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LNR Property Corp built both a business model and a balance sheet on the glut of debt financing available over the past decade. That foundation may have crumbled under the real estate investment and management firm, but a plan by private equity owner Cerberus Capital management to refinance its debt and to refocus operations could give LNR a new lease on life.

The firm hosted a bank meeting last week at the Westin in midtown Manhattan to launch a new USD 445m secured term loan, a source close to the situation and two buysiders told Debtwire. Proceeds from the loan, along with a roughly USD 450m equity capital raise, will take out LNR’s existing USD 900m in bank debt.

LNR needs to slash its debt in large part because the cash flow from the commercial real estate (CRE) bonds it bought dried up when the debt sank under water, while the value of its hard asset portfolio imploded. As the company restructures financially, it is also reorienting operations by buying up special servicing mandates for the CRE bonds it knows so well, and collecting the associated fees.

Management has been particularly aggressive in bumping other servicers off large commercial mortgage-backed securitizations (CMBS) by buying up the controlling bonds in the structures and assigning itself the new servicer, said two CMBS investors and an industry source. Taking over the servicer role allows LNR to muscle in on at least 25bps in servicing fees for each of the CMBS loans in workout.

Controlling class bond holders gain the right to replace incumbent special servicers and must sign off on all major loan restructuring decisions. The controlling class – defined as the highest rated class in the structure to realize a loss – changes as loan modifications and sales eat into CMBS cash flows.

Anatomy of a servicing takeover

LNR recently bought controlling class-B pieces attached to three large CMBS – LB UBS 2007 C1, BACM 2006 5, and CSMC 2007 C1 – by outbidding incumbent servicer Midland Loan Services, according to the sources and remittance reports. For the USD 3.37bn CSMC 2007 C1 deal alone, 29 loans are in special servicing already with a balance of USD 559m, implying USD 1.4m of servicing fees based on a 25bps rate.

Most of those fees will likely stay with Midland, as the incumbent servicer typically retains servicing responsibilities for loans it has begun to workout. But LNR can claim fees on any loans that enter restructuring going forward and with 81 loans worth USD 1.4bn listed on a remittance report watchlist, CSMC 2007 C1 could generate at least USD 3.5m more in fees in addition to back ended fees for bringing a loan current again.

If CMBS data provided by Trepp are any indicator, loans slated for workout far outnumber those currently in special servicing. Around 41% of CMBS borrowers have reported their 2009 financials, and among those USD 32.7bn worth of loans report a debt service coverage ratio at or below 1x, but are not yet in special servicing, according to Trepp’s data. The CMBS data provider forecasts that after 2009 reporting is complete, USD 75m worth of non-special serviced CMBS loans are likely to report the coverage ratio below 1x.

The more deals LNR becomes special servicer of, the more loan restructurings it will manage, the better it will be able to gauge the pace of loan losses creeping up the CMBS capital stack, thereby switching the controlling class. While most CMBS controlling classes are still the B pieces that are rated below BBB-, it’s only a matter of time before investment grade tranches become affected, said multiple market participants.

The company has scale on its side as its book comprises roughly 22.5% of the entire specially serviced commercial real estate universe based on unpaid balance, according to Fitch. The challenge for LNR going forward will be to identify holders of the bonds above the B piece in an effort to buy the bonds before the power shifts, the sources noted.

LNR’s takeover of the LB UBS, BACM and CMSC deals prove it is willing to aggressively expand market share. The B pieces of the three deals went up for sale in a late-January auction of six Class-B bonds just before the former owner, Anthracite Capital, filed for bankruptcy. Midland attempted to buy the bonds itself but LNR won out with a bid exceeding USD 2m for all six bonds, speculated a third CMBS investor at the time.

Midland and LNR declined to comment.

Marketing market share

When it comes time to pitch the new USD 445m term loan, arrangers BofA Merrill Lynch and Goldman Sachs will have to convince investors to dip back into a sector plagued by defaults and volatility. The banks’ success in that effort depends on how well they sell the story that LNR is uniquely positioned to benefit from the wave of restructurings sweeping across the commercial real estate industry.

LNR will likely target hedge funds and investors with real estate expertise, as traditional loan investors like CLOs have been burned too badly by past investments in the industry, as previously reported. Leveraged loans backing Tishman Speyer DC Properties and Spirit Finance, for example, languish in the 80s while both companies await possible restructurings.

The banks provided some buyside accounts with indicative price guidance in the area of Libor+ 550bps with a 2% Libor floor and an OID to be determined, said the source close to the situation and one buyside source.

The loan will include amortization of 5% each in years one and two, 10% in years three and four, with the balance due in the final year. The excess cash flow sweep is set at 75%, the sources said.


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