Servicers and Mortgage-Backed Securities Default: Theory and Evidence
Real Estate Economics, Forthcoming
Posted: 28 Sep 2014
Date Written: August 23, 2014
We study conflicting incentives of the master and special servicers in handling troubled loans in a CMBS deal and how the frictions between the interests of the two servicers might be diminished if the master and special servicing rights are held by the same firm. We show that concentrating both servicing rights in one firm reduces the likelihood that a defaulted loan terminates in foreclosure.
Demarzo (2005) argues that the pooling of assets (loans) has an information destruction effect that operates to the disadvantage of the intermediary by preventing the intermediary from fully exploiting its information regarding each individual asset. To overcome the information destruction effect and to provide confidence to investors, agents are employed to monitor information about the assets and to ensure that timely performance of loan payments is maintained. These agents are known as asset servicers.
An example of asset servicing can be found in the Commercial Mortgage Backed Securities (CMBS) – securities backed by pools of mortgage loans on commercial real estate properties. CMBS are structured such that a master servicer oversees the administration of the underlying loans and the distribution of the cash flows to the tranche investors. One of these functions involves the administration, monitoring and disposition of the loans. When a loan in a CMBS deal fails to perform as expected, the master servicer sends the loan to a “special servicer.” The special servicer has wide latitude to foreclose on the loan or modify the loan terms in an effort to maximize the cash flows to the CMBS investors. Typically, the special servicer's activities are detailed in a Pooling and Servicing Agreement (PSA).
Keywords: CMBS, Servicing, Workouts, Defaults
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