|Servicing category||Overall ranking||Management and organization||Loan administration||Outlook ranking|
|Commercial special||ABOVE AVERAGE||ABOVE AVERAGE||ABOVE AVERAGE||Positive|
S&P Global Ratings' ranking on Rialto Capital Advisors LLC (Rialto) is ABOVE AVERAGE as a commercial mortgage loan special servicer. On Jan 24, 2023 we affirmed the ranking (see "Rialto Capital Advisors LLC ABOVE AVERAGE Commercial Mortgage Loan Special Servicer Ranking Affirmed," published Jan. 24, 2023). The ranking outlook is positive.
Our ranking reflects 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
- Considerable track record of special servicing defaulted CMBS loans and REO assets.
Since our prior review (see "Servicer Evaluation: Rialto Capital Advisors LLC," published Sept. 23, 2021), the following changes and developments have occurred:
- The unpaid principal balance (UPB) of Rialto's active CMBS portfolio decreased to nearly $7.3 billion (377 assets) as of June 30, 2022, from approximately $9.9 billion (562 assets) as of June 30, 2021, after reaching a peak level of more than $10.8 billion (612 assets) as of Dec. 31, 2020.
- Although Rialto's named CMBS special servicing portfolio increased to 141 transactions (compared with 135 at our last review), the underlying UPB declined to $105.5 billion compared with $109.2 billion.
- Rialto continued strengthening its technology capabilities to include further enhancements to Appian and workflow automation across the platform, including integrating RCAMS with a second major master servicer's nightly data feeds to update cash postings on specially serviced loans to facilitate shadow servicing.
- Rialto reported 26 employee departures (a 26.8% turnover rate) during the last 12 months ending June 30, 2022, while maintaining a flat headcount of 97. According to management, turnover has generally been in the analyst ranks and is not due to industry competition.
- Rialto resolved an aggregate UPB of approximately $3.8 billion across 219 CMBS specially serviced loans, including $2.4 billion (134 loans) that were returned to the master servicer, largely via modification or forbearance agreement, and $636 million (34 loans) that experienced a full payoff, $568 million (33 loans) that were resolved via foreclosure or deed-in-lieu of foreclosure and $218 million that experienced a discounted payoff.
- During Q1 2022, Rialto discontinued the programmatic use of Situs Company, an affiliated entity, which began providing it with real estate consultant and valuation professionals in 2020 to perform support functions for property appraisals. This relationship was not needed after Rialto's addition of internal processes and technology enhancements, including Collateral360, a centralized appraisal procurement, vendor and task management platform.
The ranking outlook is positive. The positive ranking outlook reflects Rialto's proven track record working out CMBS loans across a diverse group of property types across the U.S., particularly during the pandemic, as well as its strengthened and seasoned internal control regime. At the same time, while acknowledging the industry has experienced above-historical norm turnover since 2021, Rialto's 2022 year-to-date turnover has, nonetheless, been amongst the highest of the special servicers we rank. Further, special servicing asset managers and staff average experience levels, are in each case, generally below the highest ranked special servicers and Rialto's assets to asset manager workload is amongst the highest we rank. Nonetheless, a ranking upgrade could occur if the company continues performing well and its turnover rates stabilize during 2023, a year when delinquency rates are expected to increase and lead to higher transfer volume.
In addition to conducting a virtual meeting with servicing management, our review includes current and historical Servicer Evaluation Analytical Methodology (SEAM) data through June 30, 2022, as well as other supporting documentation provided by the company.
|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), 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 our last review, Rialto employees have increased their ownership from 11.2% to 11.8% as the firm has broadened the opportunity for its associates to invest in the firm to help mitigate turnover and Stone Point's ownership declined to 78.6% following the sale of a 9.6% interest in RMG to Bankers Life and Casualty Company. Stone Point is a private equity firm with more than $40 billion of assets under management, based in Greenwich, Conn. Stone Point, whose investment focus is on financial services and asset management, has raised and managed nine private equity funds with aggregate committed capital of more than $74 billion.
RMG is headquartered in Miami and has several offices in the U.S. and one office 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 AVERAGE as both a primary and special servicer of small-balance commercial loans (see Servicer Evaluation: Quantum Servicing Corp., Oct 7, 2021).
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. As of June 30, 2022, RCM was the sponsor of, and certain affiliates were investors in, 10 private equity fund structures and RCM also advised several other investment vehicles such as co-investments, joint ventures and separately managed accounts, with more than $13.6 billion in aggregate regulatory assets under management. Of the 10 funds, seven are focused in whole or in part on CMBS investments, with the remaining funds focused on distressed and value-add real estate related investments, mezzanine debt and/or credit investments.
Since 2010, Rialto 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.
As of June 30, 2022, Rialto was the special servicer for 141 CMBS trusts, totaling $105.5 billion in UPB, as well as six commercial real estate collateralized loan obligations (CRE-CLO) aggregating $4.7 billion with 134 loans. According to the Mortgage Bankers Assn., as of Dec. 31, 2021, Rialto is the second largest CMBS special servicer as measured by its named appointments and is the fifth largest special servicer across all investor types.
As of June 30, 2022, Rialto actively managed a $7.7 billion UPB total special servicing portfolio, including 348 loans approximating $6.7 billion UPB and 62 REO loans containing 83 REO assets, with a reported UPB of $949.5 million. CMBS comprises the vast majority of Rialto's active portfolio UPB, totaling $7.3 billion (318 loans and 59 REO loans containing 80 REO properties) (see table 1).
|Total Servicing Portfolio|
|UPB (mil. $)||YOY change (%)(ii)||No. of assets (i)||YOY change (%)(ii)||No. of staff (iii)||YOY change (%)(ii)|
|Special servicing (CMBS)|
|June 30, 2022||7,294.8||(16.5)||377||(18.0)||97||(4.9)|
|Dec. 31, 2021||8,741.4||(19.3)||460||(24.8)||102||(5.6)|
|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)|
|Special servicing (non-CMBS)|
|June 30, 2022||361.5||175.4||33||65.0||97||(4.9)|
|Dec. 31, 2021||131.3||431.5||20||100.0||102||(5.6)|
|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)|
|(i)Non-CMBS portfolio includes 2, 2, 5, 77 and 157 zero-balance REO loans as of mid-year 2022, and year-end 2021, 2020, 2019, and 2018, respectively. (ii) June 30, 2022 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 265 full time employees (FTEs) as of June 30, 2022. 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 29 years of experience, supported by a team of three 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 (16 FTEs), surveillance (7 FTEs), CMBS compliance and investor reporting (19 FTEs);
- Loan workout, which handles CMBS loan workouts (27 FTEs), as well as the monitoring of mezzanine and floating-rate loans, and loan workouts associated with RCM's investment funds (7 FTEs); and
- REO asset management (18 FTEs), which manages and liquidates REO assets.
Not included in the aforementioned headcount are the employees of Quantum, which has 13 staff members and reports to the managing director who oversees performing CMBS. This group handles RCM's non-CMBS loans, including small-balance, mezzanine, and floating-rate loans.
The asset management and servicing unit is supported by a corporate services division that provides human resources, information technology, finance and accounting, internal audit, and legal functions.
Rialto's senior managers average 23 years of experience (see table 2), which is modestly up from the 21.5 years reported at our prior review. Middle management's average experience level increased to 19 years from the 18 years reported at our prior review. Special servicing asset managers average 12 years of industry experience, and staff average five years of experience, which, in each case, are levels generally below the highest ranked special servicers.
During 2021, Rialto reported a 29.6% employee turnover rate, which is well above the 11.5% level reported during 2020. It further reported a 15.7% turnover rate, during the first half of 2022. While the industry experienced above-historical norm turnover levels during these 18 months, Rialto's 2022 year-to-date turnover has, nonetheless, been amongst the highest of the special servicers we rank.
According to management, in the last year, the drivers of turnover are: the pandemic; increased competition for qualified staffing across the commercial real estate industry; associates who have only worked with Rialto remotely not having built an in-person connection to the office and teams; and associates choosing alternative career and life paths. Generally, turnover has been in the analyst ranks and not to competitors.
|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|
|(i)As of June 30, 2022|
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 101 hours in 2021, which exceeded company targets and its ranked peers. During the first half of 2022, average training hours were reported to be 51. 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 learn sessions. Rialto's portal houses the classroom training materials, 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.
- Rialto continues to cross train all asset management associates to ensure the ability to move associates should the need arise. To facilitate this effort, a training committee of associates holding various positions from across the platform provides training sessions ranging from the basic to the most complex concepts from an asset management and organization perspective.
- 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 eight individuals in the 2022 class, is modeled off a similar endeavor that management established at a previous STRONG-ranked servicer. At the end of the rotation, each analyst selects which department to join in a permanent role.
- Rialto operates a formal internship program that typically includes hiring four to six students from undergraduate or graduate schools. The goal is for these 10-week internships to lead to full-time positions following their graduation. Rialto Capital recruited eight individuals for the 2022 internship program.
Systems and technology
Rialto has solid systems to manage its portfolio efficiently and effectively. 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 14 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 via quarterly releases.
- 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.
- 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 creates 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, bringing 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.
- Collateral360, introduced since our last review, is a centralized appraisal procurement vendor with a platform that provides Rialto simplified communication, task management and permission-based ordering. The system is integrated with RCAMS via an application programming interface.
Disaster recovery and business continuity
- Rialto's operating platforms are 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 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 can be accessed via secure internet connection, and file servers are accessible via a virtual private network where they reside in the Azure cloud data center located in the eastern U.S. with multiple levels of redundancy. File servers are also backed up daily to servers in the Azure data center in the western U.S. for geographical redundancy.
- The company performs disaster recovery tests covering the data center network, as well as its Miami and New York sites. The data center DR test was most recently performed in September 2022 and the Miami and New York tests were completed in October 2022. All tests 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 November 2022 with no issues cited.
- Rialto uses a third-party company for cybersecurity activities, including the continuous assessment and remediation of cybersecurity risks, cyber-security training, deep web scanning, domain monitoring, penetration and vulnerability scans and phishing tests.
- Third-party penetration testing is to be conducted every calendar year; the latest test was conducted in December 2022 with no issues cited. The third-party vendor also performs weekly scans of the external network perimeter.
- Rialto uses next-generation firewalls with endpoint protection and according to management, has the latest security fabric stack, which are updated automatically.
- 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 is less frequent than most servicers we rank.
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 according to management, at least annually, corresponding to the company's annual compliance reporting. However, we note that the CMBS manual has not been updated since our last review.
- 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 who are responsible for the acquisition and monitoring of RCM CMBS bond positions. Reviews of user access rights are performed semi-annually.
Compliance and quality control
- Pooling and servicing agreement (PSA) summaries are reviewed and abstracted by the CMBS compliance department and are available on RCAMS.
- The CMBS compliance department, performs quality assurance testing (monthly, quarterly, or semi-annually), depending on the servicing criteria associated with Regulation AB requirements. We note that the department, a dedicated resource within the business with five employees, continues to report within the servicing operation as opposed to outside of the unit, which would otherwise offer more independent oversight.
- 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.
- 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
- Rialto outsources its internal audit function to a major accounting firm. The firm conducts operational audits of Rialto's internal control environment working closely with the CMBS compliance department.
- The latest review, which covered the 2021 calendar year and was completed in March 2022, was robust and tested 68 controls across the 16 in-scope processes and three in-scope applications (RCAMS, Appian and BI). The auditors noted three minor design or operating testing deficiencies pertaining to appropriate internal user access to certain applications and databases. Management addressed these items with responses suggesting that it is comfortable that the risks associated with these exceptions, which were largely similar to the prior year, are adequately managed.
- An annual Reg AB attestation is also performed. The Reg AB attestation for 2021, which was completed by an external audit firm during the first quarter of 2022, 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 one material servicing-related pending litigation item described below.
On June 15, 2022, Icahn Partners LP and Icahn Partners Master Fund LP (together the "Icahn Funds") filed a lawsuit against Rialto in the District Court for Clark County, Nevada, alleging that a "Servicer Termination Event" occurred in connection with Rialto's special servicing of an outlet mall in Nevada. The Icahn Funds, who in Dec. 2021 acquired a certificate ("Certificate") with a $0 balance in the CMBS trust where the subject asset was owned, has alleged Rialto violated the servicing standard by obtaining inflated appraisals of the asset to prevent control from shifting to the Certificate and engaged in a 39-month plan to rehabilitate the asset. The trustee has not concluded that the Icahn Funds' allegations have any merit and has neither commenced an investigation nor indicated that it intends to pursue any claims related to the allegations. Rialto denies that the claims have any merit and continues to serve as special servicer of the CMBS trust. Further, Rialto does not believe that any lawsuits or legal proceedings would, individually or in the aggregate, have a material adverse effect on its business or its ability to service loans pursuant to its servicing agreements.
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 141 CMBS transactions (6,596 loans, with an UPB of $105.5 billion). As of June 30, 2022, its active CMBS special servicing portfolio (see table 3) contained 318 loans with $6.4 billion in UPB and 59 REO loans (containing 80 REO properties) with $935.6 million in UPB (see table 3). It also services an additional $362 million across 33 non-CMBS assets as of the same date.
|Special Servicing Portfolio|
|June 30, 2022||Dec. 31, 2021||Dec. 31, 2020||Dec. 31, 2019||Dec. 31, 2018|
|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)|
|Real estate owned||935.6||59||32.4||1,073.0||65||31.4||684.0||55||26.7||479.2||29||27.6||326.2||28||24.4|
|Real estate owned||13.9||3||55.0||13.9||3||49.1||13.9||6||94.8||13.9||78||85.0||18.1||166||76.1|
|Totals may not add due to rounding.(i)Avg. age reflects the time in months from the date the loan first became specially serviced to the reporting date.|
Loan recovery and foreclosure management
Rialto has substantial foreclosure experience nationwide and the UPB of Rialto's CMBS loan resolution activity has increased significantly in recent years, accelerated further by the portfolio's growth (see table 4) following the start of the pandemic. Most of its resolutions since 2020 have been "returned to master", with many of the resolutions associated with COVID-19 loan modifications or forbearances. Further, since our last review, in the trailing 12 months ended June 30, 2022, returned to master comprised 63% of the UPB of the $3.8 billion of resolution activity, followed by full payoffs of 16.5%, foreclosures at 14.8% and discounted payoffs/notes sales of 5.7%.
|CMBS Loan Resolutions|
|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)|
|Returned to master||1,495.8||74||21.1||2,191.3||133||12.6||1,954.0||96||5.1||137.0||9||14.6||207.6||9||13.9|
|DPO or note sale||66.3||6||21.8||279.3||25||21.3||126.2||4||14.0||23.5||1||12.2||14.0||1||10.6|
|Totals may not add due to rounding. (i)Avg. age reflects the time in months from the date the loan first became specially serviced to the reporting date. UPB--Unpaid principal balance. DPO--Discounted payoff. (ii)Data only includes the first six months of the year.|
Overall, Rialto's average resolution time has consistently ranged between 12 and 15 months since 2017, with the exception of 2020, when overall resolution activity averaged 8.5 months, driven by the sizable number of COVID-19 borrower relief requests Rialto accommodated (returned-to-master comprised 62% of 2020 resolution activity at an average resolution period of 5.1 months).
During the first half of 2022, however, average resolution time has reached a multi-year high of 20.2 months. We further note that within each resolution category, the average workout period also was at multi-year highs.
Its CMBS foreclosure activity has also accelerated in tandem with portfolio growth with its average foreclosure time increasing during the first half of 2022 to 20.2 months from 18.9 months during 2021 and 14.4 months during 2020. We believe foreclosure resolution periods were hampered by state-mandated COVID-19 restrictions, particularly in judicial states, resulting in sizable court backlogs.
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, 2022, total portfolio (including non-CMBS properties), average loans per asset manager was approximately 16.6. While this is a decline from an average of 22.5 loans as of our last review, it remains 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
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 6.9, 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 a 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 and follows a similar internal approval process to loan business plans. 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, albeit at a multi-year high of 20.0 months during the first half of 2022. 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 REO assets in the June 30, 2022 active portfolio, which is accompanied by property type diversity, albeit with an emphasis on retail properties (36% of REO asset count; 56% of UPB) and limited-service hotels (34% of REO asset count; 22% of UPB).
The CMBS loans that were liquidated as REO (as shown in table 5) have largely been of the smaller-balance variety. The average estimated market value of 2021-2022 REO sales transactions was $7.8 million, with average gross proceeds totaling approximately 99.2% of market value during this 18-month period, with an emphasis on limited-service hotels.
|CMBS REO Sales|
|Amount (mil. $)||No.||Avg. REO hold period (mos.)||Amount (mil. $)||No.||Avg. REO hold period (mos.)||Amount (mil. $)||No.||Avg. REO hold period (mos.)||Amount (mil. $)||No.||Avg. REO hold period (mos.)||Amount (mil. $)||No.||Avg. REO hold period (mos.)|
|Estimated market value||201.3||18||20.0||182.6||31||15.6||156.7||12||14.6||85.3||19||18.5||5.9||3||17.5|
|Gross sales proceeds||213.8||--||--||167.2||--||--||143.8||--||--||84.7||--||--||4.9|
|Gross sales proceeds/market value (%)||106.2||--||--||91.6||--||--||91.8||--||--||99.3||--||--||83.1||--||--|
|(i)Data only includes the first six months of the year. REO-- Real Estate Owned. CMBS--Commercial mortgage-backed securities|
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 containing 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 audits include 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 12 such property management audits were conducted during the trailing-12 months ended June 30, 2022, which is a sizable volume compared with peers.
Rialto asset managers select and engage third-party service providers from 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.
- 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.
Rialto has a 16-person department of 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 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 2021, Rialto completed 806 borrower requests on loans with an aggregate UPB of $22.4 billion, including 368 leasing consents, 76 forbearance requests, 50 property management changes, and 38 assumptions. During the first half of 2022, Rialto completed 386 borrower requests on loans with an aggregate of $11.9 billion UPB, including 157 leasing consents, 30 property management changes, and 29 assumptions.
Rialto has access to an in-house legal staff of four 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.
The financial position is SUFFICIENT.
This report does not constitute a rating action.
- Rialto Capital Advisors LLC ABOVE AVERAGE Commercial Mortgage Loan Special Servicer Ranking Affirmed, Jan. 24, 2023
- Select Servicer List , Oct. 13, 2022
- Servicer Category Descriptions Expanded And Revised, Feb. 28, 2022
- Servicer Evaluation: Quantum Servicing Corp. , Oct. 7, 2021
- Servicer Evaluation: Rialto Capital Advisors LLC, Sept. 23, 2021
- Servicer Evaluation Spotlight Report: Environmental, Social, And Governance Factors Have Consistently Powered Our Servicer Evaluation Rankings, Nov. 16, 2020
- Analytical Approach: Global Servicer Evaluations Rankings, Jan. 7, 2019
|Servicer Analyst:||Steven Altman, New York + 1 (212) 438 5042;|
|Secondary Contact:||Benjamin Griffis, Englewood + 1 (303) 721 4672;|
|Analytical Manager, Servicer Evaluations:||Robert J Radziul, New York + 1 (212) 438 1051;|
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