Real Estate Loan Workouts: What Lenders and Borrowers Both Want and Need ABA Section of Business Law (Real Estate Financing Subcommittee) 2009 Spring.

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Presentation transcript:

Real Estate Loan Workouts: What Lenders and Borrowers Both Want and Need ABA Section of Business Law (Real Estate Financing Subcommittee) 2009 Spring Meeting Timothy J. Boyce April 18, 2009

Summary of CMBS Issuance Source: Commercial Mortgage Alert

Holders of Commercial & Multifamily Mortgage Loans Source: CMSA, Flow of Funds Accounts of the United States Federal Reserve Release Z.1

Overview of a Securitization

Modifications, Waivers, Amendments and Consents What modifications, waivers, amendments and consents (a “modification”) can the Master Servicer agree to without the consent of any of the Special Servicer, the Trustee or any Certificateholder? The Master Servicer can agree to modifications so long as all of the following conditions are met: 1) The loan must be a non-Specially Serviced loan 2) All modifications must be in writing All modifications must comply with the Servicing Standard The modification does not violate the REMIC rules

Understanding REMICs Real Estate Mortgage Investment Conduits The purpose of a REMIC is to create multiple interests in a pool of mortgages without adding an additional layer of tax on the overall transaction (a “pass-through” entity) Substantially all of REMIC’s assets must be a static pool of qualified mortgages

Consequences of Loan Modification Modification: any alteration of a legal right or obligation of the issuer or a holder of a debt instrument Significant Modification: generally any change in the terms of an obligation that would be treated as an exchange of obligations under IRC § 1001

Consequences of Loan Modification (cont’d) If a loan is “significantly modified,” the REMIC is treated as though the unmodified loan were paid off and a “new” modified loan were made as a replacement If a significant modification occurs after the obligation has been contributed to the REMIC, the modified obligation will not be a qualified mortgage Other rules apply if the loan is in default or in imminent danger of defaulting REMIC allows any kind of modification (no restrictions) A defaulted loan will be transferred from the master servicer to the special servicer ─ remember ─ it is still subject to the servicing standard

Consequences of Loan Modification (cont’d) There are about 25 types of modifications to loans that typically do not present a problem The “original terms” exception (discussed below) Most assumptions Non material modifications: Changes in the terms of a loan due to default (or reasonably foreseeable default) Waivers of “due-on-sale” clauses Waivers of “due-on-encumbrance” clauses Lender’s stay or temporary waiver (up to 2 years) Substitution of substantially similar credit enhancement contracts Amendments to the financial covenants Subdivision of parcel without changing total collateral Most changes to a lease

Modifications That Do Not Pose a Problem A small change in yield: the yield must not vary from the annual yield on the unmodified instrument by more than the greater of-- 1/4 of one percent (25 basis points); or 5 percent of the annual yield of the unmodified instrument (.05 x annual yield) Substitution of new obligor: for non-recourse debt, such substitution does not constitute a significant modification Certain changes in timing of payments: must not result in a material deferral of scheduled payments. Addition/deletion of co-obligor: must not result in a change in payment expectations If the addition/deletion is part of a transaction that results in the substitution of a new obligor, the transaction is treated as a substitution of a new obligor, rather than as an addition/deletion of a co-obligor A minor change in security or credit enhancement: must not release, substitute, add, or alter a substantial amount of collateral on a non-recourse debt instrument Defeasance: If already permitted by the loan documents (can’t add the provision later)

Modifications That Do Not Pose a Problem (cont’d) Original Terms Exception: an alteration of a legal right or obligation that occurs by operation of the original terms of a debt instrument is not a “modification” Can occur automatically (e.g., an annual resetting of the interest rate based on the value of an index); or Alteration due to the exercise of an option is a modification unless-- The option is “unilateral”; and The holder’s exercise does not result in a deferral of, or a reduction in, any scheduled payment of interest or principal

Modifications That Do Not Pose a Problem (cont’d) An option is unilateral only if-- The other party does not have a right to alter or terminate the instrument or put the instrument to a related person Exercise of the option does not require the consent of the other party, a related party, or a court or arbiter Exercise does not require consideration, unless the consideration is a de minimis amount, a specified amount, or an amount based on objective financial information

Examples of Significant Modifications Substantial Change in Security or Credit Enhancement: if modification releases, substitutes, adds, or alters a substantial amount of collateral on a non-recourse debt instrument, it is a significant modification Change in Priority of Debt: is a significant modification if it results in a change in payment expectations Modification Changing Status as Debt: if modification results in an investment that is not debt for federal income tax purposes, it is a significant modification Change in Recourse Nature: if modification changes the debt from recourse (or substantially all recourse) to non-recourse (or substantially all non-recourse), or vice versa, it is a significant modification

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