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Servicer Evaluation: Rialto Capital Advisors LLC

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Servicer Evaluation: Rialto Capital Advisors LLC

Ranking Overview
Subrankings
Servicing category Overall ranking Management and organization Loan administration Ranking outlook
Commercial special ABOVE AVERAGE ABOVE AVERAGE ABOVE AVERAGE Positive
Financial position
SUFFICIENT

Rationale

S&P Global Ratings' ranking on Rialto Capital Advisors LLC (Rialto) is ABOVE AVERAGE as a commercial mortgage loan special servicer. On Sept. 14, 2021, we affirmed the ranking (see "Rialto Capital Advisors ABOVE AVERAGE Commercial Mortgage Servicer Ranking Outlook Revised To Positive," published Sept. 14, 2021). The ranking outlook is positive.

Our rankings reflect Rialto's:

  • Experienced and stable senior management team;
  • Sound audit, compliance, and control environment;
  • Well-defined and effective borrower request, loan workout, and real estate-owned (REO) procedures and process flows;
  • Active participation in the CMBS market as a B-piece buyer (through its affiliate);
  • Good leverage of a proprietary special servicing technology system that provides strong controls;
  • Comprehensive employee training and development; and
  • Growing track record of special servicing defaulted CMBS loans and REO assets.

Since our prior review (see "Servicer Evaluation: Rialto Capital Advisors LLC," published May 27, 2020), the following changes and developments have occurred:

  • Rialto's named CMBS special servicing portfolio increased to 135 transactions, totaling $109. 2 billion in unpaid principal balance (UPB), from 121 transactions, totaling $106. 7 billion in UPB.
  • Rialto continued to strengthen its technology capabilities to include further enhancements to Appian and workflow automation across the platform.
  • Rialto accelerated its staffing plan during the early days of the COVID-19 pandemic to address the increased volume of borrowers seeking payment relief. As a result, its full-time employees (FTEs) increased more than 38% to total 108 in 2020. However, Rialto reported 22 departures (a 20. 4% turnover rate) during the first half of 2021, resulting in a June 30, 2021, headcount of 97.
  • Rialto resolved an aggregate UPB of approximately $4. 8 billion across 278 CMBS specially serviced loans, including $3. 2 billion (169 loans) that were returned to the master servicer, largely via modification or forbearance agreement, and $732 million (57 loans) that were resolved via foreclosure or deed-in-lieu of foreclosure.
  • Rialto's active CMBS portfolio increased significantly to nearly $9. 9 billion (562 assets) as of June 30, 2021, from approximately $2. 5 billion (176 assets) as of Dec. 31, 2019, though it reached a peak level of more than $10. 8 billion (612 assets) as of Dec. 31, 2020.
  • In 2021, the company established a training committee of associates from across the platform. This group holds dynamic training sessions that cover basic to complex concepts from an asset management and organization perspective.
  • Rialto hired a director, who is an executive with over 30 years of industry experience, to oversee CMBS compliance. This director replaced the prior compliance officer who joined a competitor in 2020.
  • Rialto implemented its business continuity plan due to the COVID-19 pandemic in March 2020. Management reported that there were no disruptions to the company's operations or data facilities and its staff largely operated remotely over the following year with some employees gradually returning to the office beginning in March 2021.

Ranking Outlook

The ranking outlook is positive. The positive ranking outlook reflects Rialto's successful transition under the new ownership group that acquired the company in late 2018. The transition included efforts to replace the former parent company's technology and internal audit functions, while simultaneously enhancing the compliance function within the asset management and servicing unit. Management has indicated that its 2021 staffing plan includes increasing its mid-year headcount substantially, with plans to add 30 full-time employees to reach 127 (excluding those dedicated to its Quantum Servicing subsidiary).

A ranking upgrade could occur if the company continues to perform well as its strengthened internal control regime matures, accompanied by further demonstration of its ability to retain talented asset managers and execute on its staffing plan to successfully resolve its nearly $10 billion active portfolio, which had grown from $2.5 billion at our prior review.

In addition to conducting an on-site meeting with servicing management, our review includes current and historical Servicer Evaluation Analytical Methodology (SEAM) data through June 30, 2021, as well as other supporting documentation provided by the company.

Profile

Servicer Profile
Servicer name Rialto Capital Advisors LLC
Primary servicing location Miami, Fla.
Parent holding company Rialto Management Group LLC
Servicer affiliates Rialto Investment Management LLC and Rialto Capital Management LLC
Loan servicing system RCAMS (Rialto Capital Asset Management and Servicing System)

Rialto is the special servicing subsidiary of Rialto Management Group LLC (RMG), which has an established operating history dating back to 2007 when it was founded as a wholly owned subsidiary of Lennar, a leading U. S. homebuilder. On Nov. 30, 2018, investment funds managed by Stone Point Capital LLC (Stone Point; 88.8% ownership), in conjunction with management, acquired Rialto Capital Group Holdings LLC (Holdings), the entity that owns Rialto and its affiliated investment operations, RIM, from Lennar for $340 million. Since the acquisition, Rialto employees have increased their ownership from 10.1% to 11.2% as the firm has broadened the opportunity for its associates to invest in the firm to help mitigate turnover. Stone Point is a private equity firm, focused on financial services and asset management, based in Greenwich, Conn. Stone Point has raised and managed eight private equity funds with aggregate committed capital of more than $65 billion.

RMG is headquartered in Miami with offices located in New York City and Atlanta, and additional offices across the U. S. and in Europe. Rialto's principal special servicing office is also in Miami, though some special servicing staff operate from Las Vegas and Atlanta. Rialto also owns Tampa-based Quantum Servicing Corp. (Quantum), which it acquired in January 2014. S&P Global Ratings ranks Quantum as AVERAGE as both a primary and a special servicer of small-balance commercial loans.

Rialto's special servicing assignments are largely obtained from its affiliate, Rialto Capital Management LLC (RCM), which is wholly owned by RIM and indirectly wholly owned by Holdings. Since 2011, RCM has been one of the most active CMBS B-piece buyers and, according to management, it obtained an approximately 26% historical market share through March 31, 2021. As a result, as of June 30, 2021, Rialto was named as the special servicer for 135 CMBS trusts, totaling $109.2 billion in UPB, as well as two million commercial real estate collateralized loan obligations (CRE-CLO) aggregating $1.1 billion with 47 loans. According to the Mortgage Bankers Assn., as of Dec. 31, 2020, Rialto is the fifth largest special servicer as measured by its named appointments.

As of June 30, 2021, Rialto actively managed a $9.97 billion total special servicing portfolio, including 495 loans approximating $9.2 billion and 67 REO loans containing 114 REO assets, with a reported UPB of $800 million. CMBS comprises the vast majority of Rialto's active portfolio UPB, totaling $9.87 billion (480 loans and 58 REO loans containing 80 REO properties) (see table 1).

Since 2010, Rialto has serviced more than 15,000 nonperforming and distressed real estate loans aggregating more than $15 billion and managed the transition of the collateral to approximately 4,500 REO properties (mostly smaller-balance assets) via foreclosure or deed-in-lieu while also handling over 2,400 bankruptcy cases derived from RCM's investment activities. Since 2009, RCM has raised more than $10 billion in equity capital that it has deployed across various funds and separate accounts that invest in newly issued CMBS B-piece investments, distressed debt, value-added property investments, and high-yield debt/preferred equity investments. As of March 31, 2021, RCM managed $6.6 billion across various separate accounts, joint ventures, and 12 private equity fund structures, as well as a non-traded credit real estate investment trust (REIT) for which it acts as a subadvisor.

Table 1

Total Servicing Portfolio
UPB (mil. $) YOY change (%)(ii) No. of loans(i) YOY change (%)(ii) No. of staff(iii) YOY change (%)(ii)
Special servicing (CMBS)
June 30, 2021 9,875.0 (8.8) 538 (12.1) 97 (10.2)
Dec. 31, 2020 10,832.4 341.7 612 247.7 108 38.5
Dec. 31, 2019 2,452.3 24.3 176 31.3 78 30.0
Dec. 31, 2018 1,973.5 92.3 134 74.0 60 (27.7)
Dec. 31, 2017 1,026.2 -- 77 -- 83 --
Special servicing (non-CMBS)
June 30, 2021 97.5 294.8 24 140.0 97 (10.2)
Dec. 31, 2020 24.7 (1.6) 10 (87.8) 108 38.5
Dec. 31, 2019 25.1 (68.6) 82 (66.1) 78 30.0
Dec. 31, 2018 80.0 (91.5) 242 (59.5) 60 (27.7)
Dec. 31, 2017 941.9 -- 597 -- 83 --
(i)Non-CMBS portfolio includes 8, 5, 77, 157, and 309 zero-balance REO loans as of mid-year 2021, and year-end 2020, 2019, 2018, and 2017, respectively. (ii) June 30, 2021 YOY change based on the prior year end. (iii)Staff figures represent all special servicing full-time employees, including CMBS and non-CMBS. UPB--Unpaid principal balance. YOY--Year-over-year. CMBS--Commercial mortgage-backed securities. REO--Real estate-owned.

Management And Organization

The management and organization subranking is ABOVE AVERAGE.

Organizational structure, staff, and turnover

RMG and its operating subsidiaries have approximately 260 FTEs as of June 30, 2021. Its CEO is an industry veteran with more than 40 years of experience. The management team includes executives with extensive experience in commercial and residential real estate finance, CMBS, loan workouts, asset repositioning, capital markets, land development, and construction management.

The Rialto asset management and servicing unit has approximately 97 staff members who are involved in special servicing. The unit is headed by the managing director (MD), head of asset management and servicing, who has more than 26 years of experience, supported by a team of six finance and administrative associates. This MD oversees an asset management and servicing platform that is divided into the following three areas, each led by their respective MDs:

  • Performing CMBS, led by the MD, head of servicing operations, which handles non-transfer borrower consents, surveillance, CMBS compliance, and investor reporting;
  • Loan workout, which handles CMBS loan workouts, as well as the monitoring of mezzanine and floating-rate loans, and loan workouts associated with RCM's investment funds; and
  • REO asset management, which manages and liquidates REO assets.

The asset management and servicing unit is supported by a corporate services division outside of the business that provides human resources, information technology, finance and accounting, internal audit, and legal functions.

Rialto's senior managers average 21.5 years of experience (see table 2), which is modestly up from the 20.6 years reported at our prior review. Middle management's average experience level increased to more than 18 years from the 16 years reported at our prior review. Special servicing asset managers average 12 years of industry experience, and staff average nearly six years of experience, which are levels below the average of higher-ranked peers.

During 2020, Rialto reported a 14.7% employee turnover rate, which is above the 8.3% level reported during 2019 but generally in line with industry precedent. However, during the first half of 2021, Rialto reported a 20.4% turnover rate, which is much higher than recent experience, with over 70% of the turnover stemming from staff who found other opportunities outside of the firm.

Management indicated they have seen an increased demand for experienced commercial servicing staff due to the increase in defaulted loans following the COVID-19 pandemic. To meet its own needs, Rialto boosted its staffing; its number of FTEs rose more than 24% since our last review, including the deployment of experienced workout staff (some on an interim basis) from other areas of its investment platform to handle its workload.

Management has indicated that its 2021 business plan calls for a year-end headcount of 127 and had increased its mid-year FTEs to 110 from 97 as of Aug. 10, 2021. Not included in the aforementioned headcount are the employees of Quantum, which has 12 staff members and reports to the managing director that oversees performing CMBS. This group handles RCM's non-CMBS loans, including small-balance, mezzanine, and floating-rate loans.

Table 2

Years of Industry Experience/Company Tenure(i)
Senior managers Middle managers Asset managers Staff
Industry experience Company tenure Industry experience Company tenure Industry experience Company tenure Industry experience Company tenure
Special 22 11 18 9 12 5 6 2
(i)As of June 30, 2021.
Training

Rialto provides its staff with ongoing formal and informal training opportunities. The company targets 40 hours of training per employee per year. Average training approximated 89 hours in 2020, which exceeded company targets and its ranked peers. During the first half of 2021, average training hours were reported to be 44. However, as noted below, a substantial component of these reported hours is in the form of on-the-job training not typically included in such metrics, including weekly asset review meetings hosted by the MDs in loan workout, REO, and CMBS special servicing.

Training and development are considered during the annual employee performance evaluation process. Training formats range from live classroom and WebEx training to "lunch and crunch" sessions. The classroom training materials are housed on Rialto's portal, which is available to all associates for reference. Other highlights include the following:

  • Training focuses on building in-depth knowledge and practical experience in all aspects of real estate investing and development, finance, asset management, and loan workout.
  • Interactive training/learning forums are hosted by external and internal subject matter experts on a regular basis to inform Rialto staff of industry best practices, train on its proprietary system modules, and to ensure compliance with the latest regulatory requirements.
  • All asset managers in loan workout, REO, and CMBS special servicing attend recurring review meetings throughout the week with the MDs of those service areas, which serve as informal training sessions to transfer knowledge across the company and provide guidance to junior associates.
  • RMG maintains a two-year rotational analyst program designed to attract talent, train across multiple departments, and increase entry-level staff. The rotational program, which recruited six individuals in the 2021 class, is modeled off a similar endeavor that management established at a previous servicer. At the end of the rotation, each analyst selects which department to join in a permanent role.
  • In 2019, Rialto formalized a program to include hiring four to six students from undergraduate or graduate programs to undergo a 10-week internship. The goal is for these internships to lead to full-time positions following their graduation.
  • Since our last review, a training committee was established to offer advanced asset management courses with an emphasis on cross training.
Systems and technology

We believe Rialto has solid systems to efficiently and effectively manage its portfolio. Rialto continues to implement new applications and grow its platform and the data available within its framework, while continuing to gain efficiencies from workflow systems to enhance its controls. The technology platform's key features are described below.

Servicing system applications 

  • The technology department is led by a seasoned chief information officer, who oversees an information technology organization of 12 staff members.
  • Rialto Capital Asset Management and Servicing System (RCAMS) is a cloud-hosted asset management and servicing system that also provides integrated loan servicing and reporting throughout the loan's life. The company owns the rights to the code and license for its own internal use and that of its affiliates. System enhancements are done in collaboration with Infosys Ltd., the license holder.
  • RCAMS is designed to handle complex multiple loan, obligor, and property asset structures. RCAMS has multilanguage, multicurrency, and multidate functionality. Version updates to provide system enhancements occur throughout the year.
  • The RCAMS asset management module tracks cash flow projections, litigation, asset valuation histories, business plans, and commentary regarding asset status and workout strategies. It also provides a dashboard and real-time notifications to help asset managers with day-to-day responsibilities. Since our last review, the application has been enhanced to automate business plan generation.
  • Servicing contracts and core loan documents are imaged and captured in RCAMS and accessible from all web browsers through secure cloud-based hosting.
  • TreppPort serves as a central repository for loan, property, and portfolio information, and is utilized for surveillance, risk management, reporting, and document management of performing CMBS loans.
  • Appian business process management and workflow automation software is used to create standard and controlled processes and applications within CMBS operations, performing loan consent approvals, and other business processes across the company. Its integration with RCAMS and TreppPort provides reporting and customizable dashboard capabilities.
  • Yardi provides integrated property management software and is used for REO asset management in conjunction with NetSuite, which provides a cloud-based fully integrated system supporting general ledger, accounts payable, and invoice processing.
  • Power BI and Microsoft Azure (Azure) provide a centralized data platform, which brings together proprietary data, market data, and third-party data to enable reporting, analytics, and performance tracking across all business functions.
  • Backstop is an integrated platform that incorporates tools for private equity and real estate firms to manage client relationships, streamline sales and marketing efforts, and manage investor accounts, documents, and communication in one centralized location.

Disaster recovery and business continuity 

  • Since its Nov. 30, 2019, separation from Lennar-provided services, Rialto's operating platforms have been deployed in the cloud or hosted by software-as-a-service providers with their own business continuity and disaster recovery plans with Rialto providing additional oversight, procedures, and testing.
  • RMG's chief operating officer is responsible for the ownership, maintenance, updating and regular testing of the company's business continuity plan (BCP), which is to be reviewed annually.
  • In the event of a business disruption affecting an office location, all employees can access systems and networks remotely and may work from any of the locations that are unaffected by the business disruption or from another non-Rialto location of their choosing.
  • All cloud-based applications are accessible securely via internet connection, and file servers are accessible via a virtual private network where they reside in the Azure cloud data center located in the East U. S. region with multiple levels of redundancy. File servers are also backed up daily to servers in the Azure data center in the West U. S. region for geographical redundancy.
  • The company performs disaster recovery tests that covers the data center network, as well as its Miami and New York sites. These tests were most recently performed in September 2020 and passed as designed.
  • RCAMS has a stated recovery point objective of four hours and the target recovery time for investor reporting and all other servicing functions is one to two business days. RCAMS is deployed on a cloud server hosted by Infosys. The latest RCAMS disaster recovery test was performed in June 2020 with no issues cited.

Cybersecurity 

  • Rialto maintains procedures and controls to provide cyber, computer, and mobile device security. It employs extensive enterprise security controls for access to its systems and data
  • The company has a cyber-insurance policy and has access to legal counsel for cybersecurity matters. The company sends its employees phishing e-mails annually, which we have observed is less frequent than most servicers we rank.
  • Third-party penetration testing is to be conducted annually; the latest test was conducted in August 2021 with no issues cited.
Internal controls

Rialto has a solid internal control framework for a CMBS special servicer, including well-documented policies and procedures (P&Ps), a dedicated compliance department that provides quality assurance within the business and an outsourced internal audit function. Additional notable features are described below.

Policies and procedures 

  • Manuals are available to all staff via RCAMS.
  • Policy changes are reviewed and updated at the department level as required and at least annually, corresponding to the company's annual compliance reporting.
  • Policy updates are validated via version controls, and specific sections are labeled as "Revised" or "Issued" and contain the date of issuance or revision.
  • The CMBS manual contains sections pertaining to compliance and quality control, loan servicing and administration, asset management, REO management and administration, surveillance, and training. We believe the manual provides sufficient detail--including RCAMS screenshots, process flows, and exhibits--to guide the analyst or asset manager through its special servicing processes.
  • Rialto has also enacted policies limiting access to specially serviced loan data to appropriate individuals based on job function and prohibits access to associates that are responsible for the acquisition and monitoring of RCM CMBS bond positions. A review of user access rights is performed semi-annually.

Compliance and quality control 

  • Pooling and servicing agreement (PSA) summaries are abstracted and are available on RCAMS.
  • A weekly compliance tracker report is generated through RCAMS to track and document compliance, identify non-compliance with past-due requirements (for asset status reports, property inspections, internal valuations, and appraisals, among other items), and raise issues of noncompliance to senior management.
  • The compliance department, a dedicated resource within the business with five employees (up from three as of our last review), performs quality assurance testing (monthly, quarterly, or semi-annually), depending on the servicing criteria associated with Regulation AB requirements. We note that while Rialto has bolstered the resources dedicated to this area, the department continues to report within the servicing operation as opposed to outside of the unit, which would otherwise offer more independent oversight.
  • Other control measures include requiring the compliance director and the managing director to review all CMBS asset approval memoranda (AAM) to ensure proposed workouts are consistent with servicing standards and PSAs.

Internal and external audits 

  • Since June 2019, Rialto has outsourced its internal audit function toa major accounting firm. The firm conducts operational audits of Rialto's special servicing P&Ps.
  • The latest review, which covered the 2020 calendar year and was completed in April 2021, was robust and tested 68 controls across the 16 in-scope processes. The auditors noted three minor design or operating testing deficiencies pertaining to appropriate internal user access to certain applications and databases that management has subsequently addressed.
  • An annual Reg AB attestation is also performed. The Reg AB attestation for 2020, which was completed by an external audit firm during the first quarter of 2021, did not contain any material instances of noncompliance.
Insurance and legal proceedings

Rialto has represented that it maintains adequate directors and officers, as well as errors and omissions insurance coverage that is in line with the requirements of its portfolio size. As of the date of this report, management indicated that there were no material servicing-related pending litigation items.

Loan Administration

The loan administration subranking for commercial mortgage special servicing is ABOVE AVERAGE.

RCM has been one of the most active B-piece buyers of new-issue CMBS transactions following the global financial crisis, leading to Rialto becoming the named special servicer on 135 CMBS transactions (6,897 loans, with a UPB of $109.2 billion). As a result of the COVID-19 pandemic, Rialto saw a substantial influx of borrowers seeking relief based on cash flow concerns. Significant resources were allocated to handle the increased volume of these borrower requests. Many of these requests were resolved through the utilization of borrower reserves or through Payment Protection Program proceeds. Despite the proactive measure on borrower requests from its performing loan portfolio, Rialto experienced a significant increase in its active special servicing portfolio, with its active CMBS special servicing portfolio (see table 3) reaching 480 loans with $9.1 billion in UPB and 58 REO loans (containing 80 REO properties) with $786.4 million in UPB (see table 3) as of June 30, 2021.

Table 3

Special Servicing Portfolio
June 30, 2021 Dec. 31, 2020 Dec. 31, 2019 Dec. 31, 2018 Dec. 31, 2017
UPB (mil. $) No. Avg. age(i) UPB (mil. $) No. Avg. age(i) UPB (mil. $) No. Avg. age(i) UPB (mil. $) No. Avg. age(i) UPB (mil. $) No. Avg. age(i)
CMBS loans
Active inventory
Loans 9,088.6 480 14.1 10,148.5 557 9.5 1,973.1 147 13.2 1,647.3 106 9.2 886.4 62 8.0
Real estate-owned 786.4 58 28.8 684.0 55 26.7 479.2 29 27.6 326.2 28 24.4 139.8 15 18.5
Total 9,875.0 538 15.7 10,832.4 612 11.0 2,452.3 176 15.6 1,973.5 134 12.4 1,026.2 77 10.0
Non-CMBS loans
Active inventory
Loans 83.6 15 1.3 10.8 4 20.4 11.2 4 8.3 61.9 76 48.2 900.6 247 42.1
Real estate-owned(ii) 13.9 9 73.2 13.9 6 94.8 13.9 78 85.0 18.1 166 76.1 41.3 350 72.6
Total 97.5 24 28.3 24.7 10 65.0 25.1 82 81.3 80.0 242 67.4 941.9 597 60.0
(i)Average age reflects the time in months from the date the loan first became special serviced to the reporting date. (ii) Includes 8, 5, 77, 157, and 309 zero-balance REO loans as of mid-year 2021, and year-end 2020, 2019, 2018, and 2017, respectively. CMBS--Commercial mortgage-backed securities. UPB--Unpaid principal balance. REO--Real estate owned.
Loan recovery and foreclosure management

Rialto has substantial foreclosure experience nationwide, albeit primarily on small-balance collateral (activity not included in table 4); and the UPB of Rialto's CMBS loan resolution activity has increased significantly in recent years in conjunction with the portfolio's growth (see table 4). Nonetheless, most of its resolutions since 2020 have been "returned to master", with many of the resolutions associated with COVID-19 loan modifications or forbearances.

Overall, Rialto's average resolution time has consistently ranged between 12 and 13 months since 2017, with the exception being 2020, when overall resolution activity averaged 8.5 months, driven by the sizable number of COVID-19 borrower relief requests Rialto was able to accommodate (returned-to-master comprised 62% of 2020 resolution activity at an average resolution period of 5.1 months). Its CMBS foreclosure activity has also accelerated in tandem with portfolio growth with its average foreclosure time increasing during the first half of 2021 to 17.9 months from 14.4 months during 2020 and 15.1 months during 2019. We believe foreclosure resolution periods have been hampered by state-mandated COVID-19 restrictions, particularly in judicial states, resulting in sizable court backlogs.

Table 4

CMBS Loan Resolutions
2021(ii) 2020 2019 2018 2017
UPB (mil. $) No. Avg. age(i) UPB (mil. $) No. Avg. age(i) UPB (mil. $) No. Avg. age(i) UPB (mil. $) No. Avg. age(i) UPB (mil. $) No. Avg. age(i)
Resolutions
Loans 1,628.4 104 12.1 2,423.4 117 6.6 738.7 29 10.3 310.3 19 10.6 67.5 14 11.8
Foreclosed loans 277.3 20 17.9 454.3 37 14.4 275.5 20 15.1 209.6 17 14.8 121.2 13 12.3
Total 1,905.7 124 13.0 2,877.7 154 8.5 1,014.2 49 12.3 519.9 36 12.6 188.7 27 12.1
Resolution breakdown
Returned to master 1,269.0 73 9.9 1,954.0 96 5.1 137.0 9 14.6 207.6 9 13.9 26.5 7 11.2
Full payoffs 231.4 18 13.6 343.3 17 13.5 578.2 19 8.2 88.7 9 7.3 41.0 7 12.4
DPO or note sale 128.0 13 22.1 126.2 4 14.0 23.5 1 12.2 14.0 1 10.6 0.0 0 --
Foreclosed loans 277.3 20 17.9 454.3 37 14.4 275.5 20 15.1 209.6 17 14.8 121.2 13 12.3
Total/average 1,905.7 124 13.0 2,877.7 154 8.5 1,014.2 49 12.3 519.9 36 12.6 188.7 27 12.1
Note: Totals may not add due to rounding. (i)Average age reflects the time in months from the date the loan first became specially serviced to the reporting date. CMBS--Commercial mortgage-backed securities. UPB--Unpaid principal balance. DPO--Discounted payoff.

Management's target for its loan asset managers to manage 15-20 CMBS loan relationships (on average) is on the higher end for CMBS special servicers we rank. Further, based upon its June 30, 2021, total portfolio (including non-CMBS properties), average loans per asset manager was approximately 22.5, a level at the high end of the CMBS servicers we rank.

The assets are assigned largely based on geographic diversity and the asset size, complexity, and type. Upon assignment, an asset manager will review the file to determine if any guarantor carve-out or issuer representations and warranties breaches have occurred. Within no more than 90 days of a CMBS loan transfer, the asset manager develops an asset approval memorandum (AAM; i.e., business plan) for each assigned asset. Rialto requires executed pre-negotiation letters before meeting with a borrower.

All loan resolution options require the asset manager to seek AAM approval from the MD of loan workout; the MD, head of servicing operations; the MD, head of asset management and servicing; and the director of compliance; external approvals are sought as required by the applicable PSA.

AAMs must, at a minimum, contain:

  • An executive summary of the requested action;
  • Details of the loan, relationship, and borrower;
  • Analysis of loan exposure, summary of balance, and terms;
  • Guarantor information as applicable;
  • Collateral description;
  • Property operating statement details;
  • Explanation of the events that led to the mortgage loan default;
  • A discussion of the possible alternatives considered, supported by net present value (NPV) calculations of each alternative;
  • Recommendation and substantiation for the workout strategy that will result in the best possible outcome for the certificate holders as a whole; and
  • Evidence that all requisite third-party reports have been obtained, and other documentation and approvals have been received before taking title.
REO management and dispositions

We believe Rialto has established solid REO processes and procedures for each phase of the REO acquisition to disposition process. These processes and procedures are described below.

REO asset managers are initially assigned to each specially serviced loan and collaborate with the loan asset manager throughout the workout process. REO asset managers do not have a gearing ratio based on the number of assets due to the wide range of complexity among properties and the variability of time required to manage them. Nonetheless, average REO loans and properties per asset manager approximated 5.2 and 8.8, respectively, levels generally below peers. Staffing levels are assessed, and assets are assigned similarly to defaulted loans (i.e., based on geographic diversity, asset size, complexity, and type).

If foreclosure is the resolution strategy, the REO asset management group actively participates in transitioning a loan to an REO property. A notification process informs all relevant departments that the collateral has transferred from the loan asset manager to the REO asset manager. This includes a pre-foreclosure check list of items that must be provided and actions that must be completed before the transition date.

REO asset managers prepare a detailed REO business plan (within 60 days of taking title) that includes a hold-versus-sell analysis. REO business plans are updated no less frequently than semi-annually. For every REO property sale, the REO asset manager must complete an AAM, which includes reasons why the current offer is recommended, as well as the following details to support the conclusion:

  • Property values supported by property appraisal or broker opinion of value;
  • Amount of purchase offer;
  • NPV analysis;
  • Anticipated sale or closing date;
  • Confirmation that all legal requirements have been adhered to; and
  • Confirmation that the purchaser is not affiliated with Rialto or any interested person, as defined in a PSA.

Table 5 provides data on Rialto's CMBS REO disposition history, which has accelerated in recent years, accompanied by what we consider to be relatively favorable average hold periods of 14.6 months during 2020 and 15.9 months during the first of 2021. Although the company has liquidated a substantial amount of small-balance REO collateral (vacant land, undeveloped lots, etc. ) during its history, we note that it has more limited experience managing and disposing the larger, more complex REO assets typically found in CMBS trusts. We also note the increased complexity of the REO assets in the June 30, 2021 active portfolio, which is accompanied by property type diversity, albeit with an emphasis on retail properties (43% of REO asset count; 40% of UPB) and, to a lesser extent, limited-service hotels (35% of REO asset count; 28% of UPB).

The CMBS loans that were liquidated as REO (as shown in table 5) have largely been of the small-balance variety (average estimated market value of 2020-2021 REO sales transactions was $8.4 million, with average gross proceeds totaling $7.2 million), with an emphasis on limited-service hotels. The company's 17 REO dispositions achieved an aggregate of 75% of estimated market value, which is generally below peers. However, we note that the low percentage is attributable to a single retail asset, which was disposed of for only $400 thousand in an auction compared to its $28.2 million appraised value. Excluding that sale, the average gross proceeds approximated 110% of estimated market value for the other 16 assets.

Table 5

CMBS REO Sales
2021(ii) 2020 2019 2018 2017
Amount (mil. $) No. Avg. REO hp(i) Amount (mil. $) No. Avg. REO hp(i) Amount (mil. $) No. Avg. REO hp(i) Amount (mil. $) No. Avg. REO hp(i) Amount (mil. $) No. Avg. REO hp(i)
Estimated market value 87.5 17 15.9 156.7 12 14.6 85.3 19 18.5 5.9 3 17.5 5.5 3 16.8
Gross sales proceeds 65.7 -- -- 143.8 -- -- 84.7 -- -- 4.9 6.3 -- --
Gross sales proceeds/market value (%) 75.0 -- -- 91.8 -- -- 99.3 -- -- 83.7 -- -- 113.7 -- --
(i)Average hold period in months. (ii)Data only includes the first six months of the year. CMBS--Commercial mortgage-backed securities. REO--Real estate-owned. hp--Hold period.
REO accounting and reporting

Third-party property managers are provided with a P&Ps manual as a part of their engagement. The manual provides a general guideline to many of the processes required to manage commercial property and includes a variety of standard exhibits for reporting.

Third-party property managers must submit a reporting package that contains comprehensive financial information and supporting data to REO asset managers by the last day of each calendar month, detailing the performance of the prior calendar month. Once received, REO asset managers evaluate the report to determine if all expected revenues were collected and deposited, and that paid expenses are in line with the approved budget. After reviewing and resolving any issues, the asset manager certifies and submits the REO reporting package to the REO operations group for further review and posting of cash transactions into RCAMS for compliance purposes. In addition, if a property manager has insufficient funds in the REO operating account to satisfy outstanding invoices, advance requests are directed to the master servicer after approval from the REO asset manager.

Rialto began performing property management audits in 2017. The scope of the audits includes testing compliance with the underlying property management agreements--including reviewing leasing procedures and controls surrounding accounts receivables, accounts payable, and cash accounts--and compliance with required insurance coverage. Management reported that 11 such property management audits were conducted during the trailing-12 months ended June 30, 2021, which we observed is a sizable volume compared with peers.

Subcontracting management

Rialto asset managers select and engage third-party service providers from its approved vendor lists, which exist for all major vendor categories, including brokers, property managers, appraisers, environmental attorneys, CMBS special servicing attorneys, property inspection vendors, and business assurance services. The company does not engage any affiliate service providers. Rialto maintains a compliance module in RCAMS for its asset managers to formally track vendor engagements and monitor vendor performance. To manage various vendors/subcontractors, Rialto has documented procedures regarding property inspections, appraisals, and environmental assessments.

Performing loan surveillance

Rialto has an eight-person team dedicated to performing loan surveillance on the portfolios where the company is the appointed special servicer. Its responsibilities include the following:

  • Individual loan and collateral activity in CMBS portfolios is monitored to identify potential issues that may affect future loan performance, including payment default, property performance, tenant rollover, market conditions, and loan covenant compliance, among other factors.
  • An internal proprietary model is used to track loan data to create daily watchlists, track payments, establish risk ratings (on a 1 to 5 scale), and perform regular re-underwriting of loans.
  • A formal monthly process is in effect with all master servicers to address any questions, concerns or outstanding issues on the loans which could include collecting outdated financials and rent rolls, the cash management process and property condition updates. During the COVID-19 pandemic, Rialto has been speaking with the master servicers frequently each week to discuss process and communication.
  • On a monthly basis, total advances outstanding on each specially serviced loan are reviewed to determine if the total of advances exceed 40% of the appraised value of the property.
  • Major news sources are reviewed daily to identify and evaluate tenant and market risks, such as bankruptcies, retail store closures, natural disasters, and oil exposure.
  • The loan surveillance team participates in the consent process with the CMBS special servicing team, which provides a collaborative internal platform to exchange market intelligence, as well as share property-level information stemming from the borrower-requested consents.
Borrower requests

As of Aug. 10, 2021, Rialto has a 16-person department, including 13 asset managers, dedicated to the review process for borrower consent activity on performing CMBS loans. The unit is well-controlled, using a workflow management system to facilitate the review process and is managed by a director, who reports to the MD, head of servicing operations. Highlights include the following:

  • Unlike most other special servicers, Rialto generally controls the entire CMBS borrower consent process from initial borrower submission through analysis and completion of a transaction request.
  • In addition to analyzing the request at hand, Rialto performs a full re-underwriting of the collateral during all consent reviews in order to re-evaluate the performance of the loan and adherence to the loan documents.
  • The review process requires the same layer of internal approval as a specially serviced loan.
  • Rialto includes its surveillance department in the consent process, using such reviews as an opportunity to positively affect the performance of the entire collateral supporting the loan. While this approach should enhance the performance of underlying CMBS trust collateral, it could also result in slower turnaround times and borrower dissatisfaction, which has been an industry challenge.
  • During 2020, Rialto completed 1,026 borrower requests on loans with an aggregate UPB of $27 billion, including 407 leasing consents, 198 forbearance requests, 54 property management changes, and 28 assumptions. During the first half of 2021, Rialto completed 417 borrower requests on loans with an aggregate of $11 billion UPB, including 204 leasing consents, 76 forbearance requests, 27 property management changes, and 12 assumptions.
Legal department

Rialto has access to an in-house legal staff of three associates. The legal staff assist with forming special-purpose entities, obtaining powers of attorney, managing custodial relationships, and PSA-related activities. The legal staff report to the general counsel and chief compliance officer. For real estate mortgage investment conduit legal matters and opinions, Rialto primarily utilizes outside law firms. Such counsel is engaged from Rialto's approved attorney list with managing director approval. We believe this is an efficient structure to provide sufficient legal support and guidance.

Financial Position

The financial position is SUFFICIENT.

Related Research

This report does not constitute a rating action.

Servicer Analyst:Steven Altman, New York + 1 (212) 438 5042;
steven.altman@spglobal.com
Secondary Contact:Benjamin Griffis, Centennial + 1 (303) 721 4672;
benjamin.griffis@spglobal.com
Analytical Manager, Servicer Evaluations:Robert J Radziul, New York + 1 (212) 438 1051;
robert.radziul@spglobal.com

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