Special Servicing Units Look Like Good Buys

NEW YORK CITY-It’s no secret that the special servicing business is booming. The amount of CMBS loans in such care—penciling in at $43 billion at the end of January—has doubled in the past year alone, according to Fitch Ratings. Special servicing, which generates management and resolution fees, can be quite a lucrative business. And that fact was probably not lost on locally based Island Capital Group, which picked up Centerline Capital Group’s special servicing arm yesterday. The deal represents the second such buy in the past year, and industry observers suspect it will not be the last.

“The whole special servicing landscape is going to change this year, whether that’s through consolidation or the purchase of existing servicers,” said Stephanie Petosa, a senior analyst at Fitch, in an interview with GlobeSt.com last week.

Island Capital’s buy comes three months after Warren Buffet’s Berkshire Hathaway Inc. and Leucadia National Corp. made a $458-million play for Capmark Financial Group Inc.’s loan servicing and mortgage lending business, now known as Berkadia Commercial Mortgage. The deal emerged shortly after Capmark filed for Chapter 11 bankruptcy protection in October 2009.

Industry observers have speculated that LNR Property Corp. may be fixing to follow Centerline’s lead and sell off its special servicing arm. The Miami Beach, FL-based firm has suffered a number of write-downs on its commercial real estate investments as delinquencies continue to soar and values continue to plummet. The delinquency rate as of the end of February hovered at 6.29%, according to Fitch.

“All servicers are stressed and most of them are under financial pressure,” Petosa said.

Centerline was indeed under financial strain, having also taken tremendous write-downs on the values of its investments, according to Fitch. The agency downgraded Centerline’s servicer rating from CSS1 to CSS2 back in December citing “significant financial challenges facing the parent company.” The management and operations of the servicing group, however, did not contribute to the downgrade. As of the end of February, Centerline had been named special servicer on 533 loans valued at $7.7 billion, according to Trepp. Centerline declined to comment, while calls to Island Capital were not returned by press time.

“It’s the investment piece of the special servicers that has created the biggest problem for Centerline,” observes Frank P. Liantonio, EVP of capital markets at Cushman & Wakefield in New York City. “It’s really the B-pieces in the capital stack that they either bought or originated that placed it under water. The actual servicing business is profitable, and that’s why there has been a separation of the two.”

Island Capital, which is run by Andrew Farkas of Insignia fame, basically split Centerline into two companies: one private and one public. The special servicing and debt fund management functions were transformed into a private entity. That entity was then snapped up by an Island Capital affiliate, C-III Capital Partners LLC, for $110 million. Liantonio suspects that “the debt fund could be an attractive platform, from which one could move into the distressed debt business.”

C-III also picked up a 40% interest in the public portion, which will continue to be called Centerline Capital Group and retain the origination, asset management and agency mortgage-loan business. Island Capital essentially reprised the old structure of CharterMac and ARCap—Centerline’s predecessor. Island Capital had been working to recapitalize Centerline since last year.

The endeavor has helped Centerline rid itself of roughly $1.6 billion of aggregated liabilities and contingent exposures. It has also provided more than $100 million of new equity by restructuring a hefty portion of Centerline’s outstanding debt. For Island Capital, the transaction has positioned it to benefit from what is shaping up to be a windfall in special servicing.

“Special servicing is a very solid, safe business that’s going to be expanding over the next two or three years,” says David R. Soares, president and CEO of Lexden Capital in New York City. “Revenues should go up as more loams start to balloon and are not paid off, which automatically send them to special servicing.” Most money managers and expanding financial companies, he adds, are looking to take a very conservative approach, like this one, over the next few years.

Acting as a coordinator for bondholders with commercial-asset debt also offers special servicers dibs on the distressed properties they manage. And opportunistic plays is nothing new for Farkas, who made a name for himself in the ’90s investing in general shares of limited partnerships. Soares says he was accused of depressing prices of those partnerships to buy out his partners on the cheap. And there’s been speculation that Farkas trying to get a hold of assets through the special servicing arm.

But that’s highly unlikely, says Soares. “It would be illegal to as a trustee not be acting in the best interest of the bondholders. You can’t play around with that stuff,” he says. Calls to Island Capital were not returned.