GlobeSt.com.Those same sources, who wish to remain anonymous, say LNR'smajority stakeholder, Cerberus Capital Management LP, is nowrunning its operations. Calls to Cerberus were not returned.

|

Some observers suspect an investor will snap up LNR's specialservicing branch much like Warren Buffett's Berkshire Hathaway Inc.and Leucadia National Corp. did with Capmark's servicingbusiness, back in December. Since September 2009, CenterlineHolding Co. has been in discussions with Island Capital Group LLCto recapitalize its special servicing arm, Centerline CapitalGroup.

|

LNR's troubles came to light last November, when Moody'sInvestors Service downgraded the firm's credit rating to Ca from B3because of the "rapid deterioration in LNR's liquidity profile."This affected some $900 million of the firm's debt. LNR, theratings agency said, is under mounting pressure from declines incash interest income from its devalued CMBS investments. What'smore, the protracted credit crunch in the commercial real estatemarket has delayed collection of its special servicing resolutionfees.

|

"Every time a property comes back to the special servicer itcreates a liquidity issue because the servicer doesn't have anyreal method to create liquidity, except through the disposition ofassets," Schecher says. A series of asset sales may seem like theobvious solution, but with a fiduciary duty to protect bondholdersin the capital stack, it's not that simple.

|

"Special servicers are hired just like an independent contractorand they have to work in the best interest of the trust," saysWilliam Campbell, a partner at Strook & Strook & Lavan LLPin New York City. "Many investors feel, however, that becausespecials are conflicted they'll seek to just take action to preventtheir affiliates from taking losses. So they'll extend loans ratherthan foreclose them. However, this concern may be exaggerated."

|

Indeed, some wary observers of this practice question whetherthere is an inherent conflict of interest in having a B-piece buyerservice its own loan. "There have been allegations toward somespecial servicers that they've been over zealous in their servicingof mortgages," says Anthony Sanders, professor of finance in theSchool of Management at George Mason University in Virginia.

|

But Campbell observes, "The value of special servicing has risenas their affiliates' investments have fallen, and to avoid lawsuitsand rating agency downgrades, specials may be more vigilant inupholding their duties to the trust then some predict."

|

Still, Sanders points out that special servicers have beenaccused of unduly calling performing loans or collecting fraudulentfees. Senior bondholders have also been known to sue specialservicers if they are unhappy with the servicer's course ofaction.

|

Appaloosa Management, for example, filed a motion onTuesday alleging CWCapital Management, the special servicer forStuyvesant Town/Peter Cooper Village, violated its fiduciary dutyby seeking to foreclose on the property—exposing the trust to"wholly avoidable losses, risks and injuries," like double transfertaxes.

|

Like many of its competitors, LNR Partners has been brought tocourt for breech of contract, though there are no recordedjudgments against the special servicer. With LNR's current crisis,some question how a bankruptcy filing may affect the trusts towhich the company must answer.

|

Stephanie Petosa, a senior analyst at Fitch, says bankruptcycourts generally protect the interests of the filing entity withregard to its special servicing business. Including the specialservicing arm in bankruptcy could jeopardize its agencyratings.

|

A reorganization of LNR may result in a surge of distressedcommercial assets sales. "If LNR files for bankruptcy, it is goingto need cash and liquidity. So it sounds to me that it wouldprobably want to be auctioning some of loans in the portfolio,"says John Garth, partner and managing director of originations forthe East Coast for the Pembrook Group.

|

Recovery rates for resolved CMBS loans are lower than thehistorical average, according to Fitch. But the agency's mostrecent data show that LNR had a 90.7% recovery rate as of the endof Q3 2009. That number, however, may be a bit deceiving since LNRhas the largest portfolio of loans in special servicing, and at thetime had resolved just 119 of its 1,000-plus loans.

|

Loan extensions may be too costly an endeavor for LNR tocontinue in earnest. A torrent of asset transfers, like LNR hasexperienced, can be a crushing expense if monthly base fees orresolution fees are only trickling in. Special servicers may handleappraisal costs, legal fees and other expenses, with the hopes ofreimbursement.

|

To cover operating expenses, Schecher points out specialservicers typically borrow money from line lenders, which requirehaircut equity. But he says, "The amount of foreclosed propertiesthat are coming into the CMBS default arena creates a liquiditycrisis for the special servicer."

|

He continues, "You can't continue bringing in bad assets and notsell them and continue to borrow to pay the advances on real estatetaxes, insurance and interest payments; this is a losingproposition."

|

LNR's $1-billion senior credit facility is set to mature in2011. Moody's suspects the company, likely unable to refinance,will default on its credit obligations. Schecher suggests this linelender turmoil may create problems for other special servicers, ifLNR defaults.

|

"You are going to see line lenders getting nervous about theirposition with lesser servicers," he says. "The uncertainty of thiscould cast a pall on the industry for some time, and that means thevelocity of transactions will remain static."

|

A month after Moody's took action, Fitch Ratings downgraded thespecial servicing entity, LNR Partners, because of its parentcompany's financial trials. With 1,107 loans valued at $18.6billion as of January, LNR has been named special servicer for thelargest amount of CMBS debt, according to Trepp.

|

Were LNR Property to file for bankruptcy, those loans wouldcontinue to be serviced, says Sanders. "Even if the worst happensand they start moving toward a process of liquidation, theservicing rights will just be sold to other servicers out there.And there are still plenty of players out there," he says.

|

What's more concerning, he adds, is how this situation reflectson the state of commercial real estate. "It's sending a signal outthat there are some serious structural issues going on in thecommercial market." Sanders stresses that the skyrocketing level ofdefaults and delinquencies in the commercial real estate spacecontinues to be largely ignored by the public.

|

Petosa says, "All servicers are stressed and most of them areunder financial pressure. The whole special servicing landscape isgoing to change this year, whether that's through consolidation orthe purchase of existing servicers."

Want to continue reading?
Become a Free ALM Digital Reader.

  • Unlimited access to GlobeSt and other free ALM publications
  • Access to 15 years of GlobeSt archives
  • Your choice of GlobeSt digital newsletters and over 70 others from popular sister publications
  • 1 free article* every 30 days across the ALM subscription network
  • Exclusive discounts on ALM events and publications
NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.