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The mysteries of the universe: a step-by-step review of the basics of the CMBS loan-assumption process can clear up much of the mystery behind this complex topic.

When a tree falls in the forest, does it make a sound? [??] Which came first: the chicken or the egg? [??] Why does the commercial mortgage-backed securities (CMBS) loan assumption process cause servicers and borrowers so many headaches? [??] These are some of the great mysteries of the universe. The first two questions have been tackled by philosophers down through the ages. Yet, the last of these questions has emerged for discussion only in more recent times. In 2007, the Commercial Mortgage Securities Association (CMSA), New York, and the Mortgage Bankers Association (MBA) created a joint task force made up of master servicers, primary servicers, special servicers, mortgage bankers and attorneys (no philosophers) to study the issue. And it appears this task force of leading CMBS servicing industry participants will be left to unravel this more modern yet still vexing mystery. [??] The assumption process has become a highly scrutinized and criticized process within the CMBS industry. As an example, both New York-based Fitch Ratings and Standard & Poor's (S & P) now require servicers to provide performance statistics as part of their quarterly monitoring and annual servicer review processes. In fact, Fitch has published two research pieces on the CMBS assumption process (see Fitch's research, What Holds up the CMBS Assumption, from June 9, 2006, and U.S. CMBS Assumptions: An Update, from June 6, 2007, for additional information).

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Among the reasons assumptions receive so much attention are:

* The large number of assumptions processed annually;

* The time and effort of multiple parties required to process an assumption;

* The obligation to protect the interest of CMBS investors; and

* The high level of borrower dissatisfaction with the assumption process.

What is an assumption?

An assumption is "the act of taking over the previous borrower's obligation of a mortgage note ... a buyer's acceptance of primary liability for payment of an existing note secured by a mortgage or deed of trust," according to MBA's Mortgage Banking Terms, 10th edition, 2004.

In practice, assumptions are requested when a current borrower of a commercial/multifamily loan wishes to sell all or part of the property and the property purchaser agrees to be bound by the terms of the existing loan documents.

The assumption process is complex. Servicers are bound by the dictates of the individual loan documents and the CMBS transaction's specific pooling and servicing agreement (PSA). (Hereinafter when referring to servicer, primary servicer and/or master servicer, the applicable servicer in a transaction will depend on whether the loan is subserviced by a primary servicer that is different from the master servicer.)

Pursuant to the terms of CMBS loan documents, the current borrower is prohibited from selling its property without the consent of the lender. The ability to grant or withhold such lender consent is assigned in the PSA to either the master servicer or the special servicer if the loan is included in a CMBS transaction. Thus, the servicer becomes the central coordinator in the assumption process.

Unlike a new loan origination, which generally only goes through an internal credit approval process, an assumption has multiple external parties involved in the approval process. They include the primary servicer (only if the loan is subserviced), the master servicer and the special servicer. Certain circumstances may also require the consent of the controlling class representative (CCR), and in certain circumstances, the rating agencies that rated the CMBS transaction may review the transaction.

Master servicer: Generally, the master servicer serves as the primary point of contact for assumption requests, responsible for collecting all the due-diligence items, underwriting the assumption transaction (the assumption package) and closing the assumption once it has been approved by all parties as set forth in the PSA. If there is a third-party primary servicer, it may act as the primary point of contact with the borrower. That decision is based on the contractual subservicing agreement between that master servicer and primary servicer.

Special servicer: Under a typical arrangement, the special servicer receives the assumption underwriting package from the master servicer with the master servicer's recommendation for approval (with or without conditions to consent) or denial. The special servicer will review the submitted assumption package and the master servicer's recommendation. The special servicer will then render a determination whether or not to approve the assumption.

Controlling class representative: The CCR typically invests in the lowest-rated, highest-risk bond classes within the CMBS structure. The CCR appoints the special servicer for the CMBS trust and, in the case of loan assumptions, may require the special servicer to obtain its independent approval. (The CCR appointment of the special servicer is generally an affiliate of the CCR; however, there are certain instances when the CCR engages a non-affiliated third-party special servicer.)

Rating agencies: The rating agencies do not review all assumptions; each rating agency has its own threshold requirements for review of an assumption. Rating agencies evaluate the transaction to determine that the assumption, in and of itself, will not cause a downgrade of any of the tranches of bonds for the CMBS transaction. Their consent usually takes the form of a letter termed a rating agency confirmation (RAC). A RAC is also referred to as a "no downgrade" letter.

What is the assumption process?

In its basic form, the life of an assumption is similar to that of a newly originated loan:

* The parties submit an application and deposits, requesting that the servicer review and approve the assumption transaction.

* The servicer provides the parties with a due-diligence checklist of required items.

* The servicer completes its due diligence.

* The assumption works its way through the labyrinth of required approvals.

* The assumption is approved and any additional conditions are satisfied.

* The assumption closes.

* The servicing of the loan continues, with the new borrower taking responsibility for loan payments and other obligations required by the loan documents.

It is important to note that the proposed new borrower is assuming the transaction as it was originally closed--not the transaction that would be originated today if the loan was newly originated. Moreover, the ability to renegotiate loan terms may be deemed a significant modification under real estate mortgage investment conduit (REMIC) rules, and would therefore be prohibited.

Start of an assumption process

As with most commercial real estate transactions, an assumption begins with the borrower initiating the process by submitting an executed application (with deposits) to the servicer. While the borrower generally thinks the assumption process begins with its initial contact with the servicer; that is not the case. A servicer will not consider an assumption request as "started" until all the preliminary requirements are satisfied.

As noted in the two Fitch research pieces, it takes on average between 33 and 38 days for the servicer to receive all the necessary information from the current borrower and proposed new borrower; it is only after this time period that the servicer considers the assumption "started."

Once the executed applications and deposits are delivered, the parties should have a kick-off call to discuss the upcoming assumption, the information required and the approval and closing process (including identifying all parties with consent rights), and setting realistic timelines.

Due diligence and information requests

In general, all assumption due-diligence checklists have four basic categories of requested items that all servicers require as part of the assumption due-diligence process: current borrower information, property performance information, proposed new borrower and proposed indemnitor and guarantor information, and new property management information.

The servicer will typically send the checklist to the current borrower and proposed new borrower early in the process. The checklist for any specific loan assumption will incorporate the loan document requirements, the master servicer's company-specific requirements and any transaction-level requirements.

How is the decision made?

The servicer's ongoing responsibilities in any assumption process include--but are not limited to--enforcing the loan document terms, safeguarding the property and protecting the interest of the CMBS investors.

In practice, the assumption is viewed with an eye toward its potential impact on the performance of the securitization, with the mindset to "do no harm" toward its CMBS investors.

CMBS trust's REMIC status impact on the process

The existence of a CMBS trust significantly impacts the approval process for assumptions. (The task force discussions and this article were completed prior to any potential new rulings or guidance from the Internal Revenue Service concerning REMIC regulations and the industry REMIC reform efforts.)

A CMBS trust is created for each securitization and is possible, in part, based on tax law. The tax benefit for a CMBS trust that qualifies as a REMIC is that the trust is not subjected to an entity-level tax on its income. (For more information on CMBS and the trust structure, review the CMSA/MBA Borrower Guide to CMBS.) In order for a CMBS trust to qualify as a REMIC, it can only hold qualified mortgages and permitted investments.

If a REMIC holds a qualified mortgage that is modified in an economically significant manner, the CMBS trust will suffer adverse tax consequences. Assumptions of non-recourse mortgages without any changes to the terms of the loans generally will not be deemed a significant modification. However, if in the context of an assumption, the loan is modified to change collateral or add credit guarantees, or if other economic terms are modified, the modification may be deemed significant and therefore the mortgages may not continue to satisfy the qualified mortgage requirement.

There are significant consequences--if the CMBS trust were to hold a mortgage that is no longer qualified, a 100 percent tax will be imposed on any income received from such a loan. Moreover, if it is determined that the CMBS trust no longer qualifies as a REMIC, the income of the CMBS trust will be subject to tax at the entity level, which results in double tax, and the structure is no longer viable.

Evaluating proposed new borrower

For servicers, assessing the creditworthiness of the proposed new borrower (sponsors, indemnitor or guarantor) is one of the most difficult challenges of the assumption due-diligence and approval process. Some refer to this as the "Bill Gates" problem. That is to say, if a CMBS servicer had Microsoft[R] Corporation Chairman Bill Gates as the current sponsor, indemnitor and/or guarantor, there would be no possible buyer that would be an equal substitute.

At the same time, the current and proposed new borrowers are looking for the servicer to evaluate the proposed new borrower and proposed indemnitor and/or guarantor on their own merits, without regard to the creditworthiness of the current borrower and current indemnitor and/or guarantor. However, given the servicer's responsibility to act in the best interest of the CMBS investor, the comparison of the current to the proposed principals is inevitable.

In addition to the traditional due diligence and review of the parties, a higher standard of review in recent years has been implemented as a result of the requirements of the USA PATRIOT Act of 2001. In response to the terrorist events of Sept. 11, 2001, the U.S. government has increased the obligations of financial institutions to "know their customer," requiring servicers during the assumption process to run extensive background searches on both the individuals and the entities associated with an assumption.

How is the assumption closed?

The servicer's closing counsel will provide a final deal-specific closing checklist. That checklist will identify the closing items that must be delivered to the servicer and/or servicer's counsel for approval prior to closing. The due-diligence items subject to review and approval typically include the following:

* new title policy or endorsement to current policy;

* bankruptcy, judgment and Uniform Commercial Code (UCC) searches;

* purchase and transfer documents;

* new insurance certificates;

* property management agreement;

* organizational documents; and

* legal opinions.

Once the loan assumption receives final approval, the assumption is closed by the execution and delivery of the required loan assumption documentation.

In closing

The intent of this article is to demystify the CMBS assumption process by providing a better understanding of the roles of the parties, documentation requirements, the approval process and the challenges inherent to the assumption process. We may never know which came first--the chicken or the egg. But it is possible to decipher some of the mysteries of the assumption process. Preparation and better communication among the current borrower, proposed new borrower and servicer will help ensure a smoother flow of information and facilitate the processing of your loan assumption.

Alan Kronovet is managing director of portfolio and asset management for Wachovia Real Estate Services in Charlotte, North Carolina. and Katie Schwarting is counsel with Powell Goldstein LLP in Washington, D.C. They can be reached at alan.kronovet@wachovia.com and kschwarting@pogolaw.com.
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Title Annotation:Commercial/Multifamily; commercial mortgage-backed securities
Comment:The mysteries of the universe: a step-by-step review of the basics of the CMBS loan-assumption process can clear up much of the mystery behind this complex topic.(Commercial/Multifamily)(commercial mortgage-backed securities)
Author:Kronovet, Alan; Schwarting, Katie
Publication:Mortgage Banking
Geographic Code:1USA
Date:Feb 1, 2008
Words:2100
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