did Sunstone Hotel Investors Inc. neglect to mail its mortgage check to its servicer this month?[/b] The company wasn't facing bankruptcy or looking to walk away from a declining commercial real estate investment. The hospitality REIT didn't run out of postage stamps, either. By defaulting on a $65 million mortgage on the W San Diego Hotel, Sunstone simply hoped that its mortgage servicer, Centerline Servicing, would finally sit down and discuss modifying the loan to reflect shrunken property cashflows, according to [link=http://online.wsj.com/article/SB124458946625899921.html][u]a recent Wall Street Journal article[/u][/link]. Under the Real Estate Mortgage Investment Conduit (REMIC) rules that currently govern commercial mortgage-backed securities (CMBS) transactions, servicers generally cannot modify the mortgage unless it is in default – no matter how severely the prevailing mortgage terms fail to align with the current economic realities for the CMBS borrower. In the residential mortgage sector, proactive, pre-default borrower action is fully encouraged. Extensive and long-running campaigns, such as the popular HOPE NOW initiative, instruct borrowers to promptly contact their mortgage servicers and trained counselors if they find their current terms burdensome and foresee possible payment troubles. But there is no HOPE NOW hotline for a proactive REIT or commercial property developer seeking to prevent future repayment trouble before it happens (and with the much-discussed wave of CMBS expected to mature over the next few years, there is going to be a whole lot of future trouble). Of course, because the average CMBS borrower is a more complex entity and is much more intricately involved in the financial sector than the average homeowner, no one expects personal coaching via phone by volunteer financial counselors to be offered here. Rather, the critically needed step for enabling CMBS loan modifications is modifying the restrictive REMIC tax rules that deter servicers from even discussing loan restructuring with borrowers in advance of a default. ‘If the loan is not in default, but a default is reasonably foreseeable, the REMIC tax regulations permit the servicer broad discretion to modify the loan,’ explains a recent client bulletin issued by law firm Dechert LLP. ‘However, many [pooling and servicing agreements (PSAs)] do not expressly give the servicers such broad authority unless the loan is a specially serviced loan. If a loan is not in default, a special servicing transfer event typically does not occur unless a default is imminent (not reasonably foreseeable),’ the company says. ‘Thus, there may be situations where, while free from the constraints of the REMIC rules limiting significant modifications, the default is reasonably foreseeable (but not imminent). The special servicer, while free from the constraints of the REMIC rules limiting significant modifications, may be reluctant to effect a modification in the absence of express authority in the PSA allowing for significant modifications of a loan that is not yet a specially serviced loan,’ Dechert continues. The Treasury is reportedly considering issuing new guidance designed to promote CMBS loan restructuring for borrowers that have not defaulted but anticipate future problems. This new guidance would permit servicers to begin default-prevention talks with still-current borrowers without inducing unfavorable tax consequences, the WSJ said. Discussions could occur as early as two years in advance of the mortgage's maturity date. ‘The proposed changes also are comparable to actions already taken by Congress, Treasury and the IRS to eliminate or mitigate certain tax consequences relating to residential mortgage loan restructurings,’ the Real Estate Roundtable (RER) noted in a recent report. RER has expressed strong support for the potential new Treasury rules. In the meantime, actual CMBS loan modifications remain rare. Leadsnet Inc., an online provider of commercial mortgage leads, [u][link=http://www.mortgageorb.com/e107_plugins/content/content.php?content.3534]recently reported[/link][/u] increased traffic at the loan modification portal on its Web site. The heightened interest at Leadsnet, however, failed to translate into widespread modification success. In addition to the aforementioned restrictive REMIC rules, the domination of Fannie Mae and Freddie Mac in the CMBS buying market is preventing much-needed modification action. ‘Both Freddie and Fannie have a policy of no modifications on commercial loans,’ noted Ted Schmidt, president of Leadsnet, in the company's Web site traffic report. ‘This policy on commercial loans is the exact opposite of their policy on residential loans.’ As we await the new Treasury rules that may alleviate CMBS' loan modification roadblocks, the industry should also seek ways to address this problem from within. How can we juggle the often conflicting demands of borrower needs, servicer capabilities and investor requirements? Striking a balance will undoubtedly be tricky, but there must be a better option than an intentional borrower default simply for the sake of forcing a servicer to talk. Please send your comments to lillianj@cmi-online.com. -[b]Jessica Lillian[/b], [i]Commercial Mortgage Insigh
