Pooling and Servicing Agreement

Definition of a Pooling and Servicing Agreement (PSA)

A Pooling and Servicing Agreement (PSA) is a foundational legal document in the Commercial Mortgage-Backed Securities (CMBS) market. It is a multi-party contract that governs the management, administration, and distribution of cash flows from a pool of commercial mortgage loans that have been securitized into bonds. Essentially, the PSA serves as the "rulebook" for the life of the securitization trust, defining the rights and responsibilities of the various parties involved, including the Trustee, the Master Servicer, the Special Servicer, and the Certificate Administrator.

Detailed Description of the PSA in Commercial Mortgages

When a group of commercial mortgages is bundled together to create a CMBS, they are transferred into a Real Estate Mortgage Investment Conduit (REMIC) trust. The PSA is the primary document that dictates how this trust operates from the closing date until the final loan is paid off or liquidated. Below are the core components and functions of a typical PSA:

1. The Flow of Funds (The Waterfall)

One of the most critical aspects of the PSA is the payment waterfall. It specifies the exact order in which principal and interest payments collected from borrowers are distributed to the different classes (tranches) of bondholders. The PSA ensures that senior bondholders are paid first, followed by subordinate classes, according to the credit enhancement structure of the deal.

2. Roles of the Servicers

The PSA distinguishes between the different types of loan servicing required throughout the life of the pool:

• The Master Servicer: Responsible for day-to-day loan administration, including collecting monthly payments, managing escrow accounts, and providing regular reporting to the trust.
• The Special Servicer: Takes over the management of loans that have defaulted or are in "imminent default." The PSA grants the Special Servicer the authority to negotiate loan modifications, work-outs, or proceed with foreclosure and the management of Real Estate Owned (REO) property.

3. The Servicing Standard

The PSA mandates a Servicing Standard, which is a high level of care that the servicers must adhere to when managing the loans. Typically, this requires the servicer to act in the best interests of the bondholders as a whole, following the same priority they would use for their own portfolio, without regard to their own compensation or affiliations.

4. Advancing Requirements

To ensure consistent payments to bondholders even if a borrower misses a payment, the PSA often requires the Master Servicer to provide P&I (Principal and Interest) Advances. These are temporary funds provided by the servicer to cover shortfalls, provided the servicer deems those advances to be eventually recoverable from the underlying collateral.

5. Reporting and Transparency

The PSA outlines the requirements for the Certificate Administrator to provide monthly reports to investors. These reports include data on loan performance, delinquency status, and any modifications performed by the Special Servicer. This ensures that transparency is maintained for all stakeholders in the investment.

6. Representations and Warranties

The agreement includes detailed "reps and warrants" provided by the loan sellers regarding the quality and legal status of the mortgages. If a loan is found to be in breach of these standards shortly after the deal closes, the PSA provides the mechanism for the trust to force the original seller to repurchase the loan or provide a substitution.

In summary, the Pooling and Servicing Agreement is the central nervous system of a commercial mortgage securitization, ensuring that the complex relationship between borrowers, servicers, and investors remains legally sound and operationally consistent.