Note to File:

If you thought about it, when we take something as complicated as a pooling and servicing agreement and then modify it to do a work around changes to GAAP, it’s not going to be pretty. And it’s not. Welcome to the fair value auction. In a CMBS securitization, when a loan defaults, you’d figure the servicer would either work it out, foreclose it or sell it. That’s what we did until 2001 when the accountants concluded that, if the servicer had the ability to try to sell a mortgage loan, the trust would no longer be a qualified special purpose entity or a Q, and the securitization not a true sale. If it’s not a true sale, the mortgages stay on the issuer’s balance sheet and the transaction simply fails to work.

So, we fixed it with fair value auction. The servicer, instead of actively trying to sell a mortgage, simply values the mortgage and then any number of parties designated in the Pooling and Servicing Agreement (“PSA”) can buy it at that price. Simple, right? It added about ten pages to your average PSA and we’re all trying to figure out how the heck it really works. As you may have noticed, there are a lot of defaulted mortgage loans these days so all of a sudden this has become important. If someone can figure out how to industrialize the process of acquiring non-performing mortgage loans at a current market price, the opportunities to make real money are manifold. The actual mechanics of this somewhat Rube Goldbergian device are still, however, untested, and conflicts existing in the structure are both real and somewhat daunting. 

Standby: Will this be a driver of success in 2010 and beyond? The good news is that, given even more recent changes to GAAP, the vehicle to work around is no longer needed and in CMBS 2.0, the servicer will do the obvious thing and just try to sell the defaulted loan at the highest price.

Photo:  Flickr user medea_material