What Is a REMIC and How Does It Play Into My Defeasance?
When a CMBS loan is originated, it’s common to then securitize that loan, which is the conversion of your loan into marketable securities. The loans are bundled together and sold as bonds to investors, meaning the loans must survive to fulfill the obligations to the investors. When loans are securitized, they are frequently put into a REMIC (Real Estate Mortgage Investment Conduit) which must abide by an elaborate web of regulations to retain its tax-free status. In order to successfully consummate a defeasance, it must be completed within the rules laid out by the regulators.
Here are a couple considerations:
REMICs can only hold “permitted investments” and “qualified mortgages” which all original loans meet the requirements for. This is meaningful because general tax rules define the substitution of a “substantial amount” of the collateral as a significant modification of that loan and a defeasance does just that. Loans that have been significantly modified are typically no longer considered “qualified mortgages”.
That said, there is a special REMIC exception which allows a release of the lien on real property and will not cause the mortgage to become unqualified, so long as the transaction satisfies the following four conditions:
- The loan documents must have the proper defeasance provisions. In other words, you can’t defease a loan in a REMIC if the loan documents didn’t originally contemplate defeasance.
- The defeasance transaction cannot occur prior to the end of its “lockout” period which is typically the earlier of i) the third anniversary of the closing date or ii) two years after the REMIC’s startup day - the day the loan is actually securitized.
- This essentially means the Note must be placed in a REMIC within one year of the closing for it to be subject to defeasance.
- The defeasance must be completed to facilitate an ordinary transaction such as a sale or refi.
- The collateral portfolio must be structured using “government securities” as defined by the Investment Company Act of 1940 which generally means US Treasury, and in some cases, Agency securities. These requirements are further outlined in the respective loan agreements.
These conditions are why servicers are unable to allow a closing while in lockout or permit some alternative type of security.
There is potential that a Rating Agency (RAC) review could be conducted in connection to the defeasance for assurance that it aligns with the above provisions and to evaluate creditworthiness for the bonds issued to investors. This is common when it comes to CMBS securitizations as the rating agencies look to assess for potential inefficiencies in the pool.
Any of the agencies (eg Moody’s, DBRS, Kroll) that originally rated the bond, could elect to review the transaction at which point their counsel would provide a ‘no downgrade letter’ to confirm the transaction falls within the scope of REMIC rules. The review can add two or three weeks to the defeasance process, making it an important consideration. They most frequently occur when one or more of the following apply:
- Loan amount is >$25mm
- Loan is in the top 10 by size within the securitization pool
- The loan accounts for over 10% of the securitization pool
RAC review fees can vary by how many (if any) of the rating agencies elect to review the defeasance transaction but frequently fall within the $15K - $25K range. The Borrower is responsible for any costs and expenses incurred in connection with the RAC review.
Adherence to the above provisions allows the borrower to obtain release from the debt without impacting the REMICs tax status, leaving bondholders indifferent. For this reason, defeasance is a very regimented process, and a specific set of steps/requirements must be completed to ensure a smooth closing.
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