Commercial mortgage-backed securities (CMBS) are securitized mortgage loans backed by commercial real estate. CMBS existed early on as a private placement bond market in the late 1980s. With the creation of the Resolution Trust Company in 1991, however, the CMBS market quickly bloomed into a viable sector for bond investors.
Investors took to the CMBS market seeking generous spreads and prepayment protection. Originators took to the market to sell off underwriting risks and a concentration of geographic risk. Both investors and originators enjoyed the benefit of increased liquidity, the ability to hedge against cyclical credit crunches, increased ability to diversify.
Whether capital is needed for real estate acquisition or development the secondary market has allowed lenders to consolidate and sell their debt. Both private portfolio loans (large owners and developers) and institutional portfolio loans (insurance companies, banks, and pension funds) hold debt for which securitization is a viable option.
Below is an introductory overview of the industry's moving parts.
Securitization Process Overview
This section offers an overview of the process of pooling loans into mortgage backed securities for sale into the secondary mortgage market. The securitization process has been broken down in a way that identifies the “who, what, when and where” needed to successfully accomplish the transaction. A timeline has been utilized to schedule all responsibilities and activity in order to complete the deal.
The key participants in such transactions have been outlined as an additional reference. You will see the structure and level of involvement of each player. Also provided is an example of CMBS transaction expenses.
- CA: Certified Accountant
- IB: Investment Bank
- RA: Rating Agencies
- SC: Seller's Counsel
- SL: Seller
- SV: Servicer
- TA: Trust Accountant
- UC: Underwriter's Counsel
These key participants are as follows:
Certified Accountant: Accountant responsible for final affirmation of rent rolls, ratios, and financial
statements of both the borrowers and property.
Investment Bank: A firm that purchases and sells corporate and government securities to the public. In the case of CMBS, it is the financial intermediary which sponsors the conduit by purchasing the commercial mortgage loans from the conduit/originator and securitizes them for sale to investors. The conduit relationship between the securities firm and the originator is similar to that of a joint venture in that both parties determine the terms of the mortgage loans and the price at which they will be sold prior to their origination. The success of the interactive relationship between the investment bank and the conduit/originator is dependent upon ensuring that the quality, pricing, and volume of the mortgage loans originated is consistent with their mutual expectations.
Investors: Typical investors in CMBS include life insurance companies, pension funds, money
managers, mutual funds, and commercial banks for investment-grade tranches. For below-investment grade tranches, securities are often placed pursuant to Rule 144(a), and as a result must be sold to a Qualified Institutional Buyer (QIB). The core demand for the below-investment-grade tranches has come from
prominent real estate investment funds or CMBS servicing entities (both have the real estate expertise necessary to competently assess the real estate risk inherent in these tranches).
Rating Agencies: Agencies which examine the assets collateralizing the securities and rates securities
based on its benchmarks. Ratings range from triple-A (highest) to triple-C (lowest) and have a major influence on CMBS. Triple-A down through triple-B are investment grade securities while all securities
below double-B are below investment grade securities. (For more on Rating Agencies, click here.)
Seller: Any loan originator which sells its mortgages for securitization, e.g. commercial bank,
mortgage banker, or insurance company.
Seller’s Counsel: Attorney who represents and advises seller through securitization process.
Servicer: Institution acting for the benefit of the certificate-holders in the administration of
mortgage loans in a CMBS. Functions include collecting payments from borrowers, advancing funds for
delinquency loans, reporting to the trustee, negotiating workouts or restructures and taking defaulted properties through the foreclosure process.
- Master Servicer: Services mortgage loans which collateralize CMBS for certificate holders,
- Collects mortgage payments and passes funds to trustee;
- Provides mortgage performance reports to certificate holders;
- Advances late payments to Trustee; and
- Gives non-performing loans to Special Servicer.
- Special Servicer
- Deals with default loans by conducting “work out” or foreclosure process;
- Selection of special servicer influenced by:
- those seller/issuers retaining the first-loss piece
- those investing in “B” pieces in return for special services rights
- those appointed solely because of asset management expertise.
- Sub-Servicer
- The Master Servicer and the Special Servicer are allowed to each subcontract their duties to a sub-servicer.
- Sub-servicers may be chosen if they have distinguished aptitude in dealing with particular property’s type, location, or deficiencies.
- the Master Servicer or Special Servicer remain responsible for the performance of the delegated duties.
Trustee: Represents the trust which holds legal title to the collateral for benefit of certificate
holders, supervises master servicer/special servicer, and ensures that servicers act in accordance with pooling and servicing agreement.
Trust Accountant: Accountant who affirms financial records of cash flow to be distributed to bond holders.
Underwriter: Assesses risk, judges tenant quality, affirms property is clear of environmental liability, and examines in detail lease terms, loan amount/terms, loan to value ratios, debt service coverage ratios.
Underwriter’s Counsel: Attorney who represents underwriter and ensures a true sale.
The interaction between the Trustee, Servicer/Special Servicer, Borrower, Mortgage Banker, Issuer, Trust, and Investors is diagrammed below.
The CMBS pipeline flow from Origination to Securities, to Investors is diagrammed below.
Overview of the Collateral
This section provides commonly used definitions which are instrumental in loan underwriting. These ratios are relatively simple measures yet they are capable of characterizing a property as being profitable or distressed.
Understanding the terminology and descriptive measures in this section is the platform from which sound real estate investment decisions can occur. Therefore, the utilization of financial ratios combined with the awareness of possible future events will provide insight as to financial risk, investment performance, and credit enhancement.
The definitions are as follows:
Debt Service Coverage Ratio (DSCR): First-year net cash flow, as adjusted by DCR, divided by debt service payment using an assumed debt service constant.
Loan-to-Value Ratio (Initial) (LTV): Mortgage principal amount divided by the underwritten value of the property as adjusted by DCR.
Loan-to-Value Ratio (at maturity or balloon): The initial LTV adjusted for any amortization over the term, assuming zero property value increase.
Debt Service Constant: Derived using an assumed long-term rate equal to the higher of the actual or the average experienced preceding commercial real estate cycle. The interest rate assumed will be qualified by a number of other factors. If there is a fixed-rate, fully amortizing transaction, the gross rate on the mortgage prevailing at the time of the financing will be utilized. For fixed-rate, balloon transactions, the higher of the actual or average rate prevailing over the previous real estate cycle will be incorporated. Similarly, for floating-rate loans with balloon payments, it is assumed that the loan will need to be refinanced under the interest rate environment described above. Floating-rate loans with a high-rate cap or no-rate cap will be stress tested separately for this incremental risk.
The following is considered in any CMBS transaction:
Historical Operating Information: three years, plus trailing twelve months of income and expenses and comment on significant fluctuations on a line item basis.
Stabilizing NOI: Adjust underwritten NOI to industry standards regarding replacement reserves, management fees, and vacancies, and mark to market rents and vacancies.
Lease turnover: Take into account the point at which various leases expire, tenants' options for renewal, and incorporate the various scenarios in the cash flow analysis.
Demographic changes: Account for major economic events which could potentially impact stabilizing cash flows.
Economic property improvement: Data from market area analysis and surveys on comparable projects may be used to establish what expected rents and expenses will be. Economic and demographic trends at the local and regional level should be realized.
Documentation
The following comprise certain base representations and warranties to be delivered in connection with commercial mortgage securitizations. This list is not all-inclusive and may be modified or expanded depending on the specific terms and structure of a given transaction. This list is intended only as a general guideline for the scope and substance of typical provisions.
1. Mortgage Loan Schedule: The information with respect to each mortgage loan is true and correct in all material respects at the date or dates the information is given.
2. Ownership of Mortgage Loans: Immediately prior to the transfer and assignment of the mortgage loans to the purchaser, the seller is the sole owner of each mortgage loan and transfers the lease free and clear of all
liens. Additionally, each mortgage loan should be a whole loan and not a participation interest in a mortgage loan.
3. Ratios: The debt-service-coverage ratio and loan-to-loan ratio with respect to each mortgage loan
are not to be less than XXXX and XXXX, respectively, as of the cut-off date.
4. Payment Record: No mortgage loan is delinquent beyond any applicable grace period nor more than 30 days delinquent at any time subsequent to origination, without giving effect to any applicable grace
period.
5. First-Lien Mortgage: Each mortgage is a legal first lien on the mortgage property, subject only to (a) the lien of the current real property taxes, ground rents, water charges and sewer rents, and assessments not
yet due and payable, (b) exceptions and exclusions specifically referred to in lender's title insurance commitment or policy (including rights of way and easements), none of which materially interferes with the current use of the mortgaged property or the security intended to be provided by the mortgage, and (c) other matters to which like properties are commonly subject, none of which materially interferes with the current use of the mortgaged property or the security intended to be provided by such mortgage (collectively, "permitted encumbrances"). A UCC financing statement has been filed and/or recorded in all places necessary to perfect a valid security interest in the personal property, if any, granted under such mortgage; any security agreement, chattel mortgage or equivalent document related to and delivered in connection with the mortgage loan establishes and creates a valid and enforceable first lien and first priority security interest on the property described, provided that enforceability may be limited by bankruptcy or other laws affecting creditor's rights or by the application of the rules of equity.
6. Assignment of Leases and Rents: The mortgage file contains an assignment of leases or an assignment of rents (assignment of leases) either as a separate instrument or incorporated into the related mortgage, which
creates, in favor of the holder a valid, perfected and enforceable lien of the same priority and rights described; provided that the enforceability of such lien is subject to applicable bankruptcy, insolvency, reorganization, moratorium and other laws affecting the enforcement of creditors' rights generally, and by the application of the rules of equity. The seller has the full right to assign to the purchaser such assignment of leases and the lien created thereby as described in the immediately preceding sentence. No person other than the mortgagor owns any interest in any payments due under the related leases.
7. Valid Assignment: Each assignment of mortgage and related assignment of leases has been duly authorized, executed and delivered by the seller in recordable form, in order to validly convey the seller's
interest to purchaser.
8. Waivers and Modifications: None of the terms of any lease, mortgage note, mortgage or assignment related to mortgage loan has been impaired, waived, altered or modified in any way, except by written
instruments, all of which are included in the related mortgage file (and, to the extent necessary, all such waivers, alterations and modifications have been filed and/or recorded or submitted for record in all places necessary to perfect, maintain and continue the validity and priority of the lien of the mortgage). The related lessee, mortgagor or guarantor, if any, has not been released, in whole or in part, from its obligations related to the mortgage note, other than pursuant to releases previously approved in writing by the seller or any affiliate, copies of which are included in the related mortgage file.
9. No Offset or Defense: There is no right of rescission, offset, abatement, diminution, defense or counterclaim to any mortgage loan (including the defense of usury). The operation of any terms of the mortgage note or the mortgage, or the exercise of any rights under the agreement, will not render the
mortgage note or the mortgage unenforceable, in whole or in part, or subject to any right of rescission, offset, abatement, diminution, defense or counterclaim (including the defense of usury or the violation of any applicable disclosure or consumer credit laws). No right of rescission, offset abatement, diminution, defense or counterclaim has been asserted with respect thereto.
10. Mortgage Status: Neither the seller nor any prior holder of any mortgage loan has satisfied, canceled, rescinded or subordinated the mortgage in whole or in part, released the mortgaged property in whole
or in part from the lien of the mortgage, or executed any instrument that would effect any such satisfaction, cancellation, rescission, subordination or release. The terms of the mortgage do not provide for a release of any portion of the mortgaged property from the lien of the mortgage.
11. Condemnation: To the best of the seller's knowledge, there is no proceeding pending for the total or partial condemnation of any mortgaged property.
12. Legal Compliance-Origination: All requirements of relevant federal, state and local law, rules and regulations have been satisfied or complied with in all material respects as they relate to the origination, funding servicing and the terms of the mortgage loans, including, without limitation, usury, truth in lending, real estate settlement procedures, consumer credit protection, equal credit opportunity or disclosure.
13. Title Insurance: The lien of each mortgage is insured by an ALTA lender's title insurance policy (or a binding commitment) or its equivalent, as adopted in the applicable jurisdiction. The policy insures
the seller, its successor and assigns, as to the first priority lien of the mortgage in the original principal amount after the advances of principal, subject only to permitted encumbrances, none of which, individually or in the aggregate should interfere with the current use of the mortgaged property or materially detract from the benefit of the first priority lien of the mortgage. The seller or its successors or assigns are the sole named insured of the policy, and the policy is assignable to the purchaser without the consent of or any notification to the insurer. No claims have been made under such policy and no prior holder of the related mortgage has done anything, by act or omission, and the seller has no knowledge of any matter that would impair or diminish the coverage of such policy. The insurer issuing such policy is qualified to do business in the jurisdiction in which the mortgaged property is located, and the policy contains no exclusion for or affirmatively insures (a) access to a public road, (b) that there are no encroachments of any part of the buildings thereon over easements (except for any mortgaged property located in jurisdictions where such affirmative insurance is not available) and (c) that the area shown on the survey is the same as the property legally described in the mortgage.
14. No Holdbacks: The proceeds of each mortgage loan have been fully disbursed, or, in cases of partial
disbursement, there is no requirement for future advances. To the best of the seller's knowledge, all requirements imposed by the originator to completion of any on-site or offsite improvements and to disbursements of any escrow funds have been complied with. Construction of the improvements on the mortgaged property is complete.
15. Mortgage Provisions: The mortgage note, mortgage and assignment of leases for each mortgage loan contain customary and enforceable provisions for commercial mortgage loans secured by properties such as the mortgaged properties, so as to render the rights and remedies of the holder adequate for the realization against the mortgaged property of the benefits of the security, including realization by judicial, or if applicable, non-judicial foreclosure subject to the affect of bankruptcy and similar laws affecting the rights of creditor and the application of principles of equity.
16. No Mortgage Default: There is no default, breach, violation or event of acceleration under the mortgage note, mortgage or assignment of leases, and no event that, with the passage of time or the giving of notice, or both, would constitute a default or event of acceleration, nor has the seller waived any such default. No foreclosure action or other form of enforcement has been threatened or commenced with respect to any mortgage.
17. Other Collateral: Each mortgage note does not, and has not since the date of origination of the related
mortgage loan, secured by any collateral except the lien of the related mortgage, as assignment of the related leases, and any related security agreement. The mortgaged property does not secure any other mortgage loan not represented by the related mortgage note. No mortgage loan is cross-defaulted with any other mortgage loan nor is any mortgage loan secured by the mortgaged property that secures another mortgage loan.
18. Trustee Under Deed of Trust: In the case of any mortgage that is a deed of trust, a trustee, duly qualified under applicable law to serve as such, is properly designated and serves in accordance with applicable laws.
No fees or expenses are payable to the trustee under the deed of trust, except in connection with a trustee's sale after default by the mortgagor or in connection with the release or the mortgaged property or related security for the mortgage loan following the payment of the mortgage loan in full.
19. Leases: The seller has delivered the purchaser a complete schedule of all leases with respect to each
mortgaged property as of a date not more than 30 days prior to the closing date set forth in the attached schedule XXXX. Based on mortgagor representations, tenant estoppel certificates and other documents obtained by the seller, (i) the information contained therein is true and correct in all material respects, (ii) such leases are in full force and effect, and (iii) no default by the mortgagor or the lessees has occurred under such leases, nor, to the best of the seller's knowledge, is there any existing condition which, but for the passage of time or the giving of notice, or both, would result in a default under the terms of such lease. (Applicable to commercial loans with anchor tenants; multifamily properties may refer to attached rent roll.)
20. Lease Termination: No lease may be amended, terminated or canceled, and the lessee may not be released from its obligations, except under are certain limited events relating to material damage to, or
destruction of, the mortgaged property, or condemnation of less than the entire mortgaged property, which, in any case, the lessee in good faith determines will render its continued occupancy and use of the remainder of the mortgaged property economically unsound, or condemnation of all the mortgaged property. (Applicable to retail/office loans.)
21. Condition of Mortgaged Property: Each mortgaged property is in good repair and condition, free of any material damage.
22. Local Law Compliance: Each mortgaged property is in compliance with all applicable laws, zoning ordinances, rules, covenants and restrictions affecting the construction, occupancy, use and operation of such
mortgaged property. All inspections, licenses and certificates required, including certificates of occupancy, whether by law, ordinance, regulation or insurance standards to be made or issued with regard to the mortgaged property, have been obtained and are in full force and effect.
23. Environmental Compliance: In each mortgage, the mortgagor represents and warrants that it has not and will not use, cause or permit to exist on the related mortgaged property any hazardous materials in any
manner that violate federal, state or local laws, ordinances, regulations, orders, directives or policies governing the use, storage, treatment, transportation, manufacture, refinement, handling, reduction or disposal of hazardous materials. The mortgagor agrees to indemnify, defend and hold the purchaser and its successors and/or assigns harmless from and against any and all losses, liabilities, damages, injuries, penalties, fines, expenses, and claims of any kind whatsoever (including attorney's fees and costs) paid, incurred, or suffered by, or asserted against, any such party resulting from a breach of any representation, warranty or covenant given by the mortgagor under the mortgage. A Phase I environmental report has been conducted by an independent licensed (if required), reputable environmental engineer in connection with each mortgage loan, which did not indicate any noncompliance or existence of hazardous materials. To the best of the seller's knowledge, the mortgaged property is in material compliance with all applicable federal, state and local laws pertaining to environmental hazards, and no notice of violation of such laws has been issued by any
governmental agency or authority.
24. Opinion re Mortgage Enforceability: Each mortgage file contains an opinion letter(s) from counsel to the mortgagor which opines that, among other things, (A) the mortgage note, the mortgage, the assignment of leases, the UCC-1 or UCC-3 financing statement and all other documents and instruments evidencing,
guaranteeing, insuring or otherwise securing the mortgage loan are genuine, and that each is the legal, valid and binding obligation of the maker, enforceable in accordance with its terms, except as the enforcement may be limited by bankruptcy, insolvency, reorganization, receivership, moratorium or other laws relating to or affecting the rights of creditors and by general principles of equity (regardless of whether such enforcement is considered in a proceeding in equity or at law) (B) all parties (other than the originator) to the mortgage note, the mortgage, the assignment of lessee, the UCC-1 and UCC-3 financing statement and
each other document and instrument evidencing, guaranteeing, insuring or otherwise securing the mortgage loan have legal capacity to enter into the mortgage loan and to execute and deliver the mortgage note, the mortgage, the assignment of leases and other documents and instruments, (C) all necessary approvals, consents and authorizations required to be obtained by any party (other than the originator) have been obtained, and (D) the mortgage note, the mortgage, the assignment of leases and other documents and instruments have been duly authorized, executed and delivered by the parties (other than the originator).
25. Insurance: Each mortgaged property and all improvements are covered by insurance policies providing
coverage against loss or damage sustained by (i) fire and extended perils included within the classification "All Risk of Physical Loss" in an amount sufficient to prevent the mortgagor from being deemed a coinsurer, and to provide coverage on a full replacement cost basis; and the policies contain a standard mortgagee clause naming mortgagee and its successors as additional insureds; (ii) business interruptions or rental loss insurance, in an amount at least equal to 12 months of operations of the mortgaged property; (iii) flood insurance (if any portion of the mortgaged property is located in an area identified by the Federal Emergency
Management Agency as having special hazards); (iv) comprehensive general liability insurance in amounts as are generally required by commercial mortgage lenders, and in any event not less than $2 million per occurrence; (v) workers' compensation insurance; and (vi) other insurance as applicable to specific circumstances and criteria. The insurer in each case is qualified to write insurance in the relevant jurisdiction and has a claims paying ability rating from the rating agency of not less than 'A'. The insurance policies contain clauses providing they are not terminable and may not be reduced without 30 days prior written notice to the mortgagee, and all premiums due and payable through the closing date have been made. NO
notice of termination or cancellation with respect to any such policies has been received by the seller.
26. Loan Underwriting: Each mortgage loan complies with all of the terms, conditions and requirements of the seller's underwriting standards in effect at the time of origination of such mortgage loan.
27. Status of Mortgage Documents: The mortgage note, related mortgage, any guaranty, assignment of leases and/or rents, security agreement, and chattel mortgage, each instrument delivered, and all other documents evidencing, securing, guaranteeing, insuring or otherwise relating to the mortgage loan are
genuine and the legal, valid and binding obligation of its maker, enforceable in accordance with its terms, except as such enforcement may be limited by bankruptcy, insolvency, moratorium or other laws affecting the enforcement of creditors' rights, or by the application of the rules of equity.
28. Inspections: The seller has inspected or caused to be inspected each related mortgaged property within the last 12 months.
29. Taxes and Assessments: There are no delinquent or unpaid taxes or assessments (including assessments payable in future installments), or other outstanding charges affecting any mortgaged property that are
or may become a lien of equal or coordinate or higher priority than the lien of the mortgage.
30. Liens: There are no mechanics or similar liens or claims that have been filed for work, labor or material. There are no claims outstanding that under applicable law could give rise to such lien, affecting the related mortgaged property which are nor may be a lien prior to, or equal or coordinate with, the lien of the related mortgage.
31. Mortgagor Bankruptcy: To the best of the seller's knowledge, no mortgagor is a debtor in any state or federal bankruptcy or insolvency proceeding.
32. Fee Simple Interest: Each mortgaged property consists of an estate in fee simple in real property and
improvements owned by the mortgagor. The buildings and improvements on the mortgaged property are owned by the mortgagor and used and occupied for commercial purposes in accordance with applicable law.
33. Loan Terms: No mortgage loan has a shared appreciation feature, other contingent interest feature or
negative amortization.
34. Transfers and Subordinate Debt: The mortgage contains a "due on sale" clause that provides for the acceleration of the payment of the unpaid principal balance of the mortgage loan if, without the prior written
consent of the holder, the property subject to the mortgage, or any interest therein, is directly or indirectly transferred or sold. The mortgage prohibits any further pledge or lien on the mortgaged property, whether equal or subordinate to the lien of the mortgage, without the prior written consent of the holder. (Any exceptions must be approved by DCR.)
35. Financial Statements: Each mortgage requires the mortgagor to provide the holder with quarterly and annual operating statements, rent rolls and related information. Annual financial statements must be
audited by an independent certified public accountant upon the request of holder.
36. Escrow Deposits: All escrow deposits and payments relating to each mortgage loan are in the possession or under the control of the seller, and all amounts required to be deposited by the applicable mortgagor under the related mortgage loan documents have been deposited, and there are no deficiencies regarding them. All such escrows and deposits have been conveyed by seller to purchaser and identified as such with appropriate detail.
37. Selection Process: The seller has taken no action in selecting the mortgage loans for sale, assignment and
transfer to the purchaser which, to the seller's knowledge, would result in delinquencies and losses on mortgage loans being materially in excess of delinquencies and losses on the seller's actual portfolio of commercial mortgage loans.
38. Borrower Concentration: As of the closing date, not more than 5% of the aggregate outstanding principal amount of the mortgage loans have been the same mortgagor or, to the seller's best knowledge, are to
mortgagors which are affiliates of each other. (Exceptions should be noted. Indicate whether nonconsolidation opinions have been provided.)
39. Single-Purpose Entity: Each mortgagor is either a corporation or a limited partnership whose organizational documents provide that it is, and at least so long as the mortgage loan is outstanding will continue to be, a single-purpose entity" shall mean a person, other than an individual, which is formed or organized solely for the purpose of owning and operating a single property, does not have any assets other than those related to its interest in the property or its financing, or any indebtedness other than as permitted by the related mortgagee or the other mortgage loan documents, has its own books and records and accounts separate and apart from any other person, and holds itself out as being a legal entity, separate and apart from any other person, and holds itself out as being a legal entity, separate and apart from any other person.) If the foregoing entry is a limited partnership, (i) one general partner must be a single-purpose entity, and (ii) the partnership agreement must provide that the dissolution and winding up or insolvency filing of such limited partnership requires the unanimous consent of all general partners.
40. Servicing: No other person has been granted or conveyed the right to service the mortgage loans to
receive any consideration in connection therewith. In the event representation (32) regarding fee simple interest cannot be made, the substance of the following representations regarding ground leases should be incorporated and approved by DCR.
41. Ground Leases: With respect to any mortgage loan secured by a mortgage constituting a valid first lien on an unencumbered interest of the mortgagor as lessee under a ground lease of the related mortgaged property, but not by the related fee interest in such mortgaged property, the seller represents and warrants that: (i) The ground lease or a memorandum regarding it has been duly recorded. The ground lease permits the interest of the lessee to be encumbered by the related mortgage and does not restrict the use of the related mortgaged property by such lessee, its successors or assigns in a manner that would adversely affect
the security provided by the related mortgage. There has been no material change in the terms of such ground lease since its recordation, except by written instruments, all of which are included in the related mortgage file. (ii) The lessor under such ground lease has agreed in writing and included in the related mortgage file that the ground lease may not be amended, modified, canceled or terminated without the prior written consent of the mortgagee and that any such action without such consent is not binding on the mortgagee, its successors or assigns. (iii) The ground lease has an original term (or an original term plus one or more optional renewal terms, which, under all circumstances, may be exercised, and will be enforceable, by the mortgagee) that extends not less than 10 years beyond the stated maturity of the related mortgage loan. (iv) The ground lease is not subject to any liens or encumbrances superior to, or of equal priority with, the mortgage. The ground lease is, and provides that it shall remain, prior to any mortgage or other lien upon the related fee interest. (v) The ground lease does not permit any increase in the amount of rent payable
by the lessee thereunder during the term of the mortgagee loan. (Exceptions must be provided to DCR).
(vi) The ground lease is assignable to the mortgagee under the lease hold estate and its assigns without the consent of the lessor thereunder. (vii) As of the date of execution and delivery, the ground lease is in full force and effect and no default has occurred, nor is there any existing condition which, but for the passage of time or giving of notice, would result in a default under the terms of the ground lease. (viii) The ground lease or ancillary agreement between the lessor and the lessee requires the lessor to give notice of any default by the lessee to the mortgagee. The ground lease or ancillary agreement further provides that no notice given
is effective against the mortgagee unless a copy has been given to the mortgagee in a manner described in the ground lease or ancillary agreement. (ix) A mortgagee is permitted a reasonable opportunity (including, where necessary, sufficient time to gain possession of the interest of the lessee under the ground lease through legal proceedings, or to take other action so long as the mortgagee is proceeding diligently) to cure any default under the ground lease which is curable after the receipt of notice of any default before the
lessor may terminate the ground lease. All rights of the mortgagee under the gourd lease and the related mortgage (insofar as it relates to the ground lease) may be exercised by or on behalf of the mortgagee. (x) The ground lease does not impose any restrictions or subletting that would be viewed as commercially unreasonable by an institutional investor. The lessor is not permitted to disturb the possession, interest or quiet enjoyment of any subtenant of the lessee in the relevant portion of the mortgaged property subject to the ground lease for any reason, or in any manner, which would adversely affect the security provided by the related mortgage; (xi) Under the terms of the ground lease and the related mortgage, any related insurance proceeds or condemnation award (other than in respect of a total or substantially total loss or taking) will be applied either to the repair or restoration of all or part of the related mortgaged property, with the mortgagee or a trustee appointed by it having the right to hold and disburse such proceeds as repair or restoration progresses, or to the payment of the outstanding principal balance of the mortgage loan, together with any accrued interest. (xii) Under the terms of the ground lease and the related mortgage, any related insurance proceeds, or condemnation award in respect of a total or substantially total loss or taking of the related mortgaged property will be applied first to the payment of the outstanding principal balance of the mortgage loan, together with any accrued interest (except in cases where a different allocation would not be viewed as commercially unreasonable by any institutional investor, taking into account the relative duration of the groundlease and the related mortgage and the ratio of the market value of the related mortgage property to the outstanding principal balance of such mortgage loan). Until the principal balance and accrued interest rate are paid in full, neither the lessee nor the lessor under the ground lease will have the option to terminate or modify the ground lease without the prior written consent of the mortgagee as a result of any casualty or partial condemnation, except to provide for an abatement of the rent.
For the Trust Indenture/Trustee
Minimum requirements necessary in the indenture are:
- Eligible investment criteria for investment of trust funds will be established. All investments should be 'AAA' rated instruments or U.S. government securities (i.e., cash equivalents).
- All funds held in a corporate trust account must be segregated from other accounts. Funds held in trust should be adequately collateralized pursuant to Office of the Comptroller of the Currency regulations. The indenture should require immediate investment of funds into eligible investments.
- Cash flow of funds within the indenture will be reviewed and determinations made as to:
- Priority of distributions principal, interest, fees, expenses and subordinate classes.
- Release of funds from the indenture.
- Receipt of investment income, and whether such income will first replenish a reserve account or similar accounts.
Notice Requirements/Reports: Notice from the trustee regarding any default under the indenture, servicing agreement or mortgage, failure to maintain minimum reserve amounts, proposed replacement of trustee or servicer, and any change or default relating to existing credit enhancement should be provided. Additionally, issuer payment delinquencies and material amendment to the transaction documents and anything that alters or materially affects the transaction should be provided.
The following reports from the trustee and/or the issuer, at a minimum, should be provided:
- Audited Financial Statements within 90-120 days after fiscal year end certified by independent certified public accountants.
- Unaudited quarterly cash flow/operation statements. These should indicate DSCR.
- Delinquency reports at 30-, 60- and 90-day periods on a quarterly basis.
- Other compliance certificates and reports as provided in the indenture and other transaction documents.
Indemnification of Trustee/Limits on Liability: Standard provisions generally are acceptable; however, a "gross negligence" standard is not. The trustee will not be relieved from liability for, or indemnified against, its own action or inaction that constitutes negligence.
Provision of Reports: Trustee must take notice of defaults with respect to failure of issuer to provide timely reports, statements and certificates required by the transaction documents. Also, trustee should affirmatively check compliance with minimum ratings of insurance company, servicer or other entities on a regular basis.
Requirements of Trustee: A minimum long-term debt rating of 'A' is required if trustee is obligated to make advances directly or as back-up to servicer, otherwise a rating of 'BBB' is required. Back-up servicing or advancing function may be required. Minimum capital surplus of $50 million is required.
Bondholder Vote: In many instances a majority or super-majority is acceptable for major decisions. However, a 100% vote is required to reduce interest rate, change the term/maturity or reduce the principal and change voting percentages. Other items may require full bond-holder approval.
Redemption provisions: Whether or not there will be any requirements for or limitations on early, optional or mandatory redemptions will be determined. Defeasance of Securities requires deposit of collateral with appropriate maturities and a ratings equivalent to or better than the securities being defeased (as described in "Eligible Investments" under Trust Indenture/Trustee).
Pooling and Servicing Agreement/Master Servicer
In the case of pass-through securities where a pooling and servicing agreement is utilized, many of the considerations under "Trustee Indenture/Trustee" above will apply, together with an evaluation of the master servicer and the following points:
- Representations and warranties as to mortgage loans/assets conveyed to trustee will be confirmed. Seller/depositor should have a cure or repurchase obligation as to any material breach.
- Trustee/custodian should review mortgage file(s) to determine completeness within 30 to 120 days after closing.
- If the master servicer will have any advancing functions (e.g., principal and interest payments, taxes and insurance), they should be through foreclosure and liquidation.
- Generally, a master servicer should be rated 'A' by DCR when there is an advancing agreement. Otherwise, 'BBB' is sufficient.
- Detailed servicing and accounting records must be maintained; 30-, 60- and 90-day delinquency and default status reports and certifications should be provided quarterly.
- Collections should be remitted to the trustee on at least a monthly basis. A segregated account must be utilized.
- Master servicer may not resign or be removed until a qualified substitute servicer has been appointed.
- Property inspections should be performed on a regular basis (e.g., once per year and after 60 days delinquency).
- Special servicer may also be required to handle defaulted and troubled loans. Limits on servicer's authority to modify and reform loans should be established.
- Amount and source of compensation will be considered along with the priority in distribution of trust funds.
- Servicer should monitor borrowers' compliance with minimum insurance carrier rating policy coverage requirements.
- In general, the same criteria regarding financial statements will apply as in "Trust Indenture/Trustee" above, except that property operating statements, audited for each property, should be provided in a pool of fewer than 20 loans. If all properties are owned by the same borrower, then the statements should be provided for each property, but audited only as to the pool.
Other Matters and Comments: Transfer Restrictions In general, a sale or transfer of the property by borrower is prohibited. DCR may allow a transfer to another SPV, so long as satisfactory nonconsolidation opinion is provided or an entity with a long-term (beyond term of rated securities) debt rating equal
to or greater than rated securities.
Additional Amounts/Tax Withholding Gross-Up: International transactions frequently provide the borrower to withhold for tax liabilities. This obligation has the effect of increasing the payment obligation of the borrower by the amount of tax and could adversely impact cash flows.
Interest-Only Securities: Special disclosure should be provided in offering circular concerning significance and meaning of ratings of interest-only securities.
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