NY regulator mulls probe of CMBS loan servicers

Tue Jul 1, 2014 12:19pm EDT

* Lawsky eyes probe of commercial real estate loan servicers

* Focus on business conflicts and impact on bondholders

* Auction sites expected to fall under heavy scrutiny

By Joy Wiltermuth

NEW YORK, July 1 (IFR) - New York state bank regulators are preparing an investigation into commercial real estate mortgage loan servicers whose related businesses may be in conflict with the bondholders that the loan companies are supposed to protect.

Benjamin Lawsky, the superintendent of New York's Department of Financial Services, will be leading the initial investigation, a source with knowledge of the matter told IFR.

"He is looking at these firms to identify if subsidiaries they have developed are profiting from loans they are servicing," the source said.

The top three servicers of defaulted CMBS loans, by far the most profitable part of the servicing sector, are CWCapital Asset Management, C-III Asset Management and LNR Partners.

Together they held almost 80% of the market for servicing defaulted CMBS loans at the end of 2013, according to Fitch Ratings.

But they also all have investment arms that target the same types of problem loans and distressed properties that the servicers handle - lines of business that are expected to be at the heart of the probe.

Fortress Investment Group, for example, bought CWCapital, which manages the 110-building Peter Cooper Village Stuyvesant Town mega-complex in New York City.

CW gets paid to oversee the property's US$3bn defaulted CMBS loan as a servicer, but also controls the process that will determine what the property sells for - and Fortress is planning to bid on the property for the lowest possible price it can get.

"If they are servicing an asset for a third party and have to sell a note, or are taking back property, what steps are they taking to prove they got market bids?" one observer said.

"That seems to me what are going to check."

OCWEN AGAIN?

Lawsky's office declined to comment on the CMBS probe or provide any details on when it might be formally launched.

People briefed on the situation at all three companies told IFR they had not yet received letters from Lawsky's office. The source, though, said they would be on the way within weeks.

It's unclear what fines might be doled out - or if any suspected activity is illegal - but punishments in a similar investigation of the residential servicing space have been hefty, and the big CMBS players are on high alert.

Ocwen Financial Corp, the nation's largest non-bank residential mortgage servicer, has come under regulatory fire.

It was penalized US$2.1bn last year by the Consumer Financial Protection Bureau (CFPB) and 49 states over charges that it improperly foreclosed on borrowers, and had to compensate people who lost their homes to foreclosure between 2009 and 2012. It also promised principal reductions in a three-year period to others.

Lawsky's investigation into the RMBS sector, unlike that of the CFPB, is focused just on the size and scope of the related servicing businesses at Ocwen and rival servicer Nationstar - honing in on whether the two firms have grown too big to handle the volume of loans they service, and if they overcharge investors and borrowers to auction off foreclosed properties.

Some are worried that CMBS servicers could be blocked from pursuing some of their ancillary businesses, just as Lawsky's RMBS probe put at least a temporary halt to their explosive growth in the residential mortgage servicing arena - growth only made possible as new regulation forced banks out of the sector.

HEAT ON AUCTIONS

Scrutiny of CMBS auction arms - including LNR's stake in Auction.com - is therefore likely to be particularly intense.

In his probe of Ocwen, Lawsky has been concerned about whether its online real estate auction house Hubza was charging higher fees when the costs could be passed off to RMBS bondholders.

When Ocwen used the site to host a foreclosure or short sale, Hubza charged a 4.5% fee - a rate that dipped as low as 1.5% when it competed for business from third-party sellers.

It's still not clear what changes could be in store at Hubza, but bidders on Auction.com told IFR they expect similar questions to be asked about fees charged on the site and the way the bidding process works.

The mechanism is very opaque, and critics say that there should be more disclosure on the process for bidding on assets, minimum sale prices and fees charged across the board to buyers and sellers.

So far, though, CMBS bondholders have struggled to mount any lawsuits to force servicers to be more transparent about their activities - simply because they are not obliged to do so.

And servicers hope that will not change.

"What's transpired in CMBS is different with sophisticated parties," one servicer said.

"A lot of the issues with RMBS - clearly some of the abuses - warrant a level of scrutiny because it involves consumers." (Reporting by Joy Wiltermuth; Editing by Natalie Harrison and Marc Carnegie)