CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

Recently, the Wall Street Journal highlighted the arrival of “bad loan securities.” If this is a trend, and I both hope and think it is, we clearly have to get a better deal name for these than “Insert Bank Name”, Bad Loan Securities 2012-1. Securitization of less than ideal conduit product has been with us since the birth of securitization, but reached its apogee in the RTC series, for non-performing loans, in the early to mid 1990s. That transaction architecture is being revived, and it’s about time. Both Fitch and DBRS have published criteria, or at least guidance and the other agencies are beavering away, busy working with bankers to come up with workable ratings technology.

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On May 5, SIFMA hosted a Spotlight Series: Risk Retention and Qualified Residential Mortgages.  It was immediately apparent that unintended consequences of the proposed risk retention rules (pdf) abound.

The panelists acknowledged that the regulators had a very tough mandate, and that the rules are way more complicated than anticipated.  It was estimated that approximately 60% of the proposed rule will make its way to the final rule, and that while feelings of annoyance with respect to the drafting of the proposed rule may linger, it is up to the securitization market participants to help the regulators provide us with a clear, workable final rule.

Under the proposed rule, calculation of the amount of required risk retention would be based on a percentage of the par value of the ABS interests in an issuing entity.  The discussion began with a couple questions some of us have already been asking …

What do regulators mean by “par value”?  What is an “ABS interest”?

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Although there is renewed optimism for a vibrant CRE lending market in 2011 (or at least a significantly better market than the prior 3 years), many lenders and servicers continue to face challenges in dealing with delinquent or defaulted commercial mortgage and mezzanine loans (whether held on balance-sheet or securitized). The volume of these “scratch and dent” assets are expected to increase this year and are responsible for continued misfortune by masking positive returns and causing realized losses. Despite this misfortune and the associated headaches, there is appetite in the industry to acquire or aggregate large portfolios of these loans on the cheap, and make a buck or two in the process of restructuring the loans or exercising remedies.

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Last week, the Supreme Court of the State of New York handed down a decision in the battle between CWCapital, representing the senior mortgage debt as special servicer, and Pershing’s andWinthrop’s joint venture, who recently bought the mezz debt in this transaction at a deep discount.  Everyone knows what’s going on here.  The mezz debt was bought as a lever to attempt to get control of the property through, or in the shadow of, bankruptcy.  A successful workout would, by definition, compromise the senior debt.  To prevent that, CW sought injunctive relief to prevent the foreclosure of the mezz debt and they got it.  Unless this is reversed, it’s game over for the mezz because the foreclosure of the mortgage debt is coming up very soon. 

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As a follow up to my earlier post, we just issued this article (pdf) about the IRS’ recent Revenue Procedure (pdf) regarding the REMIC rules. The problems inherent in last September’s REMIC Regulations have been well-covered in this blog. In short, the IRS surprised the industry by requiring a mortgage loan to pass an 80% value-to-loan test as a condition to any lien release (the same test required upon initial contribution to the REMIC). While the existing REMIC Rules could have been read to only expressly permit releases of property in connection with a qualifying defeasance, the pervasive view among issuers and their counsel for years was that certain releases (outparcels, condemnation, and partial releases upon pay-down, to name a few) were permissible so long as the release was at the option of the borrower and was subject only to certain objective criteria.

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The commercial banks have largely paid it off, GM has paid it off, and even AIG says it will soon pay off the government’s emergency investment to save the Western world as we know it. As to the GSEs: not so much. We’ve got about $150 billion invested in these entities and no end in sight. In fact, as far as I can tell, there’s yet no plan in sight to ultimately come to an end in sight. Clearly, there are hard political questions about these enterprises which the political class have seen fit to dodge or kick down the road. Should they be private businesses? Conduits for subsidized housing? Both? We now know that both is the wrong answer, or at least not a very good answer. Someone said the GSEs are critical because the private markets have abandoned housing. But how can private markets compete with enterprises that have no need to make a profit, and whose debt is backstopped by the full faith and credit of the United States of America. Who’s going to compete in that market place? Moreover, you’d hope Washington is aware that many other advanced Western economies seem to do quite well without such quasi-public vehicles (not to mention without tax deductibility of mortgage payments, but that’s another story).

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As I discussed in my prior blog post, and this article, last September’s REMIC regulations left servicers, lenders and borrowers in a quandary over the effect the new “principally secured by real estate test” would have on troubled multi-property loans with release features. The new rules, in some cases, could have resulted in adverse tax consequences to REMIC containing loans with underlying real estate collateral that had fallen below a 125% ltv. Yesterday, the IRS announced Revenue Procedure 2010-30 which, at first read, provides some relief. The new Rev Proc elucidates the circumstances under which certain modifications will be deemed not to fail the principally-secured test. Specifically, loan modifications that relate either to a “grandfathered qualified mortgage” (generally, a modification effected pursuant to the terms of loan documents executed prior to December 6, 2010) or a “qualified pay-down transaction” (generally, a release of a lien in exchange for a principal pay-down of a qualifying amount) won't result in the IRS asserting a REMIC challenge. Apparently, someone at Treasury recognized the conundrum the new rules created in lien-release scenarios – more information and analysis on the new rules will be forthcoming.
 

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The Wall Street Journal and Bloomberg, among other outlets, reported last week that the Royal Bank of Scotland Group Plc is in the process of placing a multi-borrower securitization – the first such issuance to come to market since June 2008. Of course, RBS is facing several hurdles as it trailblazes once-familiar territory. The offering, variously reported to be between $300 and $500 million, would represent a significant tool for other banks in determining pricing for future multi-borrower deals. The offering will also serve as a measuring stick for investor demand in the post-TALF world.

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The changes to the REMIC rules (PDF) were intended, at least in part, to ease restrictions on servicers of securitized mortgage loans. However, while expanding the scope of permitted modifications, the new REMIC regulations also impose a requirement that the modified loan be re-tested to ensure the mortgage loan continues to be principally secured by real estate. This generally makes sense REMICs are intended to hold mortgage loans, and this new requirement presumably prevents a servicer from modifying the mortgage loan so as to be secured by other assets, such as credit-card receivables, cash or other non-real estate collateral.

The problem, however, is that the new regulations also require mortgage loans to be re-tested any time real property collateral is released (even if the release is explicitly contemplated by the loan documents). On troubled multi-property loans (with an LTV of less than 80%), this re-testing requirement potentially puts servicers between a rock and a hard place, forcing them to choose between entering into a prohibited modification (resulting in the imposition of potentially severe tax penalties) and incurring liability to borrower (and potentially, junior lenders) for failing to meet the obligations of the loan documents.

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