The entire securitized transaction relies on the income stream produced by the mortgages in the pool. The overwhelming importance of the income stream reduces the real estate to a fungible commodity. It is not the real estate that is securitized, it is the cash flow. And the market depends upon the rating agencies' assessment of the likelihood of default within the income stream drives the sizing of the traunches and the subordination levels of the offering.


  Structurally speaking, on the borrower side, the collateral assets securitizing the loan will be transferred to an SPE (Special Purpose Entity). In the case of larger loans, this entity will also be a so-called bankruptcy remote vehicle--designed to prevent the borrower from filing bankruptcy, or at least to make it more difficult for the borrower to file bankruptcy. And, conversely it is intended to make the bankruptcy process faster and simpler for the lender.


On the lender side, MBS vehicles are REMICs. "REMIC" status is crucial to the securitization market, because it assures bondholders that the trust will be a pass through entity for tax purposes, avoiding a devastating double tax if the loan pool or trust were to be taxed as well. REMIC status is gained by compliance with complex and rigid rules that prohibit prepayments (unless executed in accordance with defeasance procedures) and sales or exchanges of mortgages in the trust, including modifications to the mortgages, (unless in compliance with very strict guidelines). These tax-driven mandates severely limit when and what a Special Servicer can do when a loan gets into trouble.


FASB 140 restricts the role of the Special Servicer in workouts by limiting discretion. As noted earlier, it is critical to the rating agencies that the transfer of mortgages by the depositor to the trust be viewed as a "true sale" to insulate the trust from bankruptcy issues that might affect the depositor. FASB 140 provides, in essence, that for transfers after April 1,2001, a transfer to a trust will not quality as a sale if the trust or its agents (such as the Special Servicer) can decide when and how to dispose of assets. In other words, if the Special Servicer is given substantial discretion in disposition of assets, then the transfer to the trust might be rendered a "financing" instead of a "sale." This results in severe restriction of the flexibility that the Special Servicer has in working out the loan. It is particularly noteworthy that the FASB rejected certain arguments from the financial community that the Special Servicer should be permitted to exercise "a commercially reasonable and customary amount of discretion."


The REMIC rules, pooling and servicing agreement and loans documents (rating agency guidelines and accounting standards such as FASB 140) (11) together provide a strict regimen for securitized troubled debt. The REMIC rules require that REMIC pools be static--subject to very limited exceptions, they cannot be expanded, or significantly altered once formed.


Failure to strictly observe these rules is the tax equivalent of Armageddon for REMIC investors, servicers and other participants, because the loss of REMIC status is a cataclysmic event in terms of double taxation, and even penalty taxes, on pool income. The REMIC rules thus limit substitution of collateral and significant modifications of existing loans prior to default. Even after default, the pooling and servicing agreement severely restricts the servicer's authority to make modifications.


Where a traditional whole loan lender would have attempted to preserve the value of the asset, REMIC regulations attempt to preserve the integrity of the trust. And borrowers find themselves dealing with multiple parties representing diverse interests that in non-CMBS loans are all typically held by the whole loan lender. Unlike more flexible, traditional portfolio lenders, borrowers will find that Servicers and Special Servicers will follow the loan documents, pooling and servicing agreement, and REMIC rules to the letter in order to comply with contractual and fiduciary duties to the trustee and ultimately the bondholders.


New rules of engagement for workouts: REMICs & distressed real estate loans.

Servicers will follow and enforce precisely the strict letter of the loan documents. Servicers will also administer the loan in strict conformance with other agreements or standards that the borrower may never have seen such as the pooling and servicing agreement, REMIC rules, and accounting standards (FASB 140).


Multiple servicers confuse many borrowers who often have trouble finding out who to talk to, what authority the Master Servicer and Special Servicer may have, and when to talk to each. In addition to the Master Servicer and Special Servicer, there may be sub-servicers.


Releasing any collateral is problematic once the loan is securitized.



Once put in the pool, loans cannot be materially modified before default.  A Special Servicer may be able to approve a loan modification that a Master Servicer cannot approve for its most reliable and creditworthy borrower--only after a default or imminent default.


Prior to default, any material modification may be deemed a sale or exchange of a mortgage that jeopardizes status, the REMIC but minor modifications may be permissible as an "insignificant change." For example, modifications that are not significant include:

(1)   extensions of the loan term that are the lesser of five years or one half of the original loan term;

(2)    adjustments in interest rate that are less than the greater of 25 basis points or 5 percent of the annual yield of the original loan;

(3)   waiver of customary accounting or financial covenants; or

(4)   assumption permitted by the original loan documents or due-on-sale clause.


However, even minor modifications are likely to be complex and require considerable analysis by the servicer. Undoubtedly, REMIC opinions will be required to confirm that a change is not a "significant modification" within the meaning of the REMIC rules. Such opinions can be time-consuming and involve an additional expense.


Servicers will enforce financial, data, and other seemingly technical requirements of the loan documents. They may impose a fee for failure to deliver data on time and ultimately may declare a default. When the data is required to be in electronic form, and on the lender's form, the borrower better comply.


REMICs are likely to favor foreclosure over workouts. Foreclosure will be the relatively safe alternative for servicers charged under the pooling and servicing agreement with a standard of care, preservation of the REMIC status, and choosing the alternative that will maximize net present value (without using subjective judgments and input). With the REMIC's loan documentation, lock box, SPV structure, limitations on transfer, and yield maintenance, it may be difficult to establish clearly that a workout would produce a larger net present value than a foreclosure.



REMICs have changed the landscape of  real estate finance forever. We are now about to see how they will change the processing of troubled loans as we experience the next real estate downturn. The complexities of the structure make it imperative for all parties to the loan to know what they are doing. If borrowers are to succeed in workouts or bankruptcies, they will need to solve the maze to find the right party to talk to at the right time, and know how to present options that are within the power and prerogatives of the servicer.



This article does not explore the insurance on the loans in these trust and credit default swaps, which complicate the matter even further. The loan is insured which can also give the parties no incentive to do a loan workout, but a big incentive to foreclose. Find your trust and read the pooling and servicing agreement, know the players, and the insurers, and fight back on the same playing level. Without this information, which may only be attainable through discovery in the course of a lawsuit, or through hours of your own researching in SEC filings, you are fighting an unknown enemy, purposefully hidden from you.




Newly Proposed REMIC regulations – What do they mean for servicers and borrowers?


Background: On November 8, 2007, the Internal Revenue Service (the “IRS”) issued much-anticipated proposed regulations updating the rules related to “significant modifications” of loans held in real estate mortgage investment conduits (or “REMICs”). The changes proposed by the IRS are potentially very important to servicers of securitized loans because a significant modification of such a loan can cause the loan to cease to be a “qualified mortgage,” which could disqualify the REMIC that holds the loan or subject the REMIC to tax (sometimes referred to as an “adverse REMIC event”).


Servicers of securitized loans have long complained that the current rules prevent them from entertaining reasonable requests from borrowers for loan and collateral alterations and that the rules have not kept up with the practical issues associated with servicing real estate loans. The proposed regulations are designed to address these complaints by expanding the class of permitted modifications of securitized loans.


The Current Rules: The current rules contain the following four exceptions to the general rule prohibiting significant modifications of loans held in REMICs: (i) changes to a loan’s terms that are occasioned by default or a reasonably foreseeable default; (ii) assumptions of loans; (iii) waivers of due-on-sale or due-on-encumbrance clauses; and (iv) conversions of interest rates pursuant to the terms of a convertible mortgage.


The Proposed Rules: Under the proposed regulations, the following exceptions would be


· Modifications that release, substitute, add or alter a substantial amount of collateral for, a guarantee on, or other credit enhancement for the loan; and

· Modifications that change the recourse or nonrecourse nature of the loan.


The proposed new exceptions come with an important qualification, however. These modifications are permitted only if the modified loan continues to be “principally secured by” an “interest in real property” following the modification. The fair market value of the interest in real property securing the loan must be appraised by an independent appraiser to be at least equal to 80% of the outstanding balance of the loan on the date of the modification.


Caution: While the proposed regulations may make possible transactions that are not permissible under the current rules, they speak only to the REMIC issues associated with these transactions. Servicers must continue to abide by the prohibitions and processes contained in the REMIC’s applicable Pooling and Servicing Agreement (or “PSA”) (e.g., special servicer, rating agency and controlling class approval; PSA provisions prohibiting substitutions of material portions of loan collateral; etc.), as these provisions would be unaffected by the proposed regulations.

In addition, investors in a REMIC and the sellers of loans to it typically require the REMIC to maintain its status as a “qualified single purpose entity” under Financial Accounting Standards No. 140 (or “FAS 140”), which strictly limits the amount of discretion the servicer can exercise.


The modifications permitted by the current rules were generally thought not to violate this standard. The proposed regulations appear to allow for more flexibility in modifying loans held by REMICs than is permitted by FAS 140, which may prevent most REMICs from taking full advantage of the new exceptions.


Finally, the proposed regulations will not become effective until adopted by the IRS as final. The IRS will take comments on the proposed regulations from various sources and will hold hearings in 2008 to consider them. This process can be time consuming and, until it is complete, the proposed regulations have no effect. The final regulations could contain very different exceptions or the IRS could decide not to make any changes to the current rules.


What do the proposed regulations mean for you?

Master and Primary Servicers: For servicers dealing with performing loan requests, the biggest impact of the proposed regulations would relate to collateral changes. Under the current rules, modifications that affect a “substantial amount” of the collateral (often referred to as the “10% test”) for a securitized nonrecourse loan could result in a significant modification of that loan. Under the proposed regulations, such a modification would not cause an adverse REMIC event so long as the loan continues to be “principally secured by” an interest in real property following the modification.


A number of technical tax rules relate to the issue of what is an “interest” and what is “real property” for purposes of this test. In general, however, so long as the loan has a loan-to-value ratio of no greater than 125% (or, to use the language in the REMIC regulations, a value-to-loan ratio at least equal to 80%) following the modification, the loan will be considered “principally secured” by an interest in real property. Please contact your REMIC counsel for questions related to whether a modification of a loan causes a loan to cease to be principally secured by an interest in real property for these purposes. The proposed requirement that this be determined by obtaining an independent appraisal promises to be cumbersome.


Special Servicers. As much as the proposed regulations may be regarded as a huge step forward in servicing performing loans held in REMICs, the impact of the proposed regulations for special servicers dealing with defaulted loans and REO would probably be minimal. Current REMIC rules related to the grace period for qualified foreclosure property, the prohibition on impermissible new construction for REO, and the impact of income from REO that is other than “rents from real property” continue unchanged. Perhaps the only impact of the proposed regulations on special servicers would arise in the uncommon situation of a proposed modification of a defaulted loan that does not fall under the existing exception for modifications that are “occasioned by” the loan’s default or a reasonably foreseeable default. In these odd instances, so long as the modification falls under one of the new exceptions contained in the proposed regulations, no adverse REMIC event would result even if the modification is not be considered “occasioned by” the loan’s default.



Relaxed REMIC Requirements: IRS and Treasury Efforts to Address the Subprime Mortgage Crisis

October 16, 2008

Expanded safe harbor rules allow real estate mortgage investment conduits (REMICs) and REMIC owners to modify certain residential mortgage loans while maintaining favorable tax status.


Since the onset of the subprime residential mortgage crisis, there have been dramatic increases in mortgage loan defaults, foreclosures and calls for restructuring. With enactment of the Emergency Economic Stabilization Act of 2008, pressure has intensified for mortgage servicers to modify mortgage loans to minimize foreclosures. But if such loan modifications create serious tax disadvantages to the entities that own those mortgages, it would be difficult—if not impossible—to modify mortgage loans.


Many pools of mortgages are held in tax advantaged entities that qualify for tax purposes as REMICs that avoid double taxation under the Internal Revenue Code. But for an entity to qualify as a REMIC, the pooled mortgages must be basically treated as static pools of mortgage loans. Loan modifications could force a REMIC to lose its favorable tax treatment, and once REMIC status is lost, it is lost forever. This means that REMIC efforts to minimize foreclosures through loan modifications can threaten favorable tax status of the REMIC and its owners.


To address these risks, the Internal Revenue Service (IRS) and U.S. Department of the Treasury (Treasury) have taken actions to expand safe harbor rules that apply to REMICS. Through a number of recently issued revenue procedures, the IRS has provided assurances that REMICs can retain their favorable tax status when mortgage servicers make certain loan modifications as part of programs aimed to reduce foreclosures. The safe harbors allow REMICs to engage in certain, previously prohibited activities that in the past could have resulted in significant tax penalties.


The American Securitization Forum Framework

IRS guidance builds on recent efforts by the American Securitization Forum (ASF), an independent adjunct forum of the Securities Industry and Financial Markets Association (SIFMA), to address the subprime mortgage crisis. In June 2007, ASF published its Statement of Principles, Recommendations and Guidelines for the Modification of Securitized Subprime Residential Mortgage Loans. In the statement, ASF recommended that loan modifications should be permitted, under limited circumstances, without triggering a violation of REMIC tax status.


The statement recommended that loan modifications be made only

(1)   consistent with the operative securitization documents (that is, pooling and servicing agreements);

(2)    in a manner that is in the best interest of the securitization investors in the aggregate;

(3)    in the best interests of the borrower;

(4)    in a manner that avoids adverse tax or accounting consequences to the REMIC servicer;

(5)    where the loan is either in default or default is reasonably foreseeable;

(6)    the servicer has a reasonable basis for concluding that the borrower will be able to make the scheduled payments once modified; and (7) in a manner that provides sustainable and long-term solutions and does not reduce the required payments beyond anticipated period of borrower need.


ASF asserted that loan modifications meeting these criteria are generally preferable to foreclosure, particularly in situations in which the net present value of the loan payments is likely to be greater than the expected net recovery that would result from foreclosure.


ASF subsequently refined its position in two follow-up statements: Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans, issued in December 2007, and Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans, issued in July 2008.


These two statements recommended that fast track modifications be allowed for subprime mortgages and borrowers that meet strict criteria. Eligible loans include specific subprime adjustable rate mortgage (ARM) loans with limited loan origination and initial interest reset dates. Within the framework, borrowers are also classified into three distinct segments based on whether the borrower is current, likely to be able to refinance or likely to have difficulty meeting the introductory rate.


IRS Issues Revenue Procedures Consistent with ASF Recommendations

In response to the ASF framework and to allow REMICs to participate in loan modifications, the IRS issued revenue procedures discussed in this section.

Revenue Procedure 2007-72 and 2008-47

In December 2007, the IRS issued Rev. Proc. 2007-72, in which the IRS stated it would not challenge the qualifications of a REMIC that followed the ASF framework’s fast track modifications. In July 2008, the IRS issued Rev. Proc. 2008-47 to replace and supersede Rev. Proc. 2007-72, extending its guidance to include residential mortgage loan modifications. In Rev. Proc. 2008-47, the IRS largely reiterated its conclusions in Rev. Proc. 2007-72:

·        First, the IRS will not challenge an entity’s qualification as a REMIC on the grounds that the mortgage modifications were significant because they are deemed to fall within the exception for modifications made in anticipations of default in I.R.C. §1.860G-2(b)(3).

·        Second, the IRS will not assert that the loan modifications result in a disposition of qualified mortgage subject to the 100 percent prohibited transaction tax.

·        Third, the IRS will not challenge an entity’s qualification as a REMIC on the grounds that the modification caused a reissuance of the REMIC’s regular interests.

·        Fourth, if the securitization entity is a grantor trust, the IRS will not assert that the mortgage modifications result in the prohibited power to vary investments.


To make it clear that Rev. Proc. 2008-47 is intended as a safe harbor, the IRS cautioned that “[n]o inference should be drawn about whether similar consequences would obtain if a transaction falls outside the limited scope” of Rev. Proc. 2008-47.

<P&LT;STRONG /Revenue Procedure 2008-28

In May 2008, to expand the safe harbor protections, the IRS issued Rev. Proc. 2008-28 to address additional questions of whether loan modifications undertaken as part of foreclosure prevention programs would have adverse tax consequences to REMICs and REMIC owners. The IRS clarified that, if the conditions specified in Rev. Proc. 2008-28 are met, it will not challenge the securitization entity’s qualifications as a REMIC.

Rev. Proc. 2008-28 applies to a mortgage loan held by a REMIC if the mortgage meets six requirements:


·        the mortgage must be secured by one to four unit single family residences;

·        the residence is owner occupied;

·        only 10 percent or less of the stated principal of total assets of the REMIC consists of loans with payments 30 days or more past due at the time of securitization;

·        the servicer reasonably believes that there is a significant risk of foreclosure;

·        the terms of the modification are less favorable to the lender; and

·        the servicer believes the modification has substantially reduced the risk of a foreclosure.


Proposed Treasury Regulations


Although current REMIC Treasury regulations provide some flexibility to allow for loan modifications, a large number of other modifications continue to pose problems under the REMIC regulations. This is particularly true because commercial mortgage loans have become increasingly common in REMIC pools, presenting ongoing servicing concerns beyond those of residential mortgage loans.


To address these concerns and to acknowledge legitimate business practices currently used in the commercial mortgage securitization market, the Treasury issued Prop. Treas. Reg. §§1.860G-2(a)(8) and 2(b)(3) to expand the safe harbor rules to allow servicers to modify commercial mortgages held by a REMIC. The proposed regulations seek to strike a balance between accommodating the legitimate business concerns of the commercial real estate industry with the requirement that a REMIC remain a substantially fixed pool of mortgages that is not engaged in an active lending business.


While the proposed regulations go some distance toward easing the concerns of REMICs holding significant commercial mortgage loans, of particular concern is the Treasury’s proposal that collateral be retested by an independent appraiser for every modification that meets certain criteria. This formal appraisal requirement is unnecessarily burdensome. Hopefully, the proposed regulations, when finalized, will not require formal appraisals in situations where the value of the collateral will not decline or where the collateral will decline on a pro-rata basis in relation to the loan.


Obviously if loan modifications create serious tax disadvantages to those entities holding the pools of mortgages, modifications will be difficult--if not impossible-- to negotiate.


Rules Applicable to Foreclosure Property

When modifications cannot prevent or cure a default on a commercial loan held by a REMIC, the foreclosure rules (keyed to the foreclosure property REIT rules) apply. Unless otherwise extended, the grace period for the treatment of property as foreclosure property is at the end of the third taxable year beginning after the year that the REMIC Owned Real Estate (REO) property was acquired. A grace period can, however, under certain circumstances, terminate early. In a situation where REO property is not a permitted asset, all income and gain from that property is subject to the 100 percent prohibited transaction tax. Further, REO property can affect the tax status of a REMIC because a REMIC can only hold a de minimis amount of non-permitted assets.




Over the past year, or so, the actions of the IRS and Treasury to expand loan modification safe harbor rules and to update the REMIC regulations have set a clear standard within which REMICs and REMIC owners can be assured of continued favorable tax status. As a result, REMICs are now able to more effectively address the consequences of the current subprime mortgage crisis.


As the subprime crisis and its bailout unfolds, additional safe harbor areas are likely to be identified. Given the quick responses of the IRS and Treasury to the ASF efforts, hopefully the government will continue to assist REMICs and REMIC owners to enter into additional types of loan modifications to avoid foreclosures while maintaining favorable REMIC tax status.



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