here are three types of cash-management
systems for CMBS loans. They include hard
lockboxes, which do not allow the borrower
to have control over the property’s cash flow;
soft lockboxes, which allow some control of
cash flow; and springing lockboxes, which
are triggered when certain situations occur.
The general premise of springing cash management is that it gives
lenders the power to capture cash flow in the event of declining property
performance. Mortgage brokers and borrowers may agree with this
premise and understand its intent when they sign a deal with springing
cash-management provisions, but it’s important to remember the devil is
in the details.
Following are four common misconceptions about CMBS cash-management plans.
Some borrowers think they won’t need to worry about cash management springing on their loan if the property is performing well and the
debt-service coverage ratio (DSCR) is above the threshold spelled out in
the loan agreement.
Typical CMBS loan agreements, however, include many definitions
within definitions that give the servicer the right to calculate DSCR, and
the servicer’s calculation is “final absent a manifest error.” These words
actually appear in many loan agreements and the definitions are very important as they state what should be included in both the income and
expense components of the DSCR calculation. With interest-only loans,
the debt service used in the DSCR calculation often assumes the loan is
of the 30-year amortizing variety, making the monthly payments in the
formula much higher than interest-only payments.
Mortgage brokers and their clients should know about income that
may be excluded from the DSCR calculation in the typical CMBS loan
agreement. These examples include fully paying tenants that “go dark,”
meaning they shut down their operations but continue paying rent; rental income from a tenant that has chosen not to renew its lease; and short-term leases, such as those for seasonal businesses.
The bottom line is there are many well-performing properties today
Occupancy and rental rates
with DSCRs of 1.5 and higher that are being placed into cash-management
plans. This is because the servicer has performed its own calculation
based on the specific details of the loan agreement and is excluding
certain income line items, adding other expenses and using an amortizing
payment plan (even for interest-only loans). The servicer’s DSCR is often
much lower than the actual ratio. Again, however, the servicer’s numbers
are final, absent an obvious error. Just because the actual DSCR is above
the documented threshold for springing cash management, it doesn’t
mean the servicer’s calculation won’t be below the threshold.
A second misconception is that a borrower won’t need to worry about
cash management when his or her property is outperforming market
expectations because of higher occupancy rates or higher rental rates.
“Underwritten operating income” is a term often included in the
details of the servicer’s DSCR calculations. This stipulation allows the
servicer to adjust rental rates, occupancy rates and other factors to the
lower of (a) actual, (b) market, or (c) underwritten rates. So, in cases
where the borrower has negotiated higher-than-market rental rates
or has an occupancy rate above the market average, they will not get
credit for that when the servicer calculates their DSCR as it relates to
This can really sting a borrower, for example, if the loan was originated with
an underwritten occupancy rate of 80 percent, but the current occupancy is
90 percent. If the loan agreement defines the occupancy rate as the lower of
actual, market or under written rates, then the income will always be calculated assuming 80 percent occupancy — or lower, if market-rate occupancy is
below that — regardless of the actual occupancy rate of 90 percent.
Once again, just because the actual DSCR is above the documented
threshold for springing cash management, it doesn’t mean the servicer’s
DSCR calculation won’t be below the threshold and cause the lockbox to
be sprung. Income will be adjusted downward to the lowest allowable
number in the loan documents.
Many buyers entering into an assumption of an existing loan believe they will
receive the same terms as the previous borrower. This is partially true — but
not entirely — and this one issue causes many lawsuits between buyers and
sellers when the conditions for approval contain what the buyer believes
are deal changes.
Without a modification, there are loan-assumption terms that cannot
change, such as the interest rate and maturity date. There are other requirements that are wide open to change, however.
Ann Hambly is the founder and CEO of 1st Service Solutions, a full-service CMBS advisory company with a singular focus on owners and
borrowers. Founded in 2005, the company also is the first borrower-advocate company ranked by Morningstar Credit Ratings. Hambly has
30 years of experience heading up some of the largest servicing groups in the industry, including Prudential, GE Capital and Nomura, and
has negotiated hundreds of pooling and servicing agreements for CMBS transactions. Reach Hambly at (817) 756-7220 or firstname.lastname@example.org.
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“The general premise of springing
cash management is that it gives lenders
the power to capture cash flow in the event
of declining property performance.”