CMSA: REMIC Changes Raise Red Flag

NEW YORK CITY-The Commercial Mortgage Securities Association, based here, says some new proposals to reform the REMIC rules would essentially pull the rug out from under CMBS Investors. In a white paper issued Tuesday, the industry association says the proposed changes would give servicers too much latitude in modifying the terms of loans. “Some of these overly broad proposals, if adopted, would have a significantly negative effect on CMBS investors because any new laws that authorize servicers to prematurely modify the terms of mortgage contracts already in place can change the construct and dynamics of investor cash flows and liquidity,” says Patrick Sargent, CMSA president, in a release.

For the past several years, “the CMSA, individually and as part of a larger industry coalition, has been actively seeking additional servicer flexibility within the REMIC rules to improve the efficiency of the REMIC structure, enhance the protection of asset value for investors and eliminate certain constraints on borrowers,” according to the white paper. “However, some more recent reform proposals would go much further by seeking to change the terms of commercial real estate loans well in advance of what would be customary under the widely accepted servicing standard [‘reasonably foreseeable or imminent default'], contrary to the expectations of and disclosure to investors in CMBS, and without a clear set of principles to govern servicers’ decision to modify the loans.”

At present, the rules governing REMICs, or real estate mortgage investment conduits, impose strict limitations on the circumstances under which loans can be modified without the IRS counting them as “new loans” and losing their tax-exempt status. REMICs were created by statute in the 1980s and provide the legal basis for CMBS.

Some of the new proposals, according to the CMSA, would change the REMIC laws to allow servicers to modify the terms of mortgages well in advance of the maturity deadline if the servicer has a “reasonable” belief that the borrower “may be” unable to obtain refinancing to repay the loan. These modifications could take the form of extending the due date for repayment, lowering the interest rate or payment forgiveness.

“Under these proposals, a ‘reasonable’ belief can be formed merely on the basis of a borrower representation that in the future–e.g. five years from now–it ‘may be’ unable to obtain refinancing,” according to the CMSA paper. “One thing the current market conditions have made clear is that it is extremely difficult to anticipate where the market will be in one year, much less so in five years.”

In addition, the CMSA says, “reliance solely on borrower representations as to market conditions justifying a loan modification is inconsistent with the servicing standard which obligates the servicer to act prudently and in the best interests of the certificate holders, and typically involves independent assessment and evidence of market conditions.”

Such a change, according to the association, would make investors “hesitant to buy bonds if the constraints on that modification are essentially eliminated as some have proposed, especially when the cash flows and duration could be restructured at any time under that relaxed standard.” Because investors expect contract certainty, “proposals that effectively eliminate that certainty will serve to undermine investor confidence in CMBS” and have the opposite effect of the Obama administration’s other market recovery efforts.

For servicers, too, there would be downsides, says the CMSA. “If servicers are given an effectively unlimited modification authority as some have proposed, they would be subjected to increased liability from multiple parties adding substantial costs and burdens to securitized credit markets.” Moreover, servicers that are already dealing with significant increased activity levels anticipate they will be overwhelmed with inquiries and demands by virtually all borrowers hoping to take advantage of the new rules to negotiate a better deal.

The white paper cites other issues, including investor demands for additional spread premiums for CMBS loans and the challenges that ratings agencies would face in “rating a deal with so much uncertainty.” The CMSA did not respond to GlobeSt.com inquiries about the status of these proposals.