One of the more burdensome structural features of CMBS 2.0 (post-2010 CMBS conduit loans) has been the insistence of cash management accounts for nearly all CMBS conduit loans. In summary, cash management accounts are set up for each transaction as a bank account in the name of both the borrower and the lender, but it’s primarily under borrower control. Depending on how the loan documents read, the lender can seize control of the property cash flow in the event of declining performance or default.
The reasoning for cash management accounts stems from borrowers not considering the lender a top priority in uses of cash during periods of property stress and diverting cash flow to uses other than paying debt service, real estate taxes and the like on properties secured by CMBS conduit loans. So to protect themselves, lenders have inserted themselves in the cash flow stream.
The way cash management works is all property cash flow must pass from the property source (tenant rent payments, credit cards receipts from a hotel room sales, etc.) through the cash management account. As long as the property is generating a DSCR greater than a prescribed level (generally 1.15-1.25x) the funds pass immediately into the borrower’s operating account. This is known as a “soft” or “springing” form of cash management, as the lender’s right to control the cash “springs” upon a “trigger event,” such as the property falling below the prescribed minimum DSCR, whereby the lender stops the cash pass-through and begins to collect debt service, escrows and capital reserves and remitting the balance of the cash only in accordance with an operating budget. While “springing” cash management sounds bad, “hard” cash management is worse.
“Hard” cash management requires all of the above; however cash flow does not pass immediately into the borrower’s operating account. Instead, cash flow is directed into buckets for debt service, escrows, capital reserves, operating expenses, and once a month, the operating expense bucket is released to the borrower to pay operating expenses.
“One of my borrowers asked why the lender doesn’t simply take the property at closing since they have all the cash anyway,” said Michael D. Sneden, Executive Vice President of ValueXpress. “But he was right, it is important to negotiate into a less-onerous “springing” cash management and water down the provisions of “hard” cash management on properties such as hotels. ValueXpress has been successful in reducing the burdens of “hard” cash management in all the CMBS conduit loans that have required it,” said Sneden.