Avoiding Huge Defeasance Prepayment Penalties

CMBS loan servicers are sometimes not allowed to use common sense.  These conduit loan servicing agents work for a trust established to hold the CMBS loans in their portfolio.  This trust is not allowed to operate like a for-profit company. 

The trust must remain completely passive; otherwise the trust will lose its tax-free status and the investors in the trust will have to pay hundreds of millions of dollars in extra taxes.

Suppose a conduit loan borrower is clearly struggling.  He is constantly in and out of default, and his economic prognosis is terminal.  If the lender is forced to foreclose, it is clear the lender will lose all of its interest and 30% of its principal balance.

Suddenly a buyer for half of the project appears.  He will buy the less-desireable half of the project for enough money to pay down the conduit loan by 65%.  All the original borrower needs is for the loan servicing company to release its mortgage on half of the property.  Everyone wins.

Unfortunately the conduit loan servicer cannot release its lien on half of the project.  To do so would be a business decision, and the trust agreement specifically forbids the trust from exercising any business discretion.

Conduit loan borrowers, however, have begun to discover that once a CMBS loan is in default, the loan servicer is suddenly allowed to use some business judgment.

As a result, CMBS borrowers are starting to default on their loans on purpose in order to convince the special servicer, the loan servicing company that takes over in the event of a default, to make concessions.  The concession might be a waiver of a defeasance prepayment penalty, a partial release of collateral, or permission to expand a project.

The strategy is dangerous because the special servicer may decide instead to merely accelerate the loan (demand a complete pay-off), thereby triggering the huge defeasance prepayment penalty.

That being said, there is a lot of winking going on these days between conduit loan servicers and the attorneys for conduit loan borrowers.

You can apply to hundreds of conduit lenders in just four minutes using C-Loans.com.