CREFW-Winter2016

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CRE Finance World Winter 2016
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Misconception #3. “We required the borrower to put all the
proceeds from the release parcel into a cash reserve. That
should avoid any REMIC tax concerns.” This is an example of
servicers and borrowers confusing credit concerns with REMIC
tax concerns. While it may make an abundance of credit sense
for the servicer to require that sale proceeds go into a reserve
to make up for the loss in real property collateral following the
release, that maneuver does nothing to resolve the REMIC issue.
As noted above, generally only the real property collateral matters
in determining REMIC qualification — not cash reserves that the
borrower has pledged, letters of credit, or any other credit substitutes
that are not interests in real property. If, following the release, the
loan is not “principally secured” by an interest in real property (that
is, the loan does not satisfy the 80% value-to-loan test, taking
into account only the real property collateral) the loan will not be
a qualified mortgage that the REMIC can hold, irrespective of any
substitute credit the servicer negotiated for in exchange for agreeing
to the real property release. While other non-real property credit
enhancements may help the servicer make its credit decision
about releasing its lien on the outparcel, they do nothing for the
REMIC tax analysis.
Misconception #4. “The special servicer is requiring that the
assumptor post a debt service reserve of $1 million. Isn’t that a
REMIC problem?” In connection with a borrower’s request to sell
the collateral property and have its loan assumed by the buyer,
the servicer often requires credit enhancements for the loan.
These enhancements can include debt service and other property
maintenance reserves, leasing reserves for tenant improvements,
and even additional personal guarantees (sometimes with limited
full recourse for, say, 10% of the loan’s balance).
Prior to their revision in 2009, the REMIC provisions imposed
limitations on the amount and extent of credit enhancements.
Subject to some
exceptions, a
loan could not
be “significantly
modified”
without causing
that loan to
cease to be
a qualified
mortgage that
the REMIC
could hold. Altering a “substantial amount” of collateral for a
performing nonrecourse loan (such as the addition of the credit
enhancements discussed above) could have this effect.
After the release of the current REMIC regulations in 2009,
adding credit enhancements is no longer a potential REMIC issue.
As noted above, the primary REMIC consideration now is only
whether the borrower’s loan remains “principally secured” by an
“interest in real property.” So long as the real property collateral is
not affected, an increase or reduction of other forms of collateral
will not cause the borrower’s obligation to fail the “principally secured”
test. This is true even in extreme cases: $100,000 loan can now
be credit enhanced with a $10 million letter of credit without any
concern that an adverse REMIC event will result, provided the real
property collateral remains in place.
Conclusion: Pre-2010 assumptions about REMIC principles
persist in the minds of many borrowers and servicers, but these
assumptions may now be wrong. Servicers and borrowers must
remember that, under the current REMIC provisions, REMIC issues
are now generally determined based on a review of the real
property collateral that secures the borrower’s obligation under the
terms of the loan. With REMIC issues it really is “location, location,
location” (the real estate) that matters.
REMIC Issues in CMBS 2.0
“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.”