Borrower education and process inefficiencies among the top servicing issues for CMBS originators

Thanks to high interest rates, commercial mortgage-backed securities (CMBS) issuance declined an estimated 46.4% in 2023 from the previous year, according to research by credit rating agency KBRA. But activity has been looking up over the past few months, as banks have pulled back commercial real estate originations as a result of regulatory pressures and the Federal Reserve has signaled that it may begin lowering rates later in 2024. That has led to upbeat forecasts from industry analysts and experts, with KBRA projecting that issuance will increase by almost 25% year over year in 2024.

Still, the outlook for CMBS is not all blue skies. From origination process inefficiencies to borrower servicing disagreements, multiple issues threaten to impede the rebound in CMBS originations. Joe DeRoy Jr., senior vice president at KeyBank Real Estate Capital, participated in a panel discussion at the recent Mortgage Bankers Association Commercial/Multifamily Finance Convention and Expo, where experts discussed originator challenges and how stakeholders are addressing them. DeRoy was joined by Brian Hanson, managing director at CWCapital Asset Management LLC; David Harrison, chief operating officer at PNC Real Estate; Frankie Jones, vice president and managing director at Lincoln Financial Group; and Crystal Kalinowski, managing director at District Capital LLC.

The panel kicked off by highlighting the obstacles of working with borrowers who don’t fully understand the details of the deals they sign.
 

Borrower education

By contrast with bank loans, the process of originating a CMBS is more complicated, as there’s little standardization in CMBS structure and loan documentation. This complexity can, and does, lead to misunderstandings among borrowers, originators, and loan servicers. These disagreements can at times dissuade borrowers from taking advantage of CMBS loans in the future. The panelists agreed that the best solution is to educate borrowers on the complicated nature of these deals and the consequences of being imprecise about their objectives in taking out the loan.

“It’s really important to sit down with your client and understand what they’re trying to accomplish in the near, mid, and long term, then try to anticipate as much as you can in the loan documents,” said KeyBank’s DeRoy.

There was agreement on the panel, adding that once a deal is executed, it’s extremely difficult to change it. “As mortgage bankers, it’s incumbent on us to make sure our borrowers understand exactly what they’re getting into and what their obligations will be post-closing, and make sure they’re OK with that,” remarked one capital provider. “Because with CMBS, we’re not waiving anything post-closing.”

The panelists noted that, in addition to educating borrowers before closing, more and better pre-closing communication can also help head off challenges. “One of the things that we all learned during COVID was the value of communication,” one of the experts said. “We revamped our closing process to include more kickoff and pre-approval calls, and we include the head of our servicers on those calls. That has allowed for a much better perspective, even to thinking about other servicing items that we can plan for in the loan documents themselves.”
 

Bespoke vs commoditized

The case was made that, in addition to educating borrowers, the industry should take steps to simplify loan documents. Doing so would not only prevent many post-closing disagreements but make the loans easier to service.

“CMBS have gotten more customized and bespoke, and that makes servicing them more complicated because it removes the consistency and forces you to go deeper into documents to look for exceptions and differences,” the panelist further explained. “The servicer is rarely able to be involved in crafting these agreements, but when you get those downstream calls from someone saying, ‘Hey, that’s not how we engineered this to happen,’ the servicer has to deal with it.”

Continuing that thought, he suggested that one way to help avoid confusion about the details in CMBS agreements is to commoditize them. “CMBS works best when the similarities between documents are high and the differences are low,” he explained. “That makes it easier to administer them.”

DeRoy had a different perspective, noting the important role personal connections play in making CMBS work. “We are a relationship-based business. When I’m educating a borrower, I tell them, ‘If you want to commoditize the industry for your benefit, you’ll get commoditized results. You’re not going to get the highest white-glove service in a commoditized capital-markets lending environment as you would a portfolio lender that’s retaining all the servicing,” explained DeRoy. “But if you’ve worked with the right people, if you understand that there are people with deep expertise and experience making and administering your loan, and who are there for you after the loan closes, you realize that the ‘who’ is an incredibly important part of a successful deal.”

DeRoy suggested that rather than commoditizing CMBS, stakeholders should focus on addressing inefficiencies in the servicing process. “Borrowers often get upset with the time it takes to submit something up the chain. If the servicer finds omissions or errors, it takes a few days for them to send the paperwork back, then it takes more time for the corrected submission to get back to the top of the pile,” said DeRoy. “That’s why we always tell our borrowers to carefully review their paperwork first, before they submit it.”
 

Conclusion

DeRoy and others pointed out that the industry is attempting to address the issue of complex originations. Unfortunately, CMBS stakeholders also face some headwinds that are largely outside their control, including the cost and availability of property insurance.

“What does that do to the borrower experience and what does that do to volume? We’re never going to get back to where we were until we fix these types of issues,” added an expert.

The good news is that, in 2024, the industry can at least look forward to some macroeconomic relief while it tackles these obstacles.
 

For more information

Reach out to Joe DeRoy or visit key.com/rec to see what our real estate team has been up to.

Read more interesting articles on how the real estate market is navigating headwinds and finding creative ways to approach housing in the seniors, affordable, and multifamily sectors.