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WASHINGTON, DC-With little fanfare or formality, the IRS further narrowed the liquidity gap facing holders of CMBS loans: a tax guidance issued earlier this week, called Revenue Procedure 2009-45, allows certain commercial real estate borrowers to modify securitized loans at risk of default – without triggering the onerous tax penalties that typically would be applied.

The consensus in the commercial real estate community is that any measure that fills in, even minutely, the deep dark void that has become the capital markets is a good thing. Still, observers can’t help but note some of the unintended consequences this new guidance could bring. For starters, it could delay the painful and inevitable working through of toxic debt that will never be able to be refinanced. Also, it could worsen the so-called tranche warfare that has quietly broken out among the various bondholders.

The rule also addresses a catch-22 that is specific to securitization: In the rest of the commercial world, it is a no-brainer that borrowers aware they are about to default talk to their lenders for a modification. With CMBS, though, the rules do not allow for such pre-emptive discussion, Tino Korologos, Deloitte’s Distressed Debt leader, pointed out.

“So this ruling will allow the borrower to speak with the special servicer even though the loan is still current and discuss a challenge they believe they will have with the loan,” he tells GlobeSt.com. For instance, there could be a borrower that has a good property with a LTV of 75% that is coming due. No one is writing that coverage now, Korologos says – but there is good reason to think it may be offered again in the future. “This type of loan would be a perfect candidate for a modification, and with the tax change it is now financially feasible.”

What the new rule won’t do is wipe out the problem loans that are threatening to swamp the system, he says: These are the most ambitious CMBS underwritten during the height of the market. The buildings, as we all know, have fallen dramatically in value and now the loans coming due cannot find refinancing –even if LTVs remained the same, which they haven’t.

To save these loans, Korologos says, a return to 2007 or before would be necessary. What he fears is that the IRS tax rule could delay the inevitable day of reckoning that the market needs to move towards full health.

Another worry: The rule would worsen the so-called tranche warfare between AAA note holders and the B piece buyers. Their conflicting interests – which were baked into the system but only with this recession become overt – have been problematic for special servicers. With borrowers newfound ability to modify loans without tax consequences, AAA note holders will be even more “up in arms”, Korologos says.

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