46 / 68
CRE Finance World Winter 2016
44
B
REMIC Issues in CMBS 2.0 —
Things You Should Never Say
(Or Do)
orrowers of securitized loans are often frustrated when
servicers deny requests for modifications, even when the
changes would make perfect sense. The problem is that
servicers’ hands are tied by tax rules that limit the activity
of the trusts that govern real estate mortgage investment
conduits (REMICs).
Treasury Regulations that govern modifications were adopted
in 1986 and remained unchanged until the fall of 2009. Over
the course of those 23 years, market players developed deeply
ingrained habits to deal with loan modifications that would prove
hard to break when the rules changed.
Although it has been six years since the new rules were passed,
a number of misconceptions about the modification process
remain rampant. Let’s break down some of these misconceptions
and what can be done about them:
Misconception #1. “The conditions for the borrower’s requested
outparcel release are hardwired into the loan documents.”
That may be true, but it is in most cases no longer relevant to the
REMIC analysis. (The one exception to this is for “grandfathered
transactions,” which are discussed below.)
Borrowers often insert into their loan documents explicit conditions
for the REMIC’s release of its lien on an outparcel that makes up
part of the collateral property. The motivation for the borrower’s
efforts to include these conditions in its loan documents can come
from the borrower’s desire to sell or develop the outparcel in the
future but at the time the borrower closes its loan the outparcel
remains integrated with the overall collateral property and cannot
be separated from the collateral property. Some of the conditions
the borrower may negotiate into its loan documents to obtain the
REMIC’s release of its lien on the outparcel may include: establishing
separate tax parcel for the release parcel, updating title to the
overall collateral property following the release of the release
parcel, and paying a pre-established release price. The borrower
may also assume — incorrectly — that, if it can satisfy the conditions
provided for in its loan documents, the REMIC’s release of its lien
on the related outparcel will be automatic and will not cause any
REMIC issues.
Prior to the enactment of the current REMIC regulations in late
2009, this strategy usually worked because the REMIC test to
which the servicer would look depended on whether there would
be a “significant modification” of the borrower’s loan as a result
of the collateral release. If not, there would be no REMIC issue.
To determine whether there would be a “significant modification,”
the tax rules looked to see whether the borrower’s right to release
the outparcel from the REMIC’s lien was automatic under the loan
documents and not dependent on the consent or approval of the
REMIC. If so, the right to release was deemed to be “unilateral”
for tax purposes and the release of the outparcel would not result
in a modification to the borrower’s loan so long as the parties
followed the hardwired conditions provided for in the borrower’s
loan documents.
This meant that the servicer’s main task when reviewing a borrower’s
request for the REMIC to release its lien on an outparcel was
to determine whether the borrower’s right to release was in fact
“unilateral.” While this often led to questions about whether and to
what extent the REMIC could exercise discretion and whether the
borrower met the specified conditions in the loan documents, the
REMIC analysis under the old REMIC rules was straightforward.
Servicers and borrowers mistakenly continue to take this approach
and assume that there are no REMIC issues if the borrower’s right
to obtain the REMIC’s release of its lien on an outparcel at the
collateral property is unilateral. Under the current tax provisions,
however, a REMIC can continue to hold a loan after a release of
real property collateral only if the loan continues to be “principally
secured” by an “interest in real property” whether or not the release
was unilateral or whether or not there has been a “significant
modification” of the borrower’s loan. To meet this “principally
secured” test, the borrower’s loan must meet an 80% value-to-loan
test (or, to invert the ratio, a 125% loan-to-value test) following the
release of the outparcel. Only the real property collateral counts
for the “value” component of that fraction. This test is commonly
referred to as the “principally secured test.”
As discussed above, in most cases, the fact that release conditions
are unilateral by virtue of being hardwired into the documents is
no longer relevant to the REMIC tax analysis. One exception is for
“grandfathered transactions.” This exception was in response to
the industry uproar that followed the release of the new REMIC
regulations in 2009. Borrowers and servicers were upset at that
time because, in many cases, a borrower had negotiated specific
release provisions based on the understanding that, under the
previous REMIC tax rules, the resulting outparcel release would
not cause a REMIC problem. Not only were they now prevented
from a release that could have made economic sense for everyone
if the “principally secured” test could not be satisfied following the
Thomas J. Biafore
Partner
Kilpatrick Townsend & Stockton, LLP