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IRS Gives Servicers Flexibility to Modify CMBS Loans - 09/15/19
CRE News

The Internal Revenue Service has granted servicers of securitized commercial mortgages greater flexibility to extend those loans and otherwise modify their terms.

Effective Wednesday, servicers can extend and change the interest rates and other payment terms on securitized mortgages more than a year in advance of their maturity dates, if they foresee that the loan will not be paid off at maturity.

The IRS revised a rule that had limited servicers from modifying loans that are performing even though the paralyzed debt markets would make it unlikely for the borrower to get the new financing needed to take out the loan at maturity. Doing so would have caused the trusts that own the loans to lose their real estate investment mortgage conduits, or Remic, status, which exempts their entity-level profits from taxes.

Servicers have not been able to modify performing loans until after determining the borrower would be unable to find new financing or other alternatives to avoid defaulting at maturity. Under the IRS rule that changes Wednesday, that determination has been difficult to reach in time to grant the extension that could avert default.

In its rule change, the IRS noted, "It may be possible to foresee the risk of foreclosure even when no payment default has yet occurred."

In addition to extending securitized loans more than a year in advance of their maturities, the ruling also allows servicers to change loans' interest rates and amortization schedules, and forgive some of their principal payment. It also sets detailed criteria that servicers must meet in determining that a loan requires modifications.

The Real Estate Roundtable had been lobbying for the change since last year, noting the stalled credit markets has significantly reduced borrowers' access to new financing to take out maturing loans. Extending the maturity of securitized loans was not a major concern while debt markets were free-flowing before 2008.

In addition to the obvious benefit to the CMBS market, the IRS change is also a property-sales issue since the additional flexibility should help servicers avoid being forced to foreclose on loans and ultimately offer the loans or the properties backing them at discounted prices.

"This change removes a significant disincentive for the revision of commercial mortgages," said Sam Chandan, head of the New York research firm Real Estate Econometrics. "By reducing the cost of managing distress in mortgage portfolios, the adjustment has the potential to ameliorate outcomes for legacy CMBS, in particular."

The IRS revision does not address another Remic change sought by special servicers - the ability to originate loans from within existing trusts to facilitate the sale of foreclosed properties that had backed loans that were securitized through those deals.

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