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Servicer Evaluation: Aurora Bank Commercial Services

Publication date: 04-Feb-2010 16:08:08 EST

Opinion

We have assigned our AVERAGE ranking to Aurora Bank Commercial Services (ABCS), a division of Aurora Bank FSB, as a business-based real estate special servicer. We are currently assessing the financial position of Aurora Bank FSB, the parent company of ABCS. ABCS' admission to our Select Servicer List is pending our assessment of Aurora Bank's financial position.

Operating as Lehman Brothers Small Business Finance (LBSBF) until April 2009, ABCS specializes in and has historically primarily serviced smaller-to-moderate sized business loans principally secured by first mortgages on the associated owner-occupied and single-tenanted commercial real estate properties. The assigned ranking for special servicing, which addresses the company's operational capabilities to manage and resolve loans that have defaulted, also recognizes the company's corresponding capabilities with smaller-scale commercial mortgage loans involving multi-tenanted properties and related real estate owned (REO) assets.

The overall assigned ranking factors the following:

  • The solid industry experience of ABCS' management and professionals, along with the company's successful and ongoing hiring efforts to increase its complement of experienced asset and department managers to confront very sharply higher loan default activity during 2009.
  • An effectively designed special servicing organizational structure that includes separate loan and REO departments, a chief credit officer, a quality control function, and dedicated staff for appraisal and environmental review.
  • The overall adequacy of the company's reporting systems and technology environment.
  • The company's sound track record as an effective workout manager; ABCS has been resolving assets expeditiously during the past year, which is especially noteworthy given the constraints posed by very difficult market conditions.
  • The company's recently revised and acceptable body of documented policies and procedures that denote proactive and adequately controlled asset recovery practices.
  • ABCS' experience in managing and reporting on securitized portfolios.
  • A very sound internal audit program. Additionally, management has acted swiftly to address items raised in the latest audit report, some of which may result in making the company's asset monitoring practices more efficient.

The bankruptcy of its parent's holding company, Lehman Brothers Holdings Inc., prevented LBSBF from converting to a new servicing system. ABCS' efficiency and reporting capabilities therefore remain constrained by the shortcomings in the legacy system; although, the company intends to acquire a new system in the coming year.

ABCS' data backup and related disaster recovery protocols are acceptable. However, we note that the business continuity plan lacks a formalized arrangement for alternative office space. As such, it depends on a relationship with a property management firm to procure new office space. While ABCS staff may be able to access system applications remotely, we expect all servicers and special servicers to have a pre-designated contingent office location as part of their business continuity planning.

Outlook

The outlook is stable. Standard & Poor's Ratings Services expects ABCS to perform as a competent and proactive special servicer for third-party clients within its asset class and area of expertise.

Profile

Through its predecessor entities, ABCS has been servicing commercial loans since 1991, at which time it began operations as a California, community-based Small Business Administration (SBA) lender. In December 2004, ABCS, then operating as part of CNL Commercial Finance Inc., was acquired by and became Lehman Brothers Small Business Finance (LBSBF), a division of Lehman Brothers Bank FSB (Lehman), which was a wholly owned subsidiary of Lehman Brothers Holdings Inc. As part of the acquisition, Lehman retained almost 100% of the existing management and staff, assumed licenses, software, leases, servicing agreements, and purchased the existing whole loan portfolio. Since that time, the company was named as, and continues to be, the servicer (inclusive of special servicing duties) on a number of rated asset-backed securities (ABS) transactions.

After Lehman Brothers Holdings filed for bankruptcy in September 2008, LBSBF became ABCS in April 2009 as a division of Aurora Bank FSB formerly known as Lehman Brothers Bank FSB. The name of the bank was changed with an amendment to its thrift charter in April 2009. Aurora Bank also operates a residential mortgage servicer subsidiary, Aurora Loan Services LLC.

As of June 30, 2009, ABCS had 82 total employees, including 39 employees involved in or supporting special servicing functions. By comparison, the company had 68 employees with 26 people for special servicing at year-end 2008.

As noted, the company's servicing niche is smaller to moderately sized balance commercial real estate mortgage loans secured by properties with owner-occupied businesses or comprising only a few tenants. The occupying businesses of the real estate collateral represent various manufacturing, retail, and wholesale trade sectors. While owner-occupied collateral still represents a significant portion of the company's servicing business, ABCS' portfolio also includes some loans secured by multi-tenanted and a few larger-balance commercial real estate properties.

ABCS' business objectives are to pursue third-party servicing, special servicing, and loan origination assignments.

Table 1

Total Servicing Portfolio
June 30, 2009 Dec. 31, 2008 Dec. 31, 2007 Dec. 31, 2006 Dec. 31, 2005
Vol. ($000s) Loans (No.) Vol. ($000s) Loans (No.) Vol. ($000s) Loans (No.) Vol. ($000s) Loans (No.) Vol. ($000s) Loans (No.)
Securitized 2,714,977 4,515 2,848,605 4,723 3,136,540 5,096 1,837,229 2,745 1,432,172 2,153
Nonsecuritized 152,338 281 904,049 1,169 973,961 1,565 500,302 766 273,124 405
Total* 2,867,315 4,796 3,752,654 5,892 4,110,501 6,661 2,337,531 3,511 1,705,296 2,558
Average loan size ($000s) 598 637 617 666 667
Securitized deals (No.) 16 16 16 12 9
Loans and REO in special servicing 533,763 840 394,562 627 111,238 184 30,119 43 7,848 11
*Company sold a large portion of its balance sheet loans in early 2009.

Table 2

Loan Delinquency History
(% by unpaid principal balance and loan count)
31-60 days 61-89 days 90+ days Total
UPB No. UPB No. UPB No. UPB No.
June 30, 2009 3.46 3.38 1.59 1.54 10.26 9.36 15.31 14.28
Dec. 31, 2008 2.72 2.80 1.48 1.36 4.98 5.07 9.18 9.23
Dec. 31, 2007 1.10 1.20 0.25 0.29 1.17 1.13 2.52 2.62
Dec. 31, 2006 1.14 1.28 0.20 0.20 0.66 0.57 2.00 2.05
Dec. 31, 2005 0.61 0.64 0.07 0.16 0.27 0.20 0.95 1.00

Management And Organization

The ranking of AVERAGE is assigned for management and organization.

This assigned subranking factors the following strengths and weaknesses:

  • The hiring in the past year of well-experienced managers and asset managers to address rising volume of loans defaults.
  • Overall low staff turnover during 2009.
  • The creation of a dedicated REO department and accompanying procedures to handle growing volume more effectively.
  • The manager heading special servicing also now oversees certain parts of loan servicing. However, we find this acceptable given the overall design of the organizational structure combined with the high experience levels of the other managers.
  • Satisfactorily documented policies and procedures based on revised and expanded versions being finalized for rollout in early 2010.
  • A technology environment that is adequate but based on a servicing system with functionality limitations and does not have a centralized asset management application or database. In the interim, until the company can improve its technology tools and purchase a new servicing system, which was put on hold because of the Lehman situation, ABCS must rely on various independent spreadsheet files for much of its portfolio management reporting. ABCS has been working to centralize more of its asset status tracking and reporting.
  • A very sound internal audit function, which recently examined the company's special servicing processes.
Staff experience, organizational structure and training

ABCS enhanced its staffing depth for special servicing in 2009. During 2009, the company's special assets division, which encompasses all special servicing work, grew from 26 to 40 people: 32 positions handle loan default management and eight work in the recently established REO department.

The division consists of one SVP and four VP managers with a combined average of 28 years experience. The staff average 12 years experience, with asset managers averaging 14 years experience. The loan default department is organized into teams led by portfolio managers that oversee special assets officers and more junior specialists.

Through its hiring efforts, ABCS has satisfactorily controlled individual asset manager workloads. The company targets 50-60 loans per asset manager and about 35-40 loans per portfolio manager (team leader), noting that the actual ratios in September 2009 were 48 for asset managers and 37 for portfolio managers. At that time, each REO asset manager had 24 properties on average. Combining loans and REO, we calculate that the company's assets per asset manager ratio declined to about 21 to 1 at June 2009, compared with about 29 to 1 at year-end 2008. We do expect the assets per asset manager ratio to be higher in this asset class than for a special servicer handling much larger commercial real estate assets such as those found in commercial mortgage-backed securities (CMBS).

Table 3

ABCS Average Staff Experience
As of June 2009
Years in Industry Years with company
Senior management 21 9
Middle management 21 2
Special servicing senior management only 28 3
Special servicing middle management only 27 4
Special servicing asset managers 14 2

In the 12-month period of July 2008 through June 2009, the company hired 26 people for special servicing and incurred low staff turnover. It had four staff departures in the second half of 2008 (16.7%), only one staff departure in the first half of 2009 (3.9%), and experienced no management turnover.

The organizational structure provides for team and asset manager portfolio accountability combined with an appropriate segregation of duties for administrative, accounting, and cash management-related processes. To address both a growing loan and REO portfolio, ABCS split its loan and REO management into two distinct departments this past year, and each area is headed by well-experienced personnel.

As an organizational strength to support special servicing, ABCS' six-person credit and collateral risk department, managed by the chief credit officer, includes two MAI review appraisers and an environmental reviewer.

ABCS has an adequate training function.

Based on its size and resource constraints, the company does not have a dedicated training manager. Although, the bank's legal and compliance officer does coordinate certain training activities.

  • The company noted that it targets 20 training hours per employee each year. Through mid-year 2009, ABCS indicated that the employees completed an average of 30 training hours.
  • The completion of staff member training is tracked as part of each employee's annual performance review, and ABCS uses a software application to track staff completion of certain online offerings.
  • Formalized training consists of online courses, some of which are required, quarterly vendor-led sessions, and general banking, lender, and servicer-oriented compliance sessions.
Technology

ABCS operates within an adequate technology environment.

  • ABCS uses a purchased servicing system called PCFS2000, which is designed to service SBA loans and ABCS notes. The system requires a high degree of manual intervention and has reporting limitations.
  • The company also does not have a centralized asset management application or singular data warehouse.
  • As a result, ABCS relies on various independent databases and spreadsheet files to supplement its asset-level monitoring and for much of its portfolio management reporting.
  • The company, recognizing its need for improved automation and centralized data management, indicated that it is exploring alternative servicing systems and expects to be positioned in the coming year to purchase a new system.
  • A four-person IT department manages security, hardware, and data backup, and software applications onsite, with support from Aurora Bank's larger IT group located in Denver, Colo.
  • The company uses an electronic file management system to image and access loan- and servicing-related documents.
  • Data backup routines seem acceptable: Daily on-site data backups are shipped off site weekly through a vendor, plus real time back-up to alternate servers located out of state.
  • The disaster recovery plan relating to data restoration is tested approximately every 12-18 months; the last test was conducted in September 2008.

While ABCS' data backup and related disaster recovery protocols seem acceptable, its business continuity plan lacks a formalized arrangement for alternative office space. It instead depends on a relationship with a property management firm to procure new office space. Although ABCS states that asset managers have remote access to applications and their files, we view the lack of a defined contingency office location as an operational weakness considering that the company's work encompasses not only special servicing but also full service loan administration. Accordingly, we will further scrutinize this issue when we next re-examine ABCS' existing primary servicer ranking.

Internal controls

Procedures   ABCS maintains adequately documented policies and procedures on a shared network drive. Partly in response to internal audit recommendations, the company has revised and enhanced its body of special servicing procedures, particularly for REO.. The revised loan default department manual provides templates for a number of standard letters and forms, but has lesser content specifics covering approval delegations, loan recovery practices, related asset analysis methodology, and asset manager subcontracting requests.

Audit   The 15-person Internal audit department of Aurora Bank, of which ABCS is a division of, conducts operational audits of ABCS annually, and two auditors are permanently based at ABCS' offices. Standard & Poor's reviewed the latest audit report dated September 2009. While this audit report had some findings and did not result in the highest possible grade, ABCS has diligently addressed the issues. As a result, all items were either entirely or almost entirely resolved by year-end 2009.

ABCS administers its own quality control program to supplement Aurora Bank's internal audit regimen. For this program, the company has a dedicated quality control manager who issues quarterly reports that examine various loan administration and special servicing performance items. However, the company has not recently completed any QC reports related to special servicing.

ABCS represents that it is not required to file an SEC Regulation AB attestation letter.

The company also noted that it achieved an acceptable review from the SBA, which ABCS said examined various aspects of the company's credit and servicing practices.

Additional items

ABCS maintains sufficient corporate insurance coverage, and represented that it had no material lawsuits outstanding.

Special Servicing Administration

The ranking of ABOVE AVERAGE is assigned for special servicing loan administration.

ABCS has a very competent special servicing function and the company has steadily built a record of successful asset resolutions principally involving smaller-scale commercial mortgage and real estate-secured business loans. The company conducts asset management and demonstrates special servicing results nationwide, although it handles its largest concentration of assets in California.

  • During 2009, the company proactively added a number of experienced asset managers, and later in 2009, ABCS began strengthening some of its asset monitoring processes to address a sharply rising volume of loan defaults.
  • We believe the company remained diligent and well focused on its asset recovery work during 2009 despite the potential distraction and uncertainties related to the Lehman Brothers Holdings Inc. bankruptcy.

The assigned subranking takes into account the company's:

  • Steady success rate, especially in the past year, in maximizing recoveries on problem loans, proactively moving them through the foreclosure process, and liquidating REO assets within difficult market conditions while effectively contending with an influx of many more newly defaulted loans.
  • Overall sound and proactive asset recovery practices, including the creation of specifically delineated REO procedures.
  • Successful establishment of a dedicated REO department comprising primarily newly hired but very experienced staff to address higher volume.
  • Efforts during late 2009 to develop more centralized portfolio and asset level activity monitoring reports.
  • Effective and centralized appraisal and environmental contracting and review function.
  • Pre-default credit/collateral monitoring practices and dedicated collections groups, which enhance the company's ability to be proactive, given that the company currently services all the loans that it specially services and moves such loans into special servicing at 30 days past due.

Table 4

Special Servicing Portfolio Activity
Jan-June 2009 2008 2007 2006
Loan portfolio Volume ($) No. loans Volume ($) No. loans Volume ($) No. loans Volume ($) No. loans
Portfolio volume at beginning of period 346,717,772 546 103,787,187 174 24,866,850 38 4,690,429 9
Add: new defaulted/troubled loans 307,130,529 464 669,911,553 1,114 186,270,280 318 61,280,485 81
Loan resolutions:
Loans restructured/returned to perf. status (22,868,506) (34) (10,654,121) (19) (27,236,097) (50) (29,506,861) (36)
Full payoffs (8,142,491) (18) (18,854,943) (33) (17,723,423) (23) (4,899,802) (7)
Liquidated at discount - DPO/note sales (4,183,585) (7) (4,317,466) (6) 0 0 0 0
Converted to REO (64,453,287) (105) (47,762,858) (81) (6,731,433) (12) (2,602,060) (5)
Removed through rep and warranty claim 0 0 (12,748,197) (20) (6,846,268) (12) 0 0
Other loans sold and adjustments (includes many loans cured at 30 days past due) (113,157,696) (159) (332,643,385) (583) (48,857,465) (85) (4,095,341) (4)
Portfolio volume at end of period 440,881,907 687 346,717,772 546 103,787,187 174 24,866,850 38
Performing loans included in ending total 0 0 0 0 0 0 9,943,350 15
Loans in foreclosure (end of period) 393,928,964 619 470,234,669 509 99,533,229 165 14,697,464 23
Loans in foreclosure and bankruptcy (end of period) 440,881,907 687 41,407,290 38 4,253,958 9 226,037 1
REO volume Volume ($) No. properties Volume ($) No. properties Volume ($) No. properties Volume ($) No. properties
Beginning of period 47,844,464 81 7,450,735 10 5,251,787 5 3,157,365 2
Add: foreclosures/deeds in lieu 64,453,307 105 47,762,858 81 6,731,433 12 2,602,060 5
Deduct: sales and adjustments (19,416,882) (33) (7,369,129) (10) (4,532,486) (7) 507,638 (2)
End of period 92,880,606 153 47,844,464 81 7,450,735 10 5,251,787 5
REO sales activity
Appraisal or market value ($) 21,588,000 8,569,000 4,755,000 590,300
Gross proceeds ($) 15,569,263 7,227,500 4,319,000 590,306
Net sale proceeds ($) 14,501,178 6,768,248 4,048,142 507,638
Net sale proceeds/market value (%) 87% (based on newer broker opinions and adjusted liquidation values) 79 85.1 86
Average hold time - from date became REO to sale (No. months) 6.8 (15.3 total time in special) 11.8 14 7

Table 5

Active Special Servicing Portfolio
As of June 30, 2009
Volume ($) Assets (No.)
By primary collateral type
Office 126384226 216
Retail 127706742 187
Industrial 128472417 175
Multifamily 53505197 95
Mixed-use 97693931 167
Total 533,762,513 840
By investor type
Held in securitizations 451,123,660 718
Held on servicer's (or parent's) balance sheet 41,933,018 57
Private third-party investors (SBA) 40,705,835 65
Total 533,762,513 840
Early stage collections

ABCS approaches early stage loan delinquencies in an acceptably proactive manner.

  • The loan administration collections staff contacts borrowers the day after the grace period ends (loans are typically due on the first day of the month and usually have a 10-day grace period), and the company issues late notices within two days of the grace period expiration.
  • Subsequent calls are placed during the first 30 days, and another notice is issued by the 30th day.
  • Notices are generated by the servicing system, which tracks collection comment histories.
  • The special assets division takes charge of the situation once a loan is 30 days past due.
Default management and loan recovery

ABCS' special assets division includes a well experienced 32-person default management department. ABCS reviews recovery options based on a net present value analysis and considers methods such as a payoff settlement with the borrower, third-party note sale, or a debt restructuring. However, foreclosure and subsequent disposition of the real estate are currently the most frequent outcome, which is understandable given the restructuring limitations often inherent in single business/owner occupied commercial properties.

  • Overall practices appear to be proactive and are handled with acceptable controls.
  • The expanded department includes two senior asset managers for larger sized loans.
  • When a new problem loan enters the department, the asset manager must conduct an initial asset file review and recovery analysis. However, no written asset action or business plan is required at the onset regardless of loan size.
  • Asset managers prepare specific asset resolution memos (credit requests), which are approved by the department manager or chief credit officer. This is acceptable given the smaller balances of most loans. To the extent that a special servicer handles larger sized loans, a documented delegation of authority matrix would be customary.
  • Early in the special servicing timeline, ABCS obtains one or more broker opinions and obtains a full appraisal for foreclosure bidding.
  • ABCS management recently improved its portfolio monitoring and reporting to include a centralized monthly asset status narrative report. Additionally, each asset manager maintains his own workload spreadsheet. Given ABCS' existing technology tools, the current asset/portfolio monitoring method is adequate.
  • Asset managers' performance is measured based on resolution volume, average resolution time, and assignment complexity.

ABCS resolved 588 loans with an average resolution time of 163 days in the first six months of 2009. Through Sept 30th, the company resolved 831 loans with an average resolution time of 169 days. The resolved assets included loans with technical defaults and past due loans cured before becoming 60 days delinquent.

Table 6

Loan Resolution Results
Jan-June 2009 2008
Full payoffs
Loans (No.) 18 33
UPB ($) 8,142,491 18,854,943
Proceeds ($) 8,141,466 20,713,414
Proceeds/UPB (%) 99.9 1.10
Average resolution time (months) 6.7 4.0
Full liquidations (discounted payoff or note sale)
Loans disposed (No.) 7 6
Net proceeds ($) 2,740,115 4,292,501
Net proceeds/collateral value (%) 86.8 49.4
Net proceeds/UPB (%) 65.5 99.0
Average resolution time (months) 7.9 6.7
Median resolution time (months) 7.1 6.1
Restructured/returned to master servicer
Loans (No.) 34 19
Loan volume - UPB ($) 22,868,506 10,654,121
Average resolution time (months) 4.7 5.0
Median resolution time (months) 4.0 5.1
Loans foreclosed and converted to REO
Loans (No.) 105 81
UPB ($) 64,453,287 47,762,858
Average time (months) 8.9 8.1 (based on first half 2008- 2nd half 2008 data not provided)
Median time (months) 8.1 7.1 (based on first half 2008)
REO management and dispositions

ABCS has an effectively controlled REO management and disposition function and the company has an expanding record of property sales achievement. It recruited a number of well experienced managers in 2009 to address its surging foreclosure activity and resulting substantially higher REO volume.

  • The department conducts its work using a newly developed REO operations manual.
  • Assigned asset managers develop written and well detailed REO disposition business plans according to a standardized format within 30 days of acquisition.
  • The company uses its own standard property management and broker listing agreements, along with an approved list of qualified firms and individuals.
  • Through the first half of 2009, ABCS sold 33 properties (5.5 per month) averaging a very reasonable 205 days in inventory.
  • Through September 2009, ABCS sold 71 REO assets, increasing its pace of REO sales to 7.8 per month.
  • ABCS stated that it achieved 87% of the appraised liquidation values for REO sales through June 2009, and a higher 96% based on broker opinions of value on sales during the third quarter.
  • Given the smaller average size of its REO assets and the fact that most do not produce rental income, few REOs involve a high degree of monthly cash flow and related accounting and reporting, and many do not require the services of a property management company. As needed, the accounting staff oversees setting up any required bank accounts and reconciling monthly property manager operating accounts.
Subcontracting management - appraisal and environmental

ABCS' six-person credit and collateral risk department has a sound and proactive oversight function for procuring and reviewing external valuations and environmental assessments.

  • The department includes three appraisers who average more than 25 years experience, including two with MAI designations, and a senior environmental reviewer with 16 years of experience.
  • The department engages appraisers using a national approved appraiser list.
  • ABCS uses a standard scope of services engagement for both valuations and environmental reports.
  • The department issues a review memorandum for each completed assignment.
  • For regulatory and audit compliance, ABCS uses a tiering system and report card process for all vendors; it is also strengthening its administrative procedures to document its vendor selection due diligence and track signed contracts.
  • Phase I environmental reports are commissioned as a pre-foreclosure requirement for all properties, and additional testing is authorized when deemed necessary.
Legal oversight

ABCS maintains an acceptably controlled process for engaging external legal counsel.

  • The company's compliance officer and Dallas-based legal department help source new law firms and manage the engagement process.
  • The company uses an approved attorney list, which currently contains pre-qualified counsel in more than 40 states.
  • A standard engagement letter is required in most matters and the legal department or compliance officer must agree to a firm's billing and rate structure.

Financial Position

The financial position for ABCS is currently pending our credit assessment of Aurora Bank.

Contact Information

George Younes, SVP

25510 Commerce Centre Drive, Suite 150

Lake Forest, CA 92630

(949) 614-4524

George.Younes@aurorabankfsb.com

www.aurorabankfsb.com

Servicer Analysts:Michael S Merriam, New York (1) 212-438-2548;
michael_merriam@standardandpoors.com
Mary Chamberlain, New York 212-438-3034;
mary_chamberlain@standardandpoors.com

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