Ann Hambly, ceo, and Brock Andrus, managing partner at 1st Service Solutions, answer SCI's questions

Q: How and when did 1st Service Solutions become involved in the structured finance market?
AH: I've been in the servicing industry for 34 years and a large amount of that time was spent in CMBS servicing. I was previously ceo at Prudential Servicing until 2005 and before that at GE and Nomura.

The year before I founded 1st Service Solutions, which acts as a borrower advocate, it became apparent that there was a need for an entity to bridge the gap between what a servicer knows and what a borrower knows about CMBS loan approvals and modifications. Most borrowers have no real understanding of what happens when a loan is put into a CMBS pool and so there is a need for someone to explain the process.

BA: Traditionally, borrowers' relationships with lenders involve loan officers for the life of the loan. But, for CMBS, the relationship with the loan officer ends when the loan is sold to the CMBS trust, so when problems crop up there is no loan officer to answer any questions.

The aim of a borrower advocate is to fill that black hole. Because we are involved in so many transactions with special servicers, we can tell borrowers what to expect and help them understand the process better, in addition to providing on a real-time basis what type of structures are successfully being consummated.

AH: I don't think anyone knew what was needed back in 2005; I certainly didn't know whether anyone would pay for this kind of service. But once I tested the water it was instantly obvious that there is huge demand for a borrower advocate.

We've expanded significantly over the last few years, growing from a staff of one (me) in 2005 to three in 2006, and now we have 16 people working here. We have US$2.5bn of assets in the pipeline, across all types of real estate assets (though 90% is CMBS). We operate from Dallas, but our clients are based across the US.

Q: How do you differentiate yourself from your competitors?
AH: I would venture to guess that there are 100 firms that claim to offer the same service as us, but I'm 99% sure that we're the only firm with hands-on experience in CMBS servicing. As the work increasingly shifted to troubled loans, clearly many more firms entered the market, but our background is the differentiating factor.

BA: I believe we still have the largest market share though.

AH: We live in the world of special servicers on behalf of a borrower. We think of ourselves as facilitators.

It doesn't do any good to take the needs of the borrower to the servicer without understanding the needs of the servicer. Our role is essentially to interpret between two different languages: the special servicer speaks the language of bondholders, while the borrower speaks the language of property owners.

Q: What are your key areas of focus today?
AH: Our role hasn't fundamentally changed over the years. In 2005 we focused on helping borrowers manoeuvre through the CMBS servicer approval process - helping them modify leases and organise waivers, for example. Lately, 80% of our time has been spent dealing with non-performing properties.

Another area of focus is on loan assumptions, which have historically been problematic, but the process is even more complicated now. It takes forever to get approval and there is no one party directing the process.

Part of the reason for the lengthy process is because the CMBS market became highly competitive, with extremely tight servicer cost structures. Consequently, there is little time to handle all the additional requests and workloads have become even more strained with the emergence of troubled assets. In such a situation, we step in and essentially call the plays and keep everyone organised and working towards the same goal.

BA: At present, most of our work involves helping clients work out distressed assets - such as in cases where they own a retail centre and the anchor tenant has left, or where they own an apartment complex that is suffering from falling rent income - and is typically cashflow-related. We outline the issues that are plaguing the asset and plan appropriate strategies.

Traditional lenders can do certain things that CMBS lenders can't do. We educate borrowers in the sorts of strategies that can be executed.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
BA: There is a trend developing that is specific to borrowers. When negotiating with special servicers, most of our clients are faced with a situation where new money needs to be brought in to turn the distressed asset around. Many borrower capital bases have been wiped out, so part of our job is to be a capital provider/coordinator.

This can be especially true when considering a borrower's option to pursue a discounted loan payoff. In this case, both new debt and equity need be raised - and a good portion of our efforts are aligned with such needs of our clients.

It's a question of marrying up distressed money that wants to participate in the CRE space with the borrowers that need it. Many distressed funds have their own pipeline of assets, but earmarking deals remains a significant challenge and there is a lot of money that needs to be deployed. Each fund has different return expectations or quality thresholds.

AH: In the days of the RTC, plenty of distressed real estate assets came onto the market as banks liquidated REO product. But today there is not the volume of foreclosed/REO properties available, as has been expected, because of the sheer number of loans that still are in the process of being worked out or will begin the workout process. Investors are realising that they have to connect with the borrower directly and get in the middle of the process rather than waiting for REO assets to come onto the market.

I believe that we'll start seeing more REO trades in one or two years' time. And then who knows how long it will take to flush all of the distressed assets out of the system? It'll take at least four or five years.

BA: The CRE market currently benefits from low interest rates. But, as rates begin increasing, institutions that have loans outstanding may find that their appetite to retain distressed assets decreases - lessening the likelihood for the 'pretend and extend' strategy to be deployed by lenders.

Q: What major developments do you need/expect from the market in the future?
AH: Many market participants are speculating about whether the commercial real estate market has hit bottom. I think we're getting close to the bottom, but the bottom has a long flat part, so it'll be a while before we see a recovery. For instance, there is no way that all of the CRE debt that's coming due over the next five years will be able to be refinanced if values don't begin recovering and banks don't begin lending again.

BA: Financing ability is creeping back, but it's nowhere near the pace that it was at in 2006-2007.

CS