New CMBS Tax Rules Miss Underwater Factor, BofA Says
The market for commercial mortgage-backed securities (CMBS) experienced a rally last week following the issuance of new guidelines regarding acceptable loan modifications within real estate mortgage investment conduits (REMICs). The total reach of the new rules may not go so deep, however, as to help some underwater borrowers, according to one research firm. New tax rules that took effect last week may increase the occurrence of modifications within CMBS by lifting a tax penalty on changes made to commercial mortgage pools after their inclusion in a securitization vehicle. The changes triggered a narrowing of CMBS spreads despite investor uncertainty of the effect on securities. Banc of America Securities - Merrill Lynch (BAS-ML) commentary last week indicated researchers expected positive CMBS credit performance, although the market experienced a strong rally in below triple-A bonds in the CMBS market. Despite the unexpected response, the changes appear unlikely to have an effect on all borrowers. "[O]ur view is that for loans that are deep underwater, and there are many of these, the new guidelines would not help," BAS-ML researchers said in market commentary. "Loans where the borrower is already turning over the keys and not even attempting to initiate discussions with the servicers come to mind." The price action seen in the market in response to the changes indicates either the changes to the REMIC tax rules are "more powerful that [BAS-ML researchers] have given them credit for" or lower than anticipated tranches are the ones on the "cusp of survival." The market rally may also have something to do with the growing role of the government in heading off the wave of growing problems in the sector, BAS-ML said. The market may grow more optimistic as government has more involvement in watching and regulating the commercial real estate space. Bids for loans to purchase legacy CMBS through the Term Asset-Backed Securities Loan Facility are in decline, however. BAS-ML noted the 38.6% decrease of bids to $1.4bn from $2.3bn last month is partly due to summer-end holidays and a trend of investors buying closer to the facility date in order to reduce volatility risk. the drop-off in bids may also be due to some uncertainty over what collateral will be acceptable to the New York Federal Reserve, the researchers said. Similar uncertainty on the Fed's acceptance and rejection process led Barclays Capital recently to urge disclosure by the Fed. Greater disclosure of the standards and procedures would ease investors and lead to a larger volume of bids. "Although no surprise, there were also no new issues brought to market in September under the TALF program (the fifth straight month)," BAS-ML researchers wrote. "We think there is a chance that October brings the first such deal but there is no guarantee." One reason for the low interest in new issues is the ability of REITs to raise money in the unsecured market. A handful have already issued debt since the middle of summer, raising millions of dollars as investors look to take advantage of the glut of distressed assets hitting the market. Write to Diana Golobay.