On September 15th the IRS issued new guidance on the modification of commercial Mortgage backed securities (CMBS) loans. Though, largely unnoticed outside of real estate circles, this was an important first step in addressing the pending maturity of hundreds of millions of dollars of CMBS debt in the coming years. I wanted to post something on this topic but before I got a chance an attorney of ours, Wythe Michael with Hirschler Fleischer in Richmond, Virginia offered an article he wrote as a guest blog. I hope this is the first of many guest posts.
Modifying Securitized Real Estate Loans – New Guidance Provides Flexibility
Over the past decade, many commercial real estate owners financed the purchase of commercial real estate with loans that were securitized by the original lenders as commercial mortgage backed securities (CMBS). Although these loans offered advantages such as lower interest rates, limited recourse and limited guarantees, the tax regulations governing the associated conduits severely limit the ability to modify the terms of such mortgages. In general, the tax regulations prohibit loan modifications unless the modification is due to a default or a reasonably foreseeable default. The tax regulations can impose still penalties – including the possible loss of favorable tax status – on the conduits (but not the borrowers) if the regulations are violated. Because there was little guidance from the IRS concerning what constituted a “reasonably foreseeable default,” loan servicers have been reluctant to discuss loan modifications until an actual default occurs.
With the collapse of the CMBS market and the lack of other financing options, borrowers attempting to negotiate with loan servicers prior to the maturity date of their loan have been ignored by the servicers or told that nothing can be done until loan maturity – when the loan defaults. The servicers generally blame their unwillingness to negotiate on the tax regulations. Given that approximately $150 billion of CMBS loans are scheduled to mature between now and 2012, numerous industry participants asked the IRS to ease the regulations.
The IRS responded to this situation by issuing guidance on September 15, 2009 concerning modifications to CMBS loans. In general, the guidance allows servicers to modify loan terms if the servicer “reasonably believes that there is a significant risk of default of the loan at maturity or at an earlier date.” A servicer must document this belief by written facts provided by the borrower. In such a case, the servicer may modify the loan if the servicer reasonably believes that the modified loan will substantially reduce the risk of default.