At a time when thecoronavirus pandemicisderailing thecommercial mortgage-backed securitieslandscape, a whistleblowerin Seattle has thrown another wrench into theCMBS market.
But financial services expertssaid there isn't enough informationto draw definitive conclusions about whether the complaint is credible orif it is, whether it would have broad implications for the CMBS market.
On Friday,a report from ProPublicadetailed a complaint by John Flynn, a mortgage insider who runs CRE Loan Advisorsand an advocate for CMBS reform, alleging that 14 lenders and CMBS servicers inflated property values on real estate collateralizing CMBS loans.
Flynnfiled the complaintwith the Securities and Exchange Commission, which declined to comment. In the complaint, he claims billions of dollars worth of CMBS loans remain linked to CRE collateral with overinflated net operating incomes, and that property addresses and names were changed from one financing to the next.
WhenBisnowcontacted Flynn, he declined to discuss the exact contents of his SEC complaint, but he did detail some of the allegedfraud he said he foundwhile studying data on collateral tied to CMBS.Attorneys for Flynn confirmed the report's existence and the accuracy ofProPublica's reporting on its details.
"It is a pattern where the loan seller is inflating the NOI (net operating income)," Flynn said. "It’s quite simple. The loan seller is inflating the NOI on a loan, and it appears to be in order to inflate the property value so that a higher loan amount can be obtained.”
The impact inflated values might have on an already shaky markettrying to price risk is substantial. CMBS suffered in the wake of the last recession, but experienced its most successful yearwithin the pastdecade in 2019, according to Trepp Analytics. Last year alone,Trepp Analytics foundthat private U.S. CMBS lenders issued about $96.7B in CMBS, a 27% increasefrom 2018,according to Trepp data cited by ProPublica.
Flynnsaid hefound other discrepancies when analyzing loan level data.He said one of his main concerns involves thediscovery ofdifferent NOI figures reported on thesame properties, including instances where properties underwent name and address changes soon after aninitial loan issuance.
In somecases, the buildings allegedly underwent thesechanges right beforeserving ascollateral in newrefinancing transactions, withsome buildingsreporting higher NOIs than before. In some cases, the NOI and cash flow reported on the same buildings changed within only a few months, Flynn said.
"You are talking about the same time period for the same collateral," Flynn said, adding that other issues caughthis attentionbefore he made his SEC complaint.
“Many times, a half-full building would be represented as fully occupied," he toldBisnow."Other times a halfway constructed building would be represented as fully constructed. The NOI represents the overreaching theme of misrepresentations that I found.”
Multiple sectors have engaged heavily in CMBS-related financing, a trend that fell after the Great Recession and picked up againas the financial recovery created more liquidity options for borrowers. Arecent report from Trepp Analyticsfoundroughly 20% of lodging properties financed by CMBS or CRE collateralized loan obligations did not make their April mortgage payments.
"This is in comparison to the previous months where that percentage hovered around 2%,"Trepp reported. About 10% of retailproperties tied to the same types of financingfailed to make their April payments,Trepp added.
Treppconfirmed the veracity of the above data when responding to the ProPublica piece, but said other ProPublica claims related to specific loan research tied to Trepp data cannot be confirmed without knowing more specifically what loans ProPublica is referencing.
ProPublicareports that it has verified data alleged in the SEC complaint detailingsix of the loansFlynn citesas having inflated NOIs.The report alsonamedbanks tied to some of the loans in question, includingDeutsche Bank, Wells Fargo and Ladder Capital.
Both Deutsche Bank and Wells Fargo declined to comment to Bisnow, while Ladder Capitaldid not return multiple requests for comments. The Mortgage Bankers Association toldBisnow it has not been made aware of any issues related to Flynn's claims.
When asked if Flynn could receive a financial reward as a whistleblower,Flynn'slegal team said if the SEC recovers more than $1M, Flynn could be eligible for an awardif the SEC recommends. Thatreward could possibly be ashigh as 20% of any amounts recovered.
One of the loan's ProPublicascrutinized is collateralized by aDoubletree San Diego hotel property in California. The original $36.7M loan was issued by Ladder Capital, ProPublica reported. The hotel property struggled for years to deliver enough net operating income, but was later part of another CMBS, it reports.
ProPublica'sreporting also found datatied to thenew loan on the same property ended up showing higher NOI figures for past years than what was initially reported duringthose same years.
TheDoubletree loan mentioned has ahighloan-to-value ratio placed on it by Moody's Investors Service. Moody's Vice President of Communications Tom Lemmon said the ratings agency does have analysts reviewing the ProPublica report.
But Lemmonsaid that the article only mentionsMoody's in the context of itsassessment of ahigh LTV ratio estimate placed by Moody's on one of theanalyzed loans. This is withinMoody's ongoing conservative LTV assessments, Lemmon said, and it'snot viewed as a negativeby the firm.
"I think we have been consistent in our loan-to-value calculations over the years," Lemmon told Bisnow. "If you look at when we calculate LTV for purposes of feeding into our ratings analysis, we look at it over the long-term. Frankly, Ihave tons of reports that [show] we consistently have a higherLTV than whatever the appraisers might come in with under the loan."
ProPublica's analysis of the SEC complaint and Flynn's filingdrew mixed reactions fromthe already shaken CMBS market on Friday.
Financial services experts warned that there'snot enough data containedwithin the newsreportto draw definitive conclusions about whether the complaint is credible or a even a market concern for CMBS.
"While the complaint filed with the SEC and theProPublica article might turn out to be true, we can't know at this point," University of Houston Law Professor Jim Hawkins said in a statement to Bisnow. "A complaint is just a series of unproven allegations that someone has made."
It's also important to put the legal significance of an SEC complaint into context in this situation, Hawkins said.
"It doesn't represent the SEC's findings about the situation," hesaid.
"ProPublica'sinvestigation was really limited, it only looked at 'six loans among the thousands Flynn identified as having inflated net operating income,'" he said. "It is possible that those six loans are not representative of the thousands of other loans, and we can't know without more research."
While skepticism abounded among the experts Bisnow talked to about the report, the CMBS market still took notice. In addition to the analysts and legal experts who commented in thisarticle,Bisnowreachedout to 11 other expertsandreceived either no response or thepartiesdeclined to comment on the ProPublica article.
“The allegations are certainly troubling," said Brian Mahany, with Mahany Law, an attorney who specializes in dealing with CMBSloans and whistleblower lawsuits. "We deal with CMBS loans every day, andI haven’t seen this."
Alhough he represents CMBS borrowers, Mahanysaidthis is notsomething he's personally witnessed.
"All of these CMBS loans are rated and presumably, until this article came out, I never knew there was a problem. I am still not sure there was a problem,"Mahanysaid.
Mahany said that he has alreadyheard multiple sources involved withCMBS taking a great interest in Flynn's allegations, but with few details to go on and not having viewedthe complaint himself, heremains unswayed.
But in the marketplace, particularly with coronavirus disrupting every asset class, the significance of the SEC complaint remains ambiguous at best.
Mahany says if he takes the whistleblower allegations inProPublica at face value, he's not sure how anyone can make a caseaboutlosseson misrepresented NOI, whenappraisalsacross the commercial property landscape are in flux after thecoronavirus.
"I don't even know what these properties are worth anymore," he said. "So I don't know how you separateanylossestied to the alleged fraudfrom just the bottom of the market, or from the market collapsing."
With or without these allegations, experts said that CMBScontinues to experience a challenging climate in whipsawing markets adjusting toskyrocketing unemployment claims and a post-coronavirus world.
“[Saying] the market is shaky is an understatement," Mahanysaid. "There has already been $100B CMBS-financed properties that have asked their special servicer for relief,helpor assistance, and I think it’s only going to get worse."