Operational Risk Assessment

Transcription

1 Operational Risk Situs Asset Management, LLC and Situs Holdings, LLC January 2013 Operational Classifications: Rankings: Forecast: Commercial Mortgage Primary and Special Servicer Primary Servicer: MOR CS2 Special Servicer: MOR CS2 Stable - Both Rankings Analysts: Michael S. Merriam, [email protected], Mary Chamberlain, [email protected], Rationale Morningstar Credit Ratings, LLC (Morningstar) has assigned its MOR CS2 ranking to Situs Asset Management, LLC as a commercial mortgage primary servicer and its MOR CS2 ranking to Situs Holdings, LLC as a commercial mortgage special servicer. The forecast for both rankings is Stable. Situs Asset Management is one of the wholly owned operating units of The Situs Companies, LLC, whose parent is Situs Holdings, LLC. In October 2011, special servicer Helios AMC, LLC, a Ranieri Partners-sponsored company, acquired The Situs Companies but retained the Situs name. As a result, Situs Asset Management and Situs Holdings now represent the consolidated operations of the two merged companies. For this report, Morningstar refers to the commercial mortgage primary servicing and special servicing entities collectively, and within their respective contexts, as Situs. The assigned rankings reflect our assessment of the company s operational infrastructure and portfolio administration capabilities for its respective duties as a primary and special servicer. Our special servicer ranking acknowledges the company s solid performance and capabilities as a special servicer principally through the merged Helios operation. Our primary servicer ranking largely reflects our view of Situs as a boutique operation experienced with non- assets, distressed portfolios, and other specialized portfolio assignments. Although primary servicing has not been the company s focus, we believe that Situs has the operational capabilities to serve as a fully competent sub-servicer. In particular, Morningstar s assessment and assigned rankings are based on the following factors: Primary Servicing: Effective and Strengthened Technology - Morningstar believes that Situs has effective technology tools to support portfolio growth. In our view, the company s July 2012 conversion to the Enterprise! loan servicing system, along with other planned and in-progress technology enhancements, such as the rollout of borrower and investor websites in 2013, should provide increased operating efficiency and improve the company s servicing capabilities as the company continues to rebuild portfolio volume. We understand that Situs is currently revising its documented policies and procedures based on the implementation of the new servicing system. Sound Operational Structure/Re-Positioned Platform - Along with the system conversion, Situs has been re-tooling and re-positioning the servicing operation. Between July 2011 and September 2012, Situs reduced its servicing staff by approximately 60% to match substantially reduced portfolio volume and to account for projected automation gains from the new system. Situs stated that the staff

2 reduction and related reorganization primarily reflected the transfer in 2011 of its FDIC portfolio out of the company, and its subsequent decision in February 2012, driven by economic considerations and a re-directed growth strategy, to resign as the servicer on a $3 billion Colony Capital portfolio. In connection with the portfolio transfers, system conversion, and the Helios merger, Situs has been redesigning aspects of its organizational structure, re-deploying certain staff, conducting extensive system training, and revising procedures. The company also noted that it is developing a metrics tool using the performance tracking features of the new servicing system to optimize staffing levels and efficiency. Morningstar believes that these initiatives collectively should strengthen Situs operational effectiveness as it pursues new client relationships and third party business opportunities. Solid Management Depth/Well-Experienced Staff - After examining the company s current staffing levels and structure, we believe that Situs is positioned to handle growth and provide customized, proactive servicing. In our view, the company: (i) has retained experienced managers and professionals (although we observed a decline in the average years of experience among middle managers from December 2010 to June 2012), (ii) currently operates with some excess staff capacity, and (iii) maintains an organizational structure that promotes portfolio management accountability. We also observe that Situs has an effective training function. Expanded Internal Audit Program - Situs recently enhanced its primary servicing audit regimen by engaging an external firm to perform semi-annual operational audits to supplement the annual Uniform Single Attestation Program (USAP). The first such audit is currently in process. Situs also has had a succession of clean USAP letters and had an exception-free Service Organization Control (SOC) report issued in early 2012 that tested cash controls, technology security, and various other operational processes. Based on our review, the scope of the SOC appears to have many similarities to that of a SSAE 16 (Statement on Standards for Attestation Engagements No. 16). Situs also indicated that it plans to establish a formal compliance function for primary servicing. Effective Portfolio Management - In our view, Situs has diligent practices for proactive asset-level management and portfolio oversight to monitor collateral performance, track compliance and trigger events, and handle borrower requests. We recognize that the company is experienced in servicing highly structured assets and distressed portfolios that are prone to documentation defects. Furthermore, we recognize that certain investors have placed their confidence in Situs capabilities to perform enhanced surveillance, shadow servicing, and reporting to supplement or, for some tasks, supplant the servicers named on their respective transactions, which may include positions, mezzanine debt, and warehouse loans. We believe the company s recent servicing system conversion strengthens its portfolio management function. Proven Client Reporting Capabilities - In our view, Situs has a successful record of delivering customized reporting for a range of institutional clients and private investors. The company also has experience with FDIC reporting. While it has not served or is actively pursuing work as a GSE or servicer, Situs currently services one securitized portfolio of smaller balance assets and has other assignments that require detailed remittance and portfolio management reporting. Some investors, including those invested in, have engaged Situs to provide supplemental reporting and to produce their quarterly investment fund portfolio performance reports. Sound Loan Administration - We believe that Situs has sound practices to perform effective loan administration related to such functions as payment processing, real estate tax and insurance administration, and loan boarding. We expect that during 2013, Situs will realize higher levels of loan administration and data management efficiency through the new servicing system. Special Servicing: Positively Trending Performance Record - Morningstar recognizes Situs, particularly through the former Helios platform, which began operating in early 2008 and consummated its first asset resolutions in 2009, for its steadily increasing performance record of successful asset management and resolution results for a range of asset types and complex structures nationwide. We consider Situs, through the legacy Helios group, to be very adept as a special servicer. We also found the company s portfolio performance reporting to be thorough based on our review of selected Morningstar published DealView surveillance reports. We found only one cited instance where more information was desired by surveillance analysts on a particular asset. Well-Experienced Professional Team - Senior managers and asset managers, overall, have a high degree of industry experience, and many have worked together for 10 years or more based on their positions at Helios and predecessor companies. Excellent Technology- Situs executes its special servicer duties using what we consider to be a very effective and highly functional proprietary asset management system, which the company continues to enhance. P a g e 2

3 Well-Controlled, Efficient Asset Management- In our view, Situs has a tightly controlled approval process and a thorough asset analysis process which are both well documented and principally managed through the asset management system. However, we will monitor the company s REO workload ratios, which appear to be slightly higher than the ratios we have observed at some other special servicers. The company does not routinely conduct property manager audits. However, we note that Situs has dedicated staff and defined procedures to review property manager reports and monitor property-level performance. Sound Internal Audit and Compliance - Situs special servicing platform is subject to annual audits through a Regulation AB examination and a supplemental audit process. Additionally, the special servicing operation has its own compliance function to monitor adherence to servicing agreement and loan-level requirements. Enhanced Platform - In our view, the special servicing platform, largely representing the former Helios operation, is steadily expanding its capabilities to resolve diverse and complex portfolios. We believe the special servicing unit will increasingly benefit from its ability to leverage the internal resources available through its parent and its related due diligence, advisory, and other business lines. It is also our opinion that Situs, particularly through its recently formed operating unit called Hanover Street Capital which exclusively manages certain Deutsche Bank assets, is demonstrating its ability to handle assets other than those associated with pools. Effective Conflicts of Interest Management - Situs is the special servicer on transactions in which two affiliated investors respectively hold first loss positions and serve as the controlling class representative (CCR). Accordingly, we reviewed Situs stated asset management practices, use of affiliates, and resolution results in this context. In our view, Situs has sound practices to manage conflicts of interest in its asset resolution work and maintain the servicing standard in its asset recovery decision-making process. As of June 30, 2012, Situs servicing portfolio consisted of 760 loans with an unpaid principal balance (UPB) of approximately $8 billion. The portfolio included one securitized transaction, Velocity , which contained 178 smaller balance commercial mortgage loans having a total UPB of approximately $67.7 million. Situs serves as a primary servicer on three commercial real estate collateralized debt obligation (CRE CDO) transactions that had a total UPB of approximately $1.9 billion and 62 remaining loans as of June 30, As of June 30, 2012, Situs was the named special servicer on 2,439 loans with an approximate UPB of $28.7 billion covering 29 transactions, inclusive of 13 transactions, its Hanover Street Capital portfolio, and certain assets in the current Situs servicing portfolio. The company s total active special servicing portfolio, inclusive of and non-, contained 658 assets consisting of 585 loans and 73 REO properties with a combined UPB of approximately $5.3 billion. The portion of the active special servicing portfolio consisted of 150 loans and 36 REO with a combined UPB of approximately $2.8 billion. Forecast Stable for both Primary and Special Servicer Rankings. The Stable forecast for the primary servicer ranking reflects our view that Situs has sound and proactive practices across all core functions, experienced personnel, and improved technology and reporting tools to continue providing quality, customized servicing during the coming year. Its recent servicing system conversion and other pending technology, procedural, and organizational enhancements should steadily strengthen the company s overall level of operational effectiveness to meet increased duties and performance expectations as it grows the portfolio. The Stable forecast for the special servicer ranking reflects our view that the company, largely representing the former Helios operation, has the practices and expertise to serve as an effective special servicer for and a range of other clients. In our view, Situs has been steadily broadening its capabilities and building a record of successful asset management and resolution achievement involving a range of complex loan structures. We believe the special servicing platform will increasingly benefit from its ability to leverage the internal resources from other Situs business lines as it further integrates and aligns its operations with the primary servicing platform. P a g e 3

4 Table Of Contents (Hyperlinks) Page Company Profile and Business Overview 6 Operational Infrastructure 7 Organizational Structure Management and Staff Experience Management and Staff Turnover Workload Ratios Training Audit, Compliance, and Procedural Completeness Legal Liability and Corporate Insurance Technology and Disaster Recovery Primary Servicing Portfolio Administration 13 Loan Boarding, Hedge Agreements, Letters of Credit, and UCCs Loan Modification Re-Boarding Activity Payment Processing Real Estate Tax and Insurance Administration Capital Expenditure Reserve Management Investor Reporting and Accounting Financial Statement Analysis and Property Inspections Watchlist, Trigger Events, and Early Stage Collections Portfolio Management: Supplemental Surveillance and Servicing Activities Borrower Consents and Requests Special Servicing Administration 20 Asset Review Process REO Property Management Vendor Oversight Managing Conflicts of Interest Asset Resolution and Recovery Performance Investor and Master Servicer Reporting P a g e 4

5 Table Of Contents (Continued) Page Ranking Definitions 28 Disclosures 28 Index of Tables and Charts (hyperlinks) Table 1: Historical Servicing Volume Table 2: Average Years of Experience Table 3: Staff Turnover Rates Table 4: Special Servicing Assets-to-Asset Manager Ratios Table 5: Servicing Concentration by State Table 6: Servicing Volume by Investor Type Table 7: Servicing Volume by Property Type Table 8: Primary Servicing Floating Rate and Cash-Managed Loans Table 9: Full Year Financial Statement Collection Rates Table 10: Supplemental Portfolio Management Activity Table 11: Borrower Consent Average Processing Times Tables 12-14: Primary Servicing Portfolio Delinquency Detail Table 15: Special Servicing Portfolio - Named and Active Assets Table 16: Aging of Active Non-Performing Loans and REO Tables 17-19: Special Servicing Loan Portfolio Activity Tables 20-22: Special Servicing REO Portfolio Activity Table 23: Asset Resolution Performance Charts 1-4: Active Special Servicing Portfolio by Property Type Percentages Chart 5-6: Special Servicing Resolution Type Percentages Charts 7-8: Average Loss Severity on Liquidated Assets vs. Morningstar Data P a g e 5

6 Company Profile and Business Overview The Situs Companies began operations in 1985 as a commercial real estate investment advisor and brokerage firm. The parent company, Situs Holdings, LLC, is currently 16.9% owned by Ranieri Partners. Other minority-share owners of Situs include Brookfield Investment Management, South Carolina Pension Fund, Castle Hill, and Situs management. In the early 1990s, Situs added loan servicing and asset management as a business line and acquired its first third party assignments which included Resolution Trust Corporation (RTC) and then FDIC contracts. Other core businesses, which have grown over the years and are managed through affiliate companies and specialized operating units, include: (i) due diligence, loan underwriting, and advisory services for, other structured transactions, and banks; (ii) technical services (property inspections and valuations); (iii) commercial real estate financial modeling, transactional analysis, and related support services; (iv) outsourcing services such as data aggregation, real estate accounting and credit administration support for other servicers and commercial real estate/finance companies; and (v) temporary staffing services for other firms. On October 7, 2011, Helios AMC, a Ranieri Partners-sponsored company principally operating as a special servicer, acquired The Situs Companies but retained the Situs name for the merged company and all its businesses including the acquired Helios operation. The majority of the current senior management team, along with much of the professional staff, consists of former employees from both companies. During 2008 and 2009, Situs served as the emergency special servicer for the FDIC, noting that it handled more than 50 failed bank portfolios. In early 2010, Colony Capital also retained Situs as the servicer and special servicer for its portfolio of loans and real estate acquired from the FDIC through a competitive bidding process. Situs had assisted Colony Capital with due diligence and valuation services during the underwriting and bidding period. The portfolio, always having a large concentration of smaller balance loans, initially comprised more than 1,200 assets from 22 failed banks. In February 2012, Situs resigned from its Colony assignment as it integrated Helios, prepared to convert to the new servicing system, and focused on new growth channels that could offer better economics for the platform. At the time when Situs resigned from its assignment, the Colony portfolio was approximately $3.2 billion containing nearly 3,100 loans. Situs became active in Europe in 2009 when it acquired the primary and special loan business of Global Servicing Solutions Germany, which was a joint venture between Ocwen Financial and Merrill Lynch. In 2011, Situs partnered with HSH Nordbank and Helios AMC to offer loan servicing and advisory services in Scandanavia. In September 2012, Situs acquired Deutsche Bank's London-based commercial mortgage loan servicing business. The acquisition included and balance sheet servicing, asset management, and special servicing. As a result, Situs is now one of the largest third party servicers in Europe with almost 20 billion under management and offices in London, Franfurt, and Copenhagen. Especially since the latter half of 2012, Situs has been re-building its U.S. servicing volume through new and expanded client relationships. During the first half of of 2012, it added 163 new loans with a total UPB of approximately $2 billion to the portfolio. The company added another 404 loans with an approximate UPB of $2 billion to the portfolio in the second half of the year. Situs expects to grow its primary servicing portfolio and customized surveillance services through assignments from banks, private investment funds, insurance companies, and possibly through the conduit market as a sub-servicer. In particular, the company expanded its relationship with Deutsche Bank in 2012 by creating a dedicated unit, Hanover Street Capital, to serve exclusively as asset manager and servicer for part of the bank s distressed loan portfolio. Situs also plans to pursue other servicing opportunities involving distressed loan portfolios. Situs expects additional special servicing assignments through new issuance and through investor relationships involving distressed debt funds. Situs also foresees additional trust advisory assignments on new issue for which it is not the special servicer. Currently, the company does not have its own loan origination business. As of June 30, 2012, the company across all its business lines, corporate divisions, technology, and other support units had 292 total employees including 35 people supporting the European operations. It had 257 U.S. -based employees of which 105 were involved in servicing or special servicing functions. Situs operates as a primary servicer through its headquarters in Houston, TX and an office in Robbins, NC. The company conducts special servicing from five offices: San Francisco, CA (the principal location); Houston, TX; Horsham, PA; New York, NY; and Robbins, NC. The San Francisco, Houston, and Horsham staff focus on both and non- assets, while staff in New York and Robbins handle only non- assets. The New York office is dedicated exclusively to Deutsche Bank s Special Situations Group through the Hanover Street Capital entity, which receives additional administrative support from the Houston servicing and San Francisco special servicing hubs. P a g e 6

7 Table 1: Historical Servicing Volume UPB (000s) # Loans UPB (000s) # Loans UPB (000s) # Loans Primary Servicing* 8,005, ,430,674 3,793 10,993,366 4,089 Average Loan Size 10,533 2,750 2,688 Active Special Servicing** 5,299, ,278, ,905, Average Asset Size 8,053 8,732 11,906 *The Colony Capital portfolio, which consisted of approximately 3,000 loans with a UPB of $3 billion, transferred to another servicer in early **Includes loans and real estate owned. December 2010 special servicing volume represents only the former Helios portfolio. Operational Infrastructure Organizational Structure Between July 2011 and September 2012, Situs reduced its primary servicing staff by approximately 60% to match substantially reduced portfolio volume. Situs stated that the staff reduction and related re-organizing reflected an earlier transfer of its FDIC contract, and its subsequent decision in February 2012, driven by economic considerations and a re-directed growth strategy, to resign as servicer from the Colony Capital portfolio, which generally comprised small balance loans. Situs also noted projected efficiency gains from the new servicing system as another factor related to the staff reductions. In conjunction with the portfolio transfers, system conversion, and the Helios merger, Situs stated that 2012 through early 2013 is a period of re-tooling and re-positioning the servicing platform. Situs has been redistributing workloads, enhancing staff training, re-deploying certain staff to leverage individual expertise, revising procedures, and acclimating staff to the new system as they learn how to optimize its added functionality. Situs also re-located its escrow administration to a new office location with mostly new staff, which the company cited was a strategic move to build a more cohesive and efficient operation. The company noted that it is developing a metrics tool using the performance tracking features of the new servicing system to monitor optimal staffing levels and workloads. Morningstar believes that these initiatives collectively should yield higher operational effectiveness and make Situs a stronger servicer as it pursues new investor relationships and third party business opportunities. As of June 30, 2012, Situs had 105 total personnel in its servicing and special servicing areas: 56 for servicing and 49 for special servicing. However, after completing its staff reduction plan associated with the removal of the Colony portfolio and system conversion, Situs had 38 employees plus three contract staff for primary servicing as of September 30, Situs does not have any off-shore employees for its U.S. servicing portfolio. However, the company does use one external vendor, Silverskills, which maintains an off-shore location and assists with the quarterly financial statement data input and spreading process. The company conducts its servicing and special servicing activities through four main divisions: Primary Servicing, Special Servicing Operations, Special Servicing Asset Management, and Hanover Street Capital. Additionally, Situs has a dedicated information technology unit, human resources department, and in-house general counsel to support servicing and all other business lines. Situs organizational structure reflects a hybrid design of functionally- and portfolio-driven teams to match the nature of respective tasks. The primary servicing operation comprises four departments: Asset Administration - This department handles all portfolio management and surveillance such as financial statement analysis, inspections, watchlist management, and loan covenant compliance/trigger event tracking. This group also handles borrower consent requests and serves as the liaison to coordinate special servicing loan transfers. Loan Administration - This department handles investor reporting, payment processing, and document/lien management. Escrow Administration - This department has respective specialists for real estate tax administration, insurance administration, and related escrow research and analysis. P a g e 7

8 Data Management, Technology, and Training - This department is responsible for developing and managing policies and procedures, servicing system training, data security, and coordinating disaster recovery/data back-up activities with the company s corporate information technology division. This department also oversees loan boarding in conjunction with the other departments and monitors floating rate loan index changes. The special servicing operation comprises three departments: Operations - This department supports the entire special servicing process, including the Hanover Street Capital portfolio, with a team of asset analysts, including dedicated REO analysts, assigned to assist the asset managers with their day-to-day tasks. This division also includes a dedicated compliance manager who serves as a liaison with external auditors, manages special servicing policies and procedures, and oversees adherence to pooling and servicing agreements relating to special servicing requirements. The Operations division has a dedicated team for investor/ reporting and accounting related to the special servicing portfolio. The head of this division also oversees user training and enhancement rollouts for MIDAS, the company s proprietary asset management system for special servicing. Special Servicing Asset Management - This department is responsible for all loan workout negotiations and asset recovery work, which largely involves assets and excludes the Hanover Street Capital portfolio. This division has certain asset managers dedicated to loan resolutions and other asset managers for REO management and dispositions. Hanover Street Capital - This department, which is based in New York City, comprises a team of asset managers exclusively working on the Deutsche Bank portfolio, which contains non- loans and REO. Hanover Street includes a number of asset analysts and administrators assigned through the Special Servicing Operations Division to support the asset managers in this group. Management and Staff Experience Within primary servicing, senior management had an average of 22 years of experience as of June 30, 2012, compared to an average of 25 years of experience as of December 31, As of June 30, 2012, middle management had an average of 9 years of experience compared to an average of 18 years of experience as of December 31, The average experience of the remaining professional staff increased to 13 years from 12 years between the two periods. Within special servicing as of June 30, 2012, the average industry experience of senior managers was 23 years and the average experience of middle managers was 19 years. Both of these averages were somewhat lower compared to December Situs reported an increase in the average experience of its asset managers from 15 years to 19 years between December 2010 and June Table 2: Average Years of Experience June 2012 December 2010* Tenure at Tenure at Industry Company Industry Company Primary Servicing Senior Management Middle Management Professional Staff Portfolio Management Staff Only** 13 2 n.a. n.a. Special Servicing Senior Management Middle Management Professional Staff Asset Managers * December 2010 averages based respectively on Situs Asset Management, LLC and Helios AMC, LLC prior to their merger. **Servicing positions involving credit, collateral performance, or borrower request analysis. Management and Staff Turnover Within primary servicing, Situs had a 14.6% employee turnover rate during the second half of 2011 and a 39.7% turnover rate in the first half of Situs classified all staff turnover, except for two positions, as being involuntary and relating mainly to the transfer of the Colony portfolio out of the company. Within special servicing, the company incurred no turnover in the second half of 2011 and had a moderate 13% turnover P a g e 8

9 rate in the first half of Situs actually experienced 14% net growth in its special servicing staff during this 12 month period to address the consolidation of the legacy Situs and Helios assets, transfers, the Hanover Street Capital assets, and other incoming asset management work for other investors. Table 3: Staff Turnover Rates* First Half 2012 Second Half 2011 Primary Servicing Special Servicing Primary Servicing Special Servicing Staff - Beg. of Period (# positions) Turnover 39.7% (33 positions) 13.0% (6 positions) 14.6% (14 positions) 0 Involuntary 37.3% (31 positions) % (14 positions) 0 Voluntary 2.4% (2 positions) 13.0% (6 positions) 0 0 Management Only 2.4% (2 positions) Staff Only 37.3% (31 positions) 13.0% (6 positions) 14.6% (14 positions) 0 New Hires (# positions) 6 **9 1 3 Staff - End of Period (# positions) * Staff departures divided by number of staff at beginning of period. ** Includes one existing information technology employee who became fully dedicated to special servicing. 38 active employees as of September 30, Workload Ratios Primary Servicing We calculated that Situs had a 14:1 ratio of loans per employee for its primary servicing portfolio as of June 30, 2012 compared to a 46:1 ratio as of December 31, The sharply reduced ratio corresponds to the transfer of the Colony Capital portfolio out of the company. Considering that the Colony portfolio predominantly comprised smaller balance loans, the prior 46:1 ratio still may be considered somewhat low compared to some other servicers handling similar type assets. Special Servicing As of June 30, 2012, Situs had 20 loan asset managers and 5 REO asset managers. We calculated that, as of June 30, 2012, Situs had a 29:1 ratio of specially serviced loans per loan asset manager, but a 12:1 ratio for those loan asset managers primarily handling loans. For its REO portfolio, we calculated that, as of June 30, 2012, Situs had an overall 15:1 ratio of REO assets per asset manager, with a 12:1 ratio for its three asset managers exclusively handling REO. Our calculated ratios also are based only on the number of asset managers and exclude the asset analysts who assist in many asset management-related activities. The company noted that as of September 30, 2012, the average loans-to-asset manager ratio for loans was up to 16:1, and that the ratio for asset managers primarily handing smaller balance loans was about 40:1. Situs stated that as of September 30, 2012, the average number of assets managed per REO asset manager was still 15. We view 16:1 as a generally reasonable loan to asset manager ratio for special servicing. We view REO per asset manager as being at the higher end of the normal range. Table 4: Special Servicing Assets-to-Asset Manager Ratios (June 30, 2012) Overall (Loans and REO) 26:1 Loan Portfolio 29:1 Loans Only 12:1 REO Portfolio 15:1 REO Only 12:1 : Morningstar considers Situs to have a reasonably-designed organizational structure, consolidated from its two legacy platforms, which addresses the company s portfolio management, cash management, asset recovery, and related reporting P a g e 9

10 requirements. In our view, the company s organizational structure leverages individuals expertise and promotes portfolio management accountability. We recognize that Situs has been re-tooling its primary servicing operation and may make further refinements and enhancements to the organizational structure during 2013, which may entail re-positioning staff, centralizing and expanding certain functions like compliance and training that straddle both primary and special servicing, and other steps aimed to increase synergies across the primary and special servicing platforms. We believe that Situs is positioned to maintain operational quality and realize added efficiencies resulting from such additional organizational adjustments, and particularly as it continues to gain proficiency with and realize the potential of the new servicing system. We believe that Situs as both a servicer and special servicer operates with an overall well experienced management and professional team. In our view, the average experience for senior managers and professional staff within primary servicing is quite solid. However, we do note that the average industry experience for middle management positions in primary servicing was much lower at June 2012 compared to December 2010, and generally lower compared to some other servicers we have ranked. Although we observe that average experience declined somewhat for both senior and middle level special servicing managers between December 2010 and June 2012, this may be due to hiring and promotions. Morningstar regards the latest averages as still being high and in line with some other highly ranked special servicers. We also view the average industry experience for the special servicing asset managers as being at the high end of the range. We recognize that the sharp increase in primary servicing staff turnover in 2012 was attributable to involuntary reductions associated with the transfer of the Colony Capital portfolio and also possibly related to projected efficiency gains from the new servicing system. Given the added functionality from the new system and the sharp reduction in portfolio volume resulting in a correspondingly much lower loans-to-employee ratio, we believe that Situs may possess sufficient excess staff capacity to substantially increase its servicing portfolio without unduly stressing current staff workloads or compromising quality. We believe the company s overall ratio of specially serviced loans-to-loan asset managers appears to be at the higher end of the customary range, and that the average number of REO assets per asset manager may also be higher than some other special servicers. However, we consider the company s loans-to-asset manager ratio to be within the industry norm, and that non- or smaller balance assets are likely skewing the overall ratio higher. We also consider these other mitigating factors: Situs has more than 10 asset analysts and administrators who support the asset managers with their business plan preparations, asset analytics, vendor engagements, market research, and other tasks. Additionally, we acknowledge that Situs asset managers are very highly experienced, that the company s proprietary asset management system, MIDAS, facilitates many aspects of the asset management process, and that some assets may in fact be part of a single relationship. The company also plans to fill a currently open asset manager position. These considerations, including the company s overall successful recovery results, generally assuage our concern regarding the company s overall special servicing capacity. However, we remain watchful as to how Situs controls its asset manager workloads, particularly for REO. Training Situs provides ongoing, formalized training activities for both servicing and special servicing personnel. The focal point for the company s training function is Situs University, which comprises a formal curriculum of scheduled classes and on-line training sessions covering a range of general business/skills development sessions and subject matter related to loan administration, commercial real estate analysis, and asset management. Through the Situs University intranet portal, all staff can register for courses, access training materials, track completed training hours (system training is separately tracked), and participate in on-line live or recorded sessions. Situs University currently comprises 144 courses that are offered at different times. Situs noted that 42 courses were offered between January 2011 and January 2012, and that it offered another 20 courses since late In addition, the special servicing area conducts a number of its own training sessions, often with invited guest speakers, throughout the year covering issues specific to special servicing and asset management. With the conversion to the Enterprise! system earlier this year, Situs also provided a substantial amount of formal user training. The company noted that some of its external clients have accessed Situs University s offerings for their own employees. The company s human resources division manages Situs University and certain training sessions in conjunction with servicing department managers. At present, the primary servicing staff uses the Situs University application to track their completed training hours, while the special servicing compliance manager separately tracks completed hours and coordinates specific training events for the special servicing staff. Situs P a g e 10

11 indicated that it intends to centralize the tracking of all training hours within Situs University during The company currently does not have a dedicated training coordinator or centralized training department for all of servicing and special servicing. The company expects the primary servicing staff to complete at least 25 hours of annual training and the special servicing staff to complete 30 hours annually. Between July 2011 and June 2012, primary servicing staff actually averaged 50 hours of training, which included training hours for the new servicing system. During the same period, special servicing staff averaged 28.5 hours of training involving formalized sessions and averaged almost 80 hours of training when their ongoing participation in investment committee meetings is included. : We believe that Situs has an active and substantive training function based on its formalized curriculum of available classes, and its high degree of employee participation. As the company grows and its primary and special servicing areas become further integrated, it may benefit from a more centralized management and tracking approach for its training function. Audit, Compliance, and Procedural Completeness Situs expanded its audit function this year by engaging an external firm to conduct annual special servicing audits and semi-annual audits of the primary servicing platform. The primary servicing operation is subject to an annual USAP attestation, but, to this point, has not been required to undergo a Regulation AB attestation. Situs noted that although a Regulation AB examination has not been required for its servicing portfolio, it strives to mirror its cash processing practices according to Regulation AB standards. Furthermore, Situs indicated that it will formally undergo annual Regulation AB examinations beginning in 2013 pursuant to the requirements of its securitized portfolio servicing agreement. Because Situs is the named special servicer on a number of transactions, its special servicing area is already required to have an annual Regulation AB attestation. Situs stated that none of its last five USAP examinations through calendar year 2011 cited any exceptions. The separately commissioned audit of its primary servicing operation began in late 2012 with the results not expected until early However, Situs received an exception-free Service Organization Control Report (SOC) issued in early 2012 that tested cash controls, technology security, and various other operational processes. Situs previously underwent an annual SSAE 16 examination (Statement on Standards for Attestation Engagements No. 16), but elected to replace it with annual SOC audits. Based on our review, the scope of the SOC appears to have many similarities to that of a SSAE 16. The Regulation AB special servicing examination covering calendar year 2011 cited one exception related to the timeframe for reconciling REO bank accounts used by external property managers. An October 2012 special servicing audit contained a few exception items, which Situs has addressed either through minor procedural adjustments or mainly through clarifying statements in its audit response letter. Based on our review of these audits and Situs responses, we concur with Situs that the findings were generally minor in nature. To supplement the internal audit program related to special servicing, the special servicing compliance manager monitors PSA compliance items and asset-level exception items through a monthly tracking report produced with data downloaded from the asset management system. Unlike some other servicers we have ranked, Situs does not yet have any dedicated compliance personnel or a formalized performance metrics testing program for its primary servicing area. However, the company indicated that it plans to establish a dedicated compliance function for primary servicing. It also stated that it intends to implement a corresponding performance metrics testing program once it gains more proficiency with the new servicing system and as it increasingly leverages its functionality to produce timeliness and accuracy tracking reports. Currently, the servicing group maintains a risk matrix of key loan administration tasks that identifies the exact task, the corresponding control activity, the document or report used to evidence control over the task, and the owner of the task. Situs operates with a set of shared network-accessible policies and procedures that it is currently revising for primary servicing to reflect the recent conversion to the new servicing system. The company controls updates and changes through centralized approval processes involving senior management in its primary and special servicing areas, respectively. : In our view, Situs has an effective internal audit function for both primary and special servicing, and we recognize the company s efforts this past year to expand its audit program. We concur with Situs plans to implement a primary servicing compliance function and a formalized performance metrics tracking process. We have observed both of these elements at some other servicers and believe they can strengthen the integrity of a servicing operation. We find that current primary servicing policies and procedures, which still largely reference and reflect the prior servicing system, are adequately documented but less complete than we have observed at other servicers. We understand that Situs expects to have a revised and enhanced set of operating policies and procedures in 2013 based on the new system. Situs personnel have been trained with and can reference a very detailed user manual P a g e 11

12 for the Enterprise! system. In our view, Situs has well-detailed policies and procedures covering all core facets of its special servicing processes and practices, and are well-tailored to address requirements and investor compliance. Legal Liability and Corporate Insurance Situs reported that it was not involved in any pending litigation related to its servicing or special servicing operations. It also reported to us that it has directors and officers (D&O), errors and omissions (E&O), and mortgage impairment insurance coverage in place. As a servicer or special servicer, the company reported that it has not received any notices of PSA default or citations related to performance. : We have reviewed the company s insurance coverage limits and believe they are well within industry guidelines based on GSE seller/servicer requirements. However, as the company s servicing and/or active asset management volume increases beyond $10 billion, it may need to review its current coverage levels. Overall, we believe that the servicer is addressing its enterprise-level insurance coverage in a fully reasonable manner. Based on Situs representations, we are not aware of any material lawsuits related to, or which could negatively affect, its operations. Technology and Disaster Recovery Situs maintains a dedicated information technology division for programming projects, user training and helpdesk, and to coordinate data backup routines and testing. Both the primary and special servicing operations have respective IT staff within their business units. In July 2012, Situs completed its conversion to the PNC Bank/Midland Loan Services-owned and hosted Enterprise! loan servicing system. Through modules in the servicing system, Situs expects to roll out new borrower and investor websites through integrated Enterprise! modules during the first quarter of The servicing system also offers an integrated, electronic document management capability. Enterprise! is not integrated with the company s general ledger accounting software or any front-end loan origination application. However, the entire portfolio is off-balance sheet and Situs is not currently self-originating loans. For special servicing, Situs uses MIDAS, a proprietary asset management system developed by the former Helios operation in MIDAS is CREFC-complaint to address the latest investor reporting package requirements along with functionality to handle workflows and detailed asset-level tracking for and a range of other client-type specifications. The company has made and continues to make various enhancements to the application. As a next step, Situs indicated that it plans to map Enterprise! to MIDAS to facilitate asset transfers for which Situs is both primary and special servicer. The special servicing operation also has a purchased general ledger/real estate accounting application linked to MIDAS. Finally, portfolio managers and special servicing staff have access to Situs Insight, a proprietary web-enabled, customizable commercial real estate market information search engine that sources and catalogues property and market-level data and documents with the ability to integrate data and analytics from public and internal sources. Situs stated that it conducts annual disaster recovery testing and that it completed successful tests for both servicing and special servicing between July and October Alternate sites for data and business recovery are located well beyond 25 miles from their respective primary sites. Situs uses EVault, a Seagate company, as part of its daily, mirrored data-backup routines to primary and alternate servers using Situs locations and the vendor s data center. Situs also maintains a contract with the vendor for full recovery services. The company stated that its disaster recovery capabilities should enable it to restore all core servicing processes within a maximum 24 to 48 hours. The documented disaster recovery/business continuity plan includes a full employee calling tree (last tested in April 2012) and a list of critical external contacts that it updates at least annually. Employees have VPN connectivity to access all network applications remotely. : In our view, Situs has an effective and strengthening technology environment. We believe the conversion to the new servicing system provides a substantial degree of process automation and facilitates data management for primary servicing. Other inprogress technology enhancement and integration projects, such as the forthcoming borrower and investor web portals, also should improve the company s data management and delivery capabilities. As a special servicer, Morningstar believes that Situs operates with excellent technology that supports all aspects of special servicer reporting and accounting, provides comprehensive asset and property-level tracking, can confidently address other investor requirements, and has the scalability to accommodate a large and complex portfolio. Situs stated data backup and disaster recovery protocols for both platforms appear to be quite sound. P a g e 12

13 Primary Servicing Portfolio Administration Table 5: Servicing Concentration by State (June 30, 2012)* State UPB (000s) % (UPB) # Properties % (# Properties) New York 1,973, California 1,000, Florida 634, Texas 498, Nevada 353, Illinois 335, Georgia 255, U.S. Territories 386, Other States and Wash., D.C. 2,567, **3, TOTAL 8,005, ,725 ***99.9 *Situs serviced collateral in all states except Alaska. **Includes one loan comprising more than 1,700 parcels of residential building lots, partially constructed homes, and spec-built homes. ***Less than 100% due to decimal rounding. Table 6: Servicing Volume by Investor Type (June 30, 2012) Investor Type UPB (000s) # Loans % (UPB) % (# Loans) Average Size (000s) Balance Sheet (excludes CRE CDO) Banks/Financial Institutions Securitized (non-) - 1 Deal* 67, CRE CDO (3 Deals) 1,888, ,466 GSE (Fannie/Ginnie/Freddie) Life Insurance Companies - 1 Deal 1,112, ,082 Other Third Party Investors - 29 Deals 4,935, ,646 Held in Warehouse (Pre-securitization) TOTAL 8,005, ,533 *Velocity , a portfolio of small balance CRE loans. Table 7: Servicing Volume by Property Type (June 30, 2012) Property Type UPB (000s) # Loans % (UPB) % (# Loans) Average Size (000s) Healthcare 226, ,143 Industrial 86, ,589 Lodging 1,660, ,636 Mixed Use 368, ,357 Mobile Home Park 840, ,246 Multifamily 745, ,035 Office 1,872, ,182 Retail 1,314, ,069 Self Storage 90, ,008 Warehouse 43, ,737 Defeased Loans Other 755, ,268 TOTAL 8,005, * ,533 *Does not total exactly to 100% due to decimal rounding. P a g e 13

14 Loan Boarding, Hedge Agreements, Letters of Credit, and UCCs During the first half of of 2012, Situs added 163 new loans with a total UPB of approximately $2 billion to the portfolio. The company added another 404 loans with a total UPB of approximately $2 billion to the portfolio in the second half of the year. By comparison, Situs boarded 162 new loans as a primary servicer in New loans have generally come from third party origination channels involving private equity funds and investment banks. As a practice, Situs stated that it can generally board individual new loans within 6 days and board whole portfolios within 14 days with data necessary to conduct payment processing and investor reporting. The company indicated that it could take up to 30 days to fully board a nonperforming loan portfolio because such portfolios tend to have missing data and documentation. To input data to the servicing system, Situs uses loan setup sheets prepared from source files. The parent company s legal department also provides the servicing staff with a summary sheet to input loan-level and PSA-level covenant and trigger requirements for more complex loans. Loan boarding procedures require staff to compare system inputs to source data, and there is a quality control process to validate inputted data. The servicing system performs logic tests and provides exception reports. The portfolio manager assigned to the borrower relationship also conducts a review of source data to the servicing system record. Situs has performed a number of whole portfolio conversions using electronic data mapping processes, which include 10% data integrity samplings for different loan types. Situs noted that it has already boarded a number of new portfolios using the new servicing system. Situs issues borrower welcome letters within one day of an individual loan closing, and issues them on the same day if the loan is being transferred from a prior servicer. Situs noted it does not automatically generate borrower welcome letters through the servicing system. The new servicing system is the main tool used to track borrower compliance items, covenant triggers, and missing documents. Because Situs has acquired a number of distressed portfolios, it tends to have a greater number of missing file documents- particularly UCC statements- than we would typically find with other servicers. The company noted that it formally tracks any outstanding documents or file exceptions. Within 30 days of a loan closing or portfolio acquisition, Situs stated that it reviews the status of outstanding file items, pursues missing documents from investors and outgoing servicers, and will re-file items as needed. Situs images all legal documents and credit files, which the staff can access through a central document repository. The company stated that it does service some loans with interest rate cap or hedge agreements. It also has serviced loans with letters of credit (LOC) as supporting collateral. Such LOCs are stored on-site in a vault with electronic copies accessible through the servicing system, which tracks upcoming expirations. However, the company indicated that it does not formally track credit rating changes of counterparties on its hedge agreements and LOCs. It reported that all letters of credit expiring during the past year were successfully renewed. The loan administration department tracks UCC filing expiration dates via the servicing system and uses a third party vendor to assist with monitoring and filing UCC continuation statements, with system ticklers to alert the company of UCC statements expiring within 90 days. The company reported no lapsed UCC filings during the second half of 2011 and the first half of 2012 related to its own servicing practices. Loan Modification Re-Boarding Activity During the first half of 2012, Situs re-boarded 36 modified loans. It re-boarded 98 modified loans in the second half of Because Situs currently services loans only in one securitized transaction that does not require CREFC-type reporting, it does not receive completed loan modification packages from external special servicers other than from Velocity Capital. As a result, Situs noted that the majority of loan modifications move internally from its own special servicing operation so that it can re-board loan modifications fairly quickly and generally within two days of closing. : Loan boarding practices are, in our view, overall efficient and controlled. We believe that the servicer s targeted timeframe to board core data on new loans is in line with industry norms and best practices. We expect that Situs will steadily realize increased loan boarding efficiency through the new servicing system. In our opinion, Situs has generally proactive administrative practices for hedge agreements, letters of credit, and UCC filings. Based on our understanding of the servicing system and its interfacing capabilities, we believe that Situs should be able to use the system to generate borrower welcome letters and other notices mainly in an automated manner. Payment Processing Situs stated that approximately 95% of all loan payments are received, deposited, and system-posted electronically (lockbox- 60%, wire- 25%, ACH-10%) with either no or minimal manual intervention. Approximately 5% of payments are live checks received at the servicer s street address. All payments are first deposited to a central clearing account and then automatically swept to investor custodial accounts, unless P a g e 14

15 flagged as a suspense or hold item. The payment receipts lockbox (operated through Wells Fargo Bank, N.A.) interfaces directly with the servicing system with loan records refreshed three times per day. Live checks received on-site are centrally logged at their entry point, deposited on-site as scanned copies, and balanced daily to system entries. Payment posting, depositing, and system balancing tasks are segregated among the staff. The servicing system balances payment receipts daily. Situs reconciles clearing and custodial investor (sweep) accounts daily, while it reconciles escrow accounts monthly. Daily reconciliations involve management review and sign-off. As of June 30, 2012, Situs did not report any un-reconciled items aged more than two days in its clearing account. It also did not report any suspense items, including specially serviced loans, aged more than 60 days. A treasury management specialist, under the supervision of the CFO, approves outgoing wire transfers prior to release. Situs noted that its cash movement routines are largely automated through interfaced banking software. As of June 30, 2012, the servicer handled 60 loans with a UPB of $2.25 billion that had cash management agreements (approximately 8% by loan count and 28% by UPB). The total serviced portfolio included 344 floating rate loans with a UPB of approximately $4 billion at June 30, 2012 (approximately 45% by loan count and 50% by UPB). Situs stated that it routinely conducts reviews to validate rate indices. Table 8: Primary Servicing Floating Rate and Cash-Managed Loans UPB(000s) # Loans UPB(000s) # Loans Primary Servicing 8,005, ,430,674 3,793 Floating Rate Loans 3,967, ,718,828 1,706 Cash-Managed Loans* 2,252, ,075, *Active hard lockbox agreements. : In our opinion, Situs has a well-automated and efficient payment processing function as supported by the short aging of suspense items and lack of un-reconciled clearing account items. The company s clear USAP record and its exception-free SOC audit during 2011 also support our positive view of this function. We also believe that Situs is experienced with loans requiring complex cash management. We do observe that its 10% ACH rate is much lower compared to many other servicers. However, this may be attributable to the servicing portfolio having a high distressed loan component and the securitized pool, which comprises small balance loans that tend to have lower ACH participation. Real Estate Tax and Insurance Administration Situs maintains a dedicated nine-person department responsible for tax and insurance administration. This department, whose manager has more than 20 years of servicing experience, handles related escrow account analysis and initiates disbursement requests in conjunction with the company s corporate treasury and accounting group. As of June 30, 2012, Situs had 504 loans, or approximately 66% of all serviced loans, escrowed for real estate taxes. Tax payments are generally remitted within early pay discount periods. The servicing system tracks tax payment due dates and the payment status for all loans whether escrowed or not. A tax service tracks, but does not directly remit, tax payments to tax authorities for escrowed loans. The tax service also reports unpaid taxes on non-escrowed loans. For non-escrowed loans, Situs uses the servicing system through a mail merge process to automatically send delinquent tax notices to borrowers and track delinquent taxes until paid. During the second half of 2011, it incurred nonreimbursable tax penalties in connection with 11 loans and the aggregate penalty amount of $15,233 was 0.04% of the total funds disbursed. In the first half of 2012, Situs had a single, $45,304 tax penalty occurrence, which equaled 0.13% of all tax funds disbursed. As of June 30, 2012, the company had 221 loans, or approximately 29% of all serviced loans, escrowed for insurance. Situs manages insurance administration completely in-house and does not use external insurance consultants to assist with policy reviews. The servicing system tracks policy expirations, required coverage, and coverage amounts. Loan administrators also manage disbursement requests electronically through the servicing system. Situs stated that it issues policy renewal reminder notices to borrowers and their insurance agents at 60 days, 30 days, and then 10 days before expiration to request new policies. All insurance notices are generated through servicing system prompts using a mail merge procedure. The company reviews insurance carrier ratings annually or prior to renewal for compliance. It reported 142 loans (19% of all serviced loans) on its forced-placed policy, which automatically provides for a full year of retroactive coverage. The forced-placed insurer is Great American Assurance Company, which has a financial strength rating of A with a Positive outlook, and an issuer credit rating of a+ with a Positive outlook by A.M. Best. P a g e 15

16 : In our opinion, real estate tax and insurance administration is soundly managed and proactive. Our assessment is based on Situs overall very low tax penalties relative to the portfolio size, its effective use of a tax service, and internal practices to track payments, obtain policy renewals, monitor coverage provisions, and notice borrowers. We recognize that because Situs services some distressed loan pools, its forced-placed activity may be higher than that of some other servicers. We view the forced-placed policy s automatic one-year retroactive coverage provision as exceeding industry standards. Capital Expenditure Reserve Management Portfolio managers in the asset administration department work in conjunction with asset administrators to review and release capital reserve requests. The company tracks reserve account escrows and controls disbursement activity through the servicing system. Management must review and approve all reserve account disbursement requests. Situs generally handles reserve accounts similar to construction loan draws by requiring backup invoices, approved line item budgets, lien waivers, and pre-funding inspections. As part of the supplemental services it provides to certain investors, Situs also performs capital reserve account analyses and disbursements for certain loans in which it may not be the full or named servicer. : In our opinion, Situs has sound oversight controls and analysis practices for capital expenditure reserve management. We expect that the functionality of the new servicing system also may facilitate this function for Situs. Investor Reporting and Accounting Situs assigns a portfolio manager to every investor client relationship. The company currently performs trustee remitting and reporting for one securitized portfolio of small balance mortgage loans which does not require advancing or CREFC-formatted reporting. It also has investor accounting/reporting responsibilities for three CRE CDO transactions and for various other institutional investors and fund owners with investment positions that include whole loans, mezzanine debt, B-notes, and. While the company is in the process of implementing a new investor web portal, investors currently have access to Situs digital online repository to access loan documents, financial statement analyses, remittance information, and other portfolio performance reports. Investor remittance and reporting tasks require management approval. The company tracks custodial banks credit ratings for servicing agreement compliance. It segregates investor report preparation, investor remittance, and account reconciliation tasks. It also requires a secondary level of review and sign off for custodial account reconciliations. Employees may access on-line custodial account activity, and Situs noted that the investor reporting and custodial bank account reconciliation processes are largely automated. Bank account activity is balanced daily, with reconciliations performed daily and more formally at every month end. During the second half of 2011 and the first half of 2012, the company reported no unidentified items in custodial accounts aged more than 60 days. During 2011and the first half of 2012, Situs reported no occurrences involving remittance recalculations and subsequent restatements of investor reports. : In our view, Situs has a well-automated and controlled investor reporting and accounting function with sound practices for accurate and timely reporting that can address a range of investor requirements. We also believe that the company s recent implementation of the new servicing system and its planned rollout of a new investor web portal in early 2013 enhance its investor reporting capabilities. Financial Statement Analysis and Property Inspections Assigned portfolio and asset managers in the asset administration department are responsible for financial statement tracking and collection, line item spreading and analysis, the preparation of related investor reports, and borrower compliance. The majority of loan documents require borrowers to submit quarterly financial statements. The company primarily uses the features of the servicing system to manage these activities. Situs uses an offshore-based company, Silverskills, to support these tasks. The vendor has no direct interaction with borrowers and is not empowered to make any credit-related decisions. The vendor has minimum performance standards it must meet related to timeliness and accuracy. Situs noted that analysts on average can spread statements and complete OSARs (operating statement analysis reports) for about four properties per day, which appears to be a lower number than reported by some other higher volume servicers we have ranked. However, Situs noted that it can usually spread and analyze a property operating statement within one to two days of receipt. Situs provides a tenant rollover risk analysis for 100% of the tenants with every OSAR, which requires a portfolio manager review before submission to a client. For some loans, Situs stated that it is required only to receive statements and forward them to the investor. Situs also noted that the Velocity portfolio of small balance loans generally does not require borrowers to submit property operating statements. However, Situs stated that starting in 2013 in accord with its servicing agreement, it will attempt to collect and analyze statements on Velocity loans. P a g e 16

17 Table 9: Full Year Financial Statement Collection Rates* Statements Received 95% by May 31 98% by June 30 Statements Spread and Analyzed** 95% by May 31 98% by June 30 *Excludes the Velocity portfolio which does not have financial statement submission requirements. Portfolio and asset managers also oversee the property inspection process and analyze results. Situs stated that it uses a national vendor for approximately 90% of property inspections, with the remainder handled in-house. Generally, all loans with balances of $250,000 or greater require annual inspections unless waived by an investor. Between July 2011 and June 2012, Situs obtained 99% of all required property inspection reports by or within 30 days of their due dates. The servicing system tracks and maintains links to the imaged inspection reports. The system also tracks the nature and resolution status of deferred maintenance issues. Borrowers receive notices to resolve deferred maintenance issues within one month and usually within two weeks, with a follow-up letter sent approximately one month later. Watchlist, Trigger Events, and Early Stage Collections Situs asset administration department has dedicated portfolio managers assigned to every borrower relationship to monitor credit performance and trigger events, provide ongoing asset status comments, and prepare more detailed quarterly asset-level and transaction-level reports. The asset administration department also oversees the loan watchlist and coordinates asset transfers to the corresponding special servicer, which is Situs own special servicing operation for the majority of the current portfolio. Situs has defined watchlist criteria that generally reflect the CREFC guidelines, although none of Situs current assignments requires the submission of watchlists strictly in the CREFC reporting format. In addition to weekly client updates on watchlisted loans and submitting monthly investor reports, Situs prepares quarterly asset reports to cover assets in greater detail. The servicing system can flag loans for watchlist inclusion based on financial statement reviews, inspections, and other defined qualifiers and thresholds. The servicer attempts to contact the borrower by telephone and issues its first notice within one day after a missed payment. Situs issues a second collection/late charge assessment notice 15 days after the due date. Situs stated that it currently does not use the servicing system to automatically generate collection notices. The servicing system tracks loan-level trigger events and covenant exceptions, and the status of their resolution. Loans failing established trigger tests are escalated to asset and portfolio managers for resolution. For the period of July 2011 through June 2012, Situs reported that no loans had their springing lockbox provisions triggered. As of June 30, 2012, Situs reported 207 loans, or 27% of the portfolio, on its watchlist. Comparatively, Situs had a much higher 53% of its portfolio on its watchlist as of December 31, 2011, which corresponded to the nature of the Colony Capital assets that were still in the portfolio at that time. Portfolio Management: Supplemental Surveillance and Servicing Activities Situs provides shadow servicing and specialized portfolio management services to investors for certain large loans, including warehouse and loans, in which it is not the named servicer. These services include supplemental asset reviews and surveillance reporting, and carveouts to perform other designated asset administration tasks such as reserve account/draw request analysis and administration, debt service coverage ratio (DSCR) reviews, covenant /trigger event monitoring, lease reviews, and certain other consents. Table 10: Supplemental Portfolio Management Activity (as of September 30, 2012) # Loans UPB(000s) Specialized Surveillance/Asset Administration 29 2,374,780 Warehouse Loan Reviews 98 2,319,052 P a g e 17 : We consider Situs to have effective practices covering financial statement analyses, property inspection reviews, covenant compliance/trigger event tracking, and watchlist management. We believe that overall it has very proactive credit event monitoring practices to identify and report loan-level and portfolio-level performance risks. However, in our view, we consider it a best practice for a servicer to attempt to collect and analyze financial statements for all serviced loans. We note that the company s stated $250,000 minimum loan size for annual property inspections denotes a proactive process and is much lower than the customary industry threshold of $2 million. Morningstar also views Situs submission of detailed quarterly asset reports to its investors as an indication of the company s efforts to provide clients

18 with added value. We also believe that the new servicing system should facilitate the tracking of trigger events and other credit issues. In our view, the company has the capabilities to conduct -centric portfolio management tasks, such as appraisal reduction (ASER) and advance recoverability analyses, and provide CREFC-compliant reporting. Borrower Consents and Requests Analysts in the asset administration department analyze borrower consents and requests such as assumptions, partial releases, and new lease/snda (subordination, non-disturbance and attornment agreement) reviews. They prepare case write-ups which require asset manager and department head approval before submission to investors for their review and approval. Besides handling consents within its own servicing portfolio, Situs, through another business unit, provides loan assumption underwriting services to other servicers. Situs currently uses some stand-alone case templates for certain consent types, and stated that it is implementing the workflow tracking features of the new servicing system to assist with consent request management. Situs also stated that it will be evaluating how to leverage and integrate its systems to automate certain aspects and streamline the preparation of consent analysis cases. The loan boarding staff receives a file maintenance form to input changes to the loan record using similar procedures and controls as those for boarding new loans. Through the first nine months of 2012, Situs reported that it completed 86 consent reviews, with an average turnaround time of less than 10 business days upon receipt of all required borrower documentation. Because Situs is not a servicer, it has not completed any defeasances. Table 11: Borrower Consent Average Processing Times (Days)* First Half 2012 Second Half 2011 Consent Type # Processed Internal Time Only ** Time # Processed Internal Time Only ** Time Assumptions 1 14(19)* Leasing 11 8(14)* Defeasance 0 n/a n/a 0 n/a n/a Partial Releases 74 4(23)* Processed/ Overall Average Time *Numbers in parentheses represent the average internal times of five Morningstar-ranked servicers excluding Situs. ** time equals internal time plus any third party review time. : In our opinion, Situs has sound control practices to analyze and approve borrower consents. Although we view the company s currently documented policies and procedures for consent reviews as less complete compared to some other servicers we have assessed, we understand that Situs may be addressing this as part of its in-progress project to update its entire body of policies and procedures. Overall, we believe the company proactively responds to consents, has diligent analytics and knowledgeable staff for this function, and has experienced very reasonable turnaround times based on a still relatively moderate volume of activity. Situs processing times appear to be generally faster compared to the averages of some large volume servicers. Tables 12-14: Primary Servicing Portfolio Delinquency Detail In recent years, Situs acquired a number of servicing assignments comprising distressed loan portfolios. As a result, its loan delinquencies have been well above those of many other servicers and industry averages. The sharp drop in delinquency rates between December 2011 and June 2012 is largely attributable to the transfer of the Colony Capital loans out of the servicing portfolio. P a g e 18

19 Table 12: Historical Delinquency Percentages UPB # Loans UPB # Loans UPB # Loans 30 Days Days Days* TOTAL *90+ delinquencies include any REO. Table 13: Delinquency Percentages by Investor Type (June 30, 2012) 30 Days 60 Days 90+ Days* UPB # Loans UPB # Loans UPB # Loans Balance Sheet Banks/Financial Institutions Securitized (Velocity ) CRE CDO GSE (Fannie /Freddie/FHA-Ginnie) Life Insurance Companies Other Third Party Warehouse/Pre-Securitized TOTAL *90+ delinquencies include any REO. Table 14: Delinquency Percentages by Property Type (June 30, 2012) 30 Days 60 Days 90+ Days* UPB # Loans UPB # Loans UPB # Loans UPB # Loans Healthcare Industrial Lodging Mixed Use Mobile Home Park Multifamily Office Retail Self Storage Warehouse Other TOTAL *90+ delinquencies include any REO. P a g e 19

20 Special Servicing Administration As of June 30, 2012, Situs was the named special servicer on 29 transactions containing 2,439 loans with an approximate UPB of $28.7 billion. This total included 13 transactions with an aggregate remaining $25.2 billion UPB and 1914 loans, the Hanover Street Capital portfolio (251 assets and $1.4 billion by UPB), and some other non-, third party investor-owned pools (274 assets and $2 billion UPB). The company s total active special servicing portfolio contained 658 assets consisting of 585 loans and 73 REO with a combined UPB of approximately $5.3 billion. Approximately 28% by count and 50% by UPB of the actively managed assets were contained in. Table 15: Special Servicing Portfolio - Named and Active Assets (June 30, 2012) UPB (000s) # Assets As Named Special Servicer: 25,208,625 1,914 Hanover Street Capital 1,421, Other 3 rd Party Investors 2,051, TOTAL 28,681,517 2,439 Actively Managed Assets: 2,877, Hanover Street Capital 1,421, Other 3 rd Party Investors 999, TOTAL 5,299, Charts 1-4: Active Special Servicing Portfolio by Property Type Percentages (June 30, 2012) Chart 1: Loan Portfolio (by # Loans)* Chart 2: Loan Portfolio (by UPB)* Other 14.9% Co-operative 0.2% Retail 17.1% Healthcare 0.2% Industrial 8.9% Lodging 10.1% Mixed Use 7.0% Other 9.3% Co-operative 0.3% Retail 14.8% Healthcare 0.1% Industrial 5.0% Lodging 22.8% Office 18.5% Multifamily 23.2% Office 28.5% Multifamily 17.0% Mixed Use 2.1% P a g e 20

21 Chart 3: REO Portfolio (by # Properties)* Chart 4: REO Portfolio (by UPB) Retail 23.3% Other 17.8% Industrial 2.7% Lodging 9.6% Multifamily 27.4% Mixed Use 4.1% Retail 23.6% Other 18.3% Industrial 3.0% Lodging 5.1% Mixed Use 3.8% Multifamily 25.9% Office 15.1% Office 20.3% *Charts 1-3 do not total exactly to 100% due to decimal rounding. As of June 30, 2012, Situs classified approximately 10% of its specially serviced loan portfolio by loan count and 20% by UPB as performing. The median loan UPB was $1.9 million, while the average loan UPB was $8.0 million ($15.7 million for ). For the unsold REO, the median balance was $5.3 million and the average balance was $8.4 million ($11.8 million for ). Approximately 85% of the non-performing loans and REO were aged more than six months. Of those assets aged more than six months, the average aging was 24 months and the median was 21 months. Table 16: Aging of Active Non-Performing Loans and REO (June 30, 2012) Assets Aged > 6 Months Average Time in Special Servicing (Months)* Median Time in Special Servicing (Months)* NPLs and REO 85% (132 of 155 assets) NPLs Only 81% (96 of 119 loans) *For non-performing loans and REO aged more than six months. Asset Review Process The special servicing compliance manager receives new loan transfers from Situs primary servicing group or from external servicers. Upon the transfer of assets to special servicing, loan asset managers, in collaboration with asset analysts, conduct full file reviews (including a review of an online PSA abstract), order property inspections, and complete new asset transfer checklists. Through their initial file reviews, asset managers are expected to formulate potential recovery options and strategies. Before engaging in any workout discussions, Situs requires that borrowers sign pre-negotiation agreements. Asset managers prepare and obtain approval of initial asset recovery and business plans generally within 90 days or sooner of a loan transfer. Asset managers submit an updated asset business plan as an approval request case before initiating foreclosure or requesting a courtappointed receiver, when they have negotiated specific resolution terms, or before committing to other major asset decisions. Initial business plans and updated cases include a net present value (NPV) analysis of each alternative resolution scenario. Situs stated that it typically pursues a dual track resolution strategy. Asset managers are expected to form asset value opinions using multiple market sources, and recommend actions that are based on pursuing the highest net present value recovery for trusts or investment entities as a whole. The company s procedures also address handling loans involving borrower bankruptcy filings. P a g e 21

22 Asset managers must follow documented delegations of authority to obtain approvals of business plans and cases. Based on established authority delegations, the majority of plans, cases, and resolution decisions require asset managers to obtain internal approval through their team leaders and a formal senior management investment committee that convenes at least weekly. For assets, Situs stated that it formally monitors master servicers outstanding advances against property values and expected recovery amounts. The company has formal policies and procedures to interact with master servicers, and stated that it routinely consults with master servicers on their advancing decisions. Situs uses its proprietary asset management system, MIDAS, to prepare business plans and cases, to electronically control approvals, and to serve as the central tracking tool to manage the life cycle of each specially serviced asset. : Morningstar considers Situs to have proactive and controlled asset analysis, workout, and recovery practices based on its stated policies and procedures, which we find to be very inter-related with the highly functional asset management system. We believe that the company s formal committee process represents a best practice for controlling asset resolution approvals and other major decisions. We agree with Situs that its inclusive committee meetings also serve a training function. In our view, Situs has proactive procedures to coordinate asset transfers from and discuss advancing decisions with master servicers. Finally, we believe that Situs stated procedures soundly reflect diligent asset management practices to address a variety of asset types having complex structures, and we believe that Situs has been steadily building significant experience and success in this regard. REO Property Management The loan asset manager prepares a preliminary 90-day budget as part of the required business approval case to complete a foreclosure action and take title to the property. During the two to four weeks before a foreclosure date, the loan and REO asset managers are expected to discuss immediate property issues and finalize choices for the property management company and listing broker. The loan asset manager prepares and circulates a pre-foreclosure checklist to the REO asset and compliance managers at least 10 days in advance. Twice per month, the compliance manager also distributes a foreclosure pipeline report. Once a loan becomes an REO asset, the REO asset manager prepares and obtains approval of an REO business plan, with subsequent REO cases submitted to obtain approval of specific sales offer terms or other major decisions. Situs noted that it has revised its policy and now requires that asset managers complete and obtain approval of their initial REO business plans within 120 days rather than 90 days of taking title. Situs uses single trust accounts rather than separate rent collection and expense accounts for REO property management. It receives monthly operating statements and property performance reports from external property managers, and stores that information in shared network drive folders. The company has dedicated REO asset analysts who, along with the assigned asset managers, review monthly property manager reporting packages. REO analysts perform monthly reconciliations of property manager bank accounts, and then provide asset managers and the compliance manager with an updated control report containing system-downloaded data that tracks completed property manager financial package reviews and year-to-date net operating income. Situs requires property managers and brokers to use its own standardized engagement agreements. It also provides property managers with a set of specific reporting requirements. Except for one occasion in 2009, Situs does not routinely conduct independent audits of its property management companies. : In our view, Situs has proactive practices to acquire and manage REO properties, along with overall sound controls to oversee REO property managers, brokers, and their respective monthly reporting. We believe the manner in which Situs formally monitors property performance and reconciles monthly property manager operating accounts, which involves a dedicated, experienced REO analyst working with the respective asset manager, is essentially tantamount to the usual practice of involving an REO accountant. Although Situs has a fairly sizable REO portfolio, it does not routinely conduct property manager audits. We usually observe our highest ranked special servicers having formal and active property management company audit practices. Additionally, we believe that Situs changed policy of lengthening the time period to complete initial REO business plans to 120 days is a longer than usual time frame, particularly given Situs stated pre-acquisition preparation work, and contrary to best practices. Vendor Oversight Situs stated that it plans to establish a centralized vendor contracting unit in early 2013, and that it is now training a person for this role. The company maintains a central list of approved vendors for such needs as appraisals, environmental and engineering assessments, legal counsel, property management, and brokerage services. It also stated that it generally conducts a request for a proposal (RFP) bidding process to engage a vendor. For almost all engagements, Situs requires vendors to use Situs own standardized agreements. For appraisals, Situs generally uses its affiliate, Valuation Analytics, to engage appraisers and then review their submissions. For environmental assessments, Situs contracts with one firm to obtain bids and review submitted reports. Situs does not have an in-house legal staff. Instead, it relies on one external firm for general counsel and to assist with hiring local law firms. Asset managers, along with their team leader, review and approve legal invoices prior to P a g e 22

23 payment. Situs centrally tracks all pending and completed vendor work orders through the asset management system. The company also maintains vendor performance ratings in the system as part of managing the approved lists. : In our view, Situs has soundly managed and generally efficient vendor management practices. We believe that the company s plan to establish a centralized unit for all vendor engagements should benefit the organization with added efficiency and increased control over the procurement process. Although Situs does not have any dedicated in-house legal staff for special servicing, we believe that the company engages and oversees external legal counsel in a controlled manner overall. However, we have observed that many special servicers find it beneficial to have a dedicated, in-house legal unit, which can serve as an internal resource for asset managers, participate in the resolution approval process, and assist with engaging/overseeing external counsel. Managing Conflicts of Interest Situs is the special servicer on transactions in which Ranieri Partners, the principal owner of Situs, and another affiliated investor respectively hold first loss positions and serve as the controlling class representative (CCR). Accordingly, we reviewed Situs stated asset management practices and assessed its resolution results in this context. Situs, as a special servicer, stated that it does not use affiliates for property management. It currently uses an affiliate broker for one, non- asset and expects such occasions to be infrequent and not likely to involve assets. Although it uses an affiliate to order and review third party property valuations, Situs indicated that it would not involve that firm to review appraisals if itself or an affiliated investor ever sought to acquire an asset out of the trust such as by exercising a fair market value purchase option. To date, Situs stated that its ownership principals have not purchased any assets out of the respective pools. Situs also stated that it does not seek an additional fee from the trust if it has already obtained an equivalent fee from the borrower and the collection of such a fee from the trust would create or increase a loss to a trust. To address new disclosure requirements in the investor reporting package (IRP) for special servicers with respect to their using affiliates and reporting loan modifications, Situs noted that it has enhanced its system with additional data fields and reporting capabilities. : In our view, Situs prudently manages its inherent conflicts of interest relative to involving affiliated parties in its asset resolution work and maintaining the servicing standard in its asset recovery practices and decision-making processes. Asset Resolution and Recovery Performance During the 18 month period between January 2011 and June 2012, Situs resolved 223 loans: 42% through discounted payoffs (DPO), 38% through restructures, 9% through individual note sales, and 11% through full payoffs. It also sold 26 REO properties. Approximately 65% of all asset resolutions in this period were in transactions. The average loan resolution time frames ranged between 14 to 21 months with restructures generally taking longer than other resolution types. The average REO disposition time was 17 months in 2011, and approximately 14 months for sales in the first half of Additionally, total REO net sales proceeds were approximately 130% of Situs stated property values for 2011 sales and approximately 91% of Situs stated property values for first half 2012 sales. The company s loan resolutions for the first half of 2012 equated to approximately 16% of its beginning year loan inventory, and its REO sales equated to approximately 18% of its beginning year REO inventory. During 2011, Situs realized loss severity for liquidated assets averaged approximately 48%, and its average loss for all resolved assets including modifications and full payoffs having no loss, was approximately 23%. During the first half of 2012, Situs average realized loss severity for liquidated assets was approximately 35%, and approximately 16% based on all resolved assets. On a weighted average basis, we calculated that Situs realized losses were approximately 39% for 2011, and approximately 25% for the first half of Between January 2011 and June 2012, approximately 95% of all resolved assets were in transactions involving bondholders having an ownership affiliation with Situs. The majority of resolutions have involved loans in issued between the years 2004 to Situs stated that it has been doing fewer workouts using A/B note structures in the past year, but indicated that it expects one of its B notes to pay off in full soon. The company also stated that it has resolved some assets through receivership sales with a corresponding loan assumption/modification. P a g e 23

24 Tables 17-19: Special Servicing Loan Portfolio Activity (January June 2012) Table 17: Special Servicing Loan Portfolio Activity (First Half 2012) $ Vol(Mil) # Loans # Props $ Vol(Mil) # Loans # Props Loan Portfolio at Beginning of Period 3, , Loans Transferred Into Portfolio: Re-Transferred/Re-Defaulted Loans Pre-Existing from Another Special Servicer New Non-Monetary/Imminent Default Transfers New Monetary Default Transfers 1, Transfers Into Special Servicing 1, Loans Resolved or Transferred Out: Modified or Corrected Loans (405.7) (23) (21) (405.7) (23) (21) Completed Foreclosures and Converted to REO (135.5) (25) (25) (78.7) (10) (10) Individual Note Sales (58.0) (12) (20) (1.4) (1) (5) Discounted Payoffs (excludes note sales) (112.2) (21) (23) (51.3) (6) (11) Full Payoffs (126.5) (12) (15) (68.0) (5) (7) Loans Resolved and Foreclosed (837.9) (93) (104) (605.1) (45) (54) Net Adjustments and Other Loans Transferred Out (14.8) (5) Loan Portfolio at End of Period 4, , Average Loan Size at End of Period* Performing Loans Within at End of Period (20%) Table 18: Special Servicing Loan Portfolio Activity (Second Half 2011) 56 (10%) (30%) 32 (21%) $ Vol(Mil) # Loans # Props $ Vol(Mil) # Loans # Props Loan Portfolio at Beginning of Period 5, ,242 1,418 3, Loans Transferred Into Portfolio: Pre-Existing from Another Special Servicer New Non-Monetary/Imminent Default Transfers New Monetary Default Transfers Transfers Into Special Servicing Loans Resolved or Transferred Out: Modified or Corrected Loans (879.3) (34) (160) (711.5) (25) (24) Completed Foreclosures and Converted to REO (220.1) (30) (31) (193.4) (14) (14) Individual Note Sales (41.6) (8) (7) (3.1) (2) (2) Discounted Payoffs (excludes note sales) (306.3) (32) (30) (259.7) (13) (14) Full Payoffs (138.9) (8) (6) (135.7) (3) (3) Rep. and Warranty Claim Settlements (0.5) (3) (3) Loans Resolved and Foreclosed (1,586.7) (115) (237) (1,303.4) (57) (57) Net Adjustments and Other Loans Transferred Out* (617.9) (773) (819) (0.1) (2) 0 Loan Portfolio at End of Period 3, , Average Loan Size at End of Period Performing Loans Within at End of Period (24%) 72 (17%) (28%) 45 (29%) P a g e 24

25 Table 19: Special Servicing Loan Portfolio Activity - Helios Only (First Half 2011) $ Vol(Mil) # Loans # Props $ Vol(Mil) # Loans # Props Loans Transferred Into Portfolio: 3, , Pre-Existing from Another Special Servicer New Non-Monetary/Imminent Default Transfers New Monetary Default Transfers Transfers Into Special Servicing 1, Loans Resolved or Transferred Out: Modified or Corrected Loans (233.9) (28) (26) (233.9) (28) (26) Completed Foreclosures and Converted to REO (129.4) (13) (13) (125.1) (11) (11) Individual Note Sales Discounted Payoffs (excludes note sales) (240.8) (41) (40) (204.3) (32) (31) Full Payoffs (381.9) (4) (3) (381.6) (3) (2) Loans Resolved and Foreclosed (986.0) (86) (82) (944.9) (74) (70) Net Adjustments and Other Loans Transferred Out (97.7) 0 (1) (97.7) 0 (1) Loan Portfolio at End of Period* 3, , Average Loan Size at End of Period* Performing Loans Within at End of Period 1,277.6 (32%) 88 (22%) Tables 20-22: Special Servicing REO Portfolio Activity (January June 2012) Table 20: REO Portfolio Activity (First Half 2012) 1,052.3 (32%) 47 (25%) $ Vol(Mil) # Properties $ Vol(Mil) # Properties REO Portfolio At Beginning of Period Assets Already REO when Acquired Completed Foreclosures REO Sold During Period (60.2) (11) (57.8) (7) Other REO Transferred Out (0.9) (1) 0 0 Other Adjustments (23.8) (1) (20.9) 0 REO Portfolio At End of Period Average REO Size Table 21: REO Portfolio Activity (Second Half 2011) $ Vol(Mil) # Properties $ Vol(Mil) # Properties REO Portfolio At Beginning of Period Assets Already REO when Acquired Completed Foreclosures REO Sold During Period (74.4) (6) (74.4) (6) Other REO Transferred Out Other Adjustments (4.6) 0 (4.6) 0 REO Portfolio At End of Period Average REO Size P a g e 25

26 Table 22: REO Portfolio Activity - Helios Only (First Half 2011) $ Vol(Mil) # Properties $ Vol(Mil) # Properties REO Portfolio At Beginning of Period Completed Foreclosures REO Sold During Period (59.3) (9) (57.0) (8) Other Adjustments (0.7) (1) (0.7) (1) REO Portfolio At End of Period Average REO Size Table 23: Asset Resolution Performance (January June 2012)* First Half 2012 Year Ended 2011 Net Net Net Proceeds/ Proceeds/ **Avg Time Net Proceeds/ Proceeds/ Value (%) UPB (%) (Months) Value (%) UPB (%) **Avg Time (Months) Resolution Type Loan Modifications n/a n/a 20.8 (20.5) n/a n/a 15.3 (14.1) Individual Note Sales (15) Included in discounted payoff metrics Discounted Payoffs (13.2) (13.2) Full Payoffs (7.3) (7.8) REO Dispositions** 37.2 (Avg realized loss) 13.6 (25) (Avg realized loss) 17.4 (26.7) 91.0 Completed Foreclosures n/a n/a 14.3(12.9) n/a n/a 14.2 (11.1) *Based only on period Situs served as special servicer. **Based on time held as an REO. Numbers in parentheses represent median time, except for REO sales which is the total time asset was in special servicing at Situs DPO metrics include note sales. Chart 5-6: Special Servicing Resolution Type Percentages (January June 2012) Chart 5: Resolution Type Percentages by UPB Chart 6: Resolution Type Percentages by Asset Count Converted to REO 14% Modified 42% Full Payoffs 18% Sold REO 5% Modified 27% Converted to REO 21% Sold REO 8% Discounted Payoffs 18% Discounted Payoffs 30% Note Sales 3% Note Sales 6% Full Payoffs 8% P a g e 26

27 Charts 7-8: Average Loss Severity on Liquidated Assets vs. Morningstar Data* January - December 2011 January - June % 50% 40% 30% 20% 48% 47.9% 22.5% 40% 30% 20% 43.5% 34.7% 10% 10% 15.7% 0% Morningstar Realized Losses** Situs Realized Losses** Situs Losses (All Resolutions) 0% Morningstar Realized Losses** Situs Realized Losses** Situs Losses (All Resolutions) *Source: Morningstar Monthly Delinquency Reports. **Unweighted average. Includes liquidated loans, sold REO, and full payoffs with trust losses, and excludes restructured loans and full payoffs having no trust losses. : In our view, Situs achieved very successful asset recovery results between January 2011 and June 2012, based on net recovery proceeds relative to collateral values. We also find that its average completion times based on all resolutions were generally in line with some other special servicers we have ranked although its average times for completed loan modifications and REO sales may be somewhat longer by comparison. We recognize that the company, despite increased volume and predominantly handling assets in issued between the 2004 to 2007 period, achieved realized losses, especially for REO, that were generally in line with, and very often lower, compared to the industry averages reported by Morningstar. While Situs achieved loan resolutions through a variety of methods, we observe that it was particularly successful with discounted payoffs, which accounted for almost one-third of all loan resolutions (by count) and generally yielded high net recovery-to-value percentages. We believe that the company s steadily increasing record of asset resolution achievement, which includes many complex credits covering a range of property types, dovetails with our view that it has proactive, controlled practices led by a well-seasoned management and professional team. Although Situs did not provide Morningstar with data on its incurred legal fees on resolved assets, we surmise that Situs generally has been effectively controlling its legal expenses considering the company s comparatively low overall realized losses. Investor and Master Servicer Reporting The special servicer s compliance unit oversees communication with investors and external master servicers in conjunction with a dedicated special servicing investor reporting team. We believe that Situs procedures and asset management system address the company s formal reporting requirements as a special servicer and monthly CREFC-compliant reporting content including asset status updates, submitting additional information on completed asset resolutions, tracking property protection advances, submitting updated appraisals and assisting with ASER calculations, computing realized losses, and communicating with master servicers on imminent transfers and pending asset resolution decisions. Situs also noted that it has been steadily customizing its system and procedures to cover reporting requirements for its non- portfolios. Morningstar calculated that approximately 77% of all unresolved assets as of June 2012 had appraisals aged less than one year based on data provided by Situs. : We believe that Situs, principally through its merger with the former Helios platform, is fully experienced with and has effective special servicer-related reporting capabilities to address and other investor type reporting requirements. Morningstar believes that Situs also is suitably positioned in its reporting capabilities to address the additional disclosure and reporting requirements now expected from special servicers with respect to their use of affiliates and providing information on completed resolutions. P a g e 27

28 Ranking Definitions The numerical scale of MOR CS1 to MOR CS4 is defined as follows: 1 Exceeds prudent loan servicing standards in key areas of risk 2 Demonstrates proficiency in key areas of risk 3 Demonstrates compliance in key areas of risk 4 Demonstrates lack of compliance in one or more key areas of risk A servicer assigned a ranking of at least MOR CS3 is deemed to comply with what we view as the minimum prudent loan servicing standards and requirements for the servicer s operational category and role. To access Morningstar s Operational Risk s of Commercial Servicers: Methodology and Process, please visit Disclosures The material contained herein (the Material ) is being distributed in the United States by Morningstar Credit Ratings, LLC ( Morningstar ) and is solely for informational purposes, and should not be considered a solicitation to buy or sell any security. THE MATERIAL PROVIDED IS AS IS AND NOT SUBJECT TO ANY WARRANTIES, EXPRESS OR IMPLIED, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. Morningstar does not undertake to update any information or opinions contained in the Material. From time to time, Morningstar and its affiliates and/or or their officers and employees may perform other services for the company and/or its affiliates mentioned in the Material. Morningstar rankings, forecasts, and assessments contained in this Material are evaluations and opinions of non-credit related risks, and therefore, are not credit ratings within the meaning of Section 3 of the Securities Exchange Act of 1934 ( Exchange Act ) or credit ratings subject to the Exchange Act requirements and regulations promulgated thereunder with respect to credit ratings issued by nationally recognized statistical rating organizations. The past performance of the companies described in this Material is not necessarily indicative of the future performance. While Morningstar obtains information for its assessment contained from sources it believes are reliable, Morningstar does not audit the information it receives from third-parties in connection with its assessment and rankings contained in these Materials, and it does not and cannot independently verify that information, nor is such information subject to any warranty, guaranty, or representation. Certain assumptions, including, but not limited to, an assumption that the information received from third-parties is complete and accurate, in connection with its assessment, may have been made by Morningstar in preparing the Material that has resulted in the opinion provided. For more information about Morningstar s assessment methodology, please visit This Material, and the rankings and forecasts contained herein, represent Morningstar s opinion as of the date of this Material, and thus are subject to change and should not be viewed as providing any guarantee. In no event shall Morningstar be liable to any party for any direct, indirect, incidental, punitive, special or consequential damages, costs, expenses, legal fees or losses in connection with any use of the Material, even if advised of the possibility of such damages. The Material may not be reproduced, modified, or distributed in any form without the prior written permission of Morningstar. Morningstar Credit Ratings, LLC, 410 Horsham Road, Suite A, Horsham, PA (800) P a g e 28