U.S. Treasury Department Issues Guidance on Modification of Commercial Mortgages Held By Real Estate Mortgage Investment Conduits (REMICs): Will the Floodgates Open?
In September, Keith Mullen posted a blog entry attaching the IRS and Treasury Department's announcement clarifying and expanding the "significant modification" REMIC rules.
The first announcement was the IRS guidelines contained in Rev. Proc. 2009-45, which provides guidance for modifications to certain loans without triggering an IRS challenge to the tax status of the REMIC. The guidance changes the standard under which loans may be modified without triggering the prohibited transaction tax on the income of the trust. Prior to Rev. Proc. 2009-45's current announcement, loans could be modified only if a change in the terms of the obligation was "occasioned by default or reasonably foreseeable default." Rev. Proc. 2009-45 changes this standard and permits a change in the terms to be negotiated if, based on all the facts and circumstances and after meeting the threshold for a qualified loan, the holder or Servicer reasonably believes that there is a "significant risk of default" of the loan upon maturity of the loan or at an earlier date, and that the modified loan will present a "substantially reduced risk of default." Rev. Proc. 2009-45 makes a point of stating that there is "no maximum period after which a default is not per se foreseeable." Previously, Special Service practice was not to entertain a modification for impending "maturity defaults" with maturity dates beyond one year, because maturities beyond one year were not, per se, a reasonably foreseeable default. The guidance is clearly intended to allow Servicers to have greater flexibility in considering "all the facts and circumstances in servicing distressed mortgages." Additionally, those facts and circumstances can come from written factual representations made by the borrower as long as the Servicer "neither knows nor has reason to know that such representations are false." Interestingly, these guidelines will apply to loan modifications effected on or after January 1, 2008.
Additionally, the Treasury Department issued final regulations ("TD 9463") specifically expanding the list of exceptions that will not be considered "significant modifications" of mortgage obligations held by the REMIC. TD 9463 became effective September 16, 2009, with an expanded list of exceptions that include modifications that release, substitute, add or otherwise alter, a substantial amount of the collateral so long as the obligation continues to be "principally secured by an interest in real property."
And lastly, the final regulations clarify that "value retesting" for modifications to satisfy the requirement that the loan principally be secured by real property will not be necessary as long as the fair market value of the interest in real property that secures the loan immediately after the modification equals or exceeds the fair market value of the interest in the real property that secured the loan immediately before the modification. This alternative test is consistent with the general rule that a decline in the value of collateral does not cause a mortgage to cease to be principally secured by real property. Finally, the regulation provided that changes in the nature of an obligation from nonrecourse to recourse or from recourse to nonrecourse are permitted so long as the obligation continues to be principally secured by an interest in real property.
Will the floodgates Open?
As many readers know, there has been an ongoing battle between Special Servicers and borrowers regarding the loan modification process. Special Servicers, needing to be certain that their actions were consistent with Pooling and Servicing Agreements, as well as REMIC regulations, were unwilling to take any significant risk that their Servicing actions would be considered a violation of REMIC rules or of the terms and conditions of Pooling and Servicing Agreements to which they were a party.
The new clarifying rules are resulting in a new flood of requests to Special Servicers to consider loan modifications of loans which are not in default but which are not "refinanceable" on their future maturity date (in some cases beyond a year).
Keep in mind that REMIC regulations were one, but not the only impediment to Servicers acting decisively and expeditiously. Other factors include the staffing and expertise levels of the Servicer and Special Servicer, different investment perspectives of the respective parties given their economic position in the transaction, as well as ill-defined or uncertain rights and obligations of Servicers and Bondholders under the Pooling and Servicing Agreement itself.
Much has been written about the impending "maturity default crisis" bubbling up in the last half of 2010. The regulators have done their part in anticipating needed regulatory reform and clarification. Now it is time for the securitized lending industry to step up to the plate and provide the expeditious and cost effective resolution to the maturity default issue.
If indeed the securitized mortgage lending industry is to reconstitute itself, it will need to demonstrate to its customers (i.e., both mortgage loan borrowers and bondholders) that it can efficiently and prudently address these mounting Servicing concerns.
