A Miranda Warning for Potential Conduit Borrowers.

Author:HILL, MARK A.
Position:Brief Article

Avoid boxing your borrowers into an ill-fitting structure for their needs by reading this list of warnings. Commercial MBS structures can be rigid and unforgiving for some borrowers--don't let it come as an unwelcome surprise.

WITH ALMOST A DECADE OF SERIOUS CONDUIT lending under our belt, you Could be forgiven for thinking that most borrowers would have a fairly clear understanding of the workings of the commercial mortgage backed securities (CMBS) sector of the commercial mortgage lending business. Mortgage bankers have cycled through nearly all their borrowers and loans over the last decade, refinancing many via a conduit.

The Federal Reserve calculates that nearly one-fifth of all outstanding commercial mortgage debt is securitized--about $281 billion, according to New York--based Morgan Stanley Dean Witter.

Even with all that CMBS experience, borrowers continue to bombard mortgage bankers and loan servicers with impossible postclosing requests and breathtakingly naive questions. Confusion about the servicing process still appears widespread. Why is this?

We have concluded there are three possible explanations: Borrowers do not read their loan documents, ever; borrowers do not have long memories; and mortgage bankers and conduit lenders are not doing a very good job explaining the requirements and ramifications of the CMBS structure to borrowers before loans close.

Although there is some evidence in support of the first two propositions, we have chosen not to bite the hand that feeds us and will instead focus on the third hypothesis--that the primary culprit is a communications failure. Indeed, informal industry reconnaissance suggests that not only is this true, but many mortgage bankers and loan originators are ill-equipped to effectively communicate CMBS servicing realities to their customers.

Moreover, some in the loan origination process may look at CMBS servicing realities with an ill-conceived "don't ask, don't tell" policy. But whether from ignorance or a wrongheaded concern that an informed borrower is a missed opportunity, not educating the borrower is a bad idea. First, many borrowers already have a visceral, negative feeling about CMBS. Education and demystification of the CMBS process can only improve your chances that these borrowers will not reject a CMBS lending source out of hand. In addition, if a borrower gets a nasty surprise after closing, that borrower is unlikely to feel kindly toward the lender or mortgage banker who got him or her into the mess in the first place. It is absurdly shortsighted to trade one deal for continued borrower enmity.

The reality is that CMBS lending can, in many cases, provide a substantially better execution than competing portfolio products. That's news that is easy to tell, and the industry is reasonably good at telling it. But there are also servicing restrictions attendant to the structure that make it ill-suited for some transactions. It behooves professional originators or bankers to be educated about CMBS servicing and be forthright with their borrowers.

To help lenders and mortgage bankers educate the borrowers, we propose that every borrower be read, before closing, his or her CMBS Miranda Warning. Once the banker determines that a loan may "fit" in the conduit box (terms, loan-to-value, debt coverage, rate-lock requirements, etc.), the Miranda Warning will help determine whether a conduit execution is right for the borrower.

The Miranda Warning

WARNING No. 1. If you pursue this securitized loan product, you may be required to meet a series of complex and sometimes expensive requirements regarding the need for a new, single-purpose entity; adoption of separateness covenants; employment of independent directors; and delivery of a nonconsolidation opinion.

Depending on the size of the loan, some or all of these criteria may be imposed. Generally, the larger the loan, the more of these requirements will be applicable. Separateness covenants can have a real (albeit generally mild) impact on operating efficiency. These are binding legal agreements to operate the borrower in a manner separate and distinct from any affiliates.

The need for a new entity can either be a modestly expensive nuisance or a real headache if the local jurisdiction imposes a tax triggered by the transfer of the...

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