September 16, 2009
Treasury Relaxes CMBS Restructuring Rules
In my previous post on the looming commercial real estate crisis, I promised to blog in more detail about Commercial Mortgage-Backed Securities (CMBS) loans. I had not planned to do so today, but the Treasury Department has made the subject timely.
CMBS loans are "permanent loans," meaning that they were designed for commercial, incoming-producing assets, normally with a 10 year term. They were not designed for undeveloped land or to fund construction costs. An originating lender would make a number of CMBS loans meeting certain criteria, bundle them into a portfolio, and then shares of that portfolio would be sold to investors in the CMBS market. The individual loans would then be taken off the originating lender's balance sheet and the lender would earn a fee for putting the deal together. CMBS loans were particularly attractive to borrowers because interest rates were normally lower than traditional permanent loans.
Because the individual loans were packaged into securities, strict deal requirements evolved. The central requirement was that the borrower in a CMBS loan must be a special purpose entity (SPE). An SPE's sole purpose is to own and operate the mortgaged asset. SPE's were routinely created for the purpose of entering into the loan so that the lender could loan to a "clean" entity with no prior liabilities. Typically formed as Delaware limited liability companies, SPE operating agreements contained form provisions requiring them to maintain a separate existence from other entities and business enterprises (including separate letterhead, a separate telephone number, etc.). The purpose of an SPE was to isolate the operations of the borrower from the borrower's parent and affiliates. Each loan was intended to stand alone. SPEs were also designed and intended to be "bankruptcy-remote," meaning that they contained provisions which limited the borrower's ability to declare bankruptcy without the lender's consent (through an independent director) and limited the ability of the SPE to be involuntarily brought into a bankruptcy declared by the SPE's parent or affiliates.
In a CMBS loan, the role of the lender can be thought of as bifurcated. The holders of the securities own the economic interest in the loan, but the authority of the lender pursuant to the loan documents is vested in the servicer, usually another large financial institution. The servicer is permitted to do little more than receive and process loan payments and approve routine matters like new leases. The major force limiting the servicer's authority are tax rules that create taxable events for the securities holders if the servicer oversteps the bounds of its authority. For example, a servicer had no authority to renegotiate the terms of a loan, agree to a forbearance, or negotiate term or interest rate unless the borrower is in default. It is this inflexibility that General Growth Properties cited in its bankruptcy filing.
Commercial real estate owners have been petitioning Treasury to relax those rules, panicked at the thought of finding new debt (and equity) to cover the $150 billion in CMBS loans that will come due between now and 2012. (Non-CMBS loans are being routinely extended for a year or so to give the market time to readjust.) Treasury has now responded, issuing guidance which allows servicers to modify interest rates and term, regardless of when the loan matures. The only criteria is that the servicer must believe that there is a "significant risk of default," which may be true even if the loan is not currently in default.
Treasury's new guidelines are outlined in an article in the Wall Street Journal today on page C6 entitled "New Rules Ease the Restructuring of CMBS Loans." Unfortunately, I cannot link to the WSJ.
I wouldn't try calling a CMBS servicer today -- I'll bet the phone lines are jammed.
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