Debt Workout

March 30, 2010Reznick Group

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Don’t Tell Me You Planned a Workout Before Bringing in the

Tax Guy?!?

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When Borrowers Need to Call

If you want to negotiate a loan write-down or turn over the property to the lender

If you or your affiliate plans to buy back your publicly-traded debt at a discount

If you want to redeem a note for equity or a hope note

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Current Environment

Borrower Preparation for Presenting Best Case

•Realistic assessment of current economic situation/analysis of relative strengths and weaknesses of various parties – Includes a review of legal/tax positions, interests and underlying causes of current problems at Borrower and/or property.

• Get control of the facts/information•Look at cash flow, liquidity, valuation and/or capitalization pressure points from both sides.

Borrower Preparation for Presenting Best Case

•Understanding of the complex (opaque) nature of today’s credit markets and effect on any loan modification/recapitalization planning as well as execution. This may also extend to terms/parameters for additional capital (via recapitalization, etc.)

Internal additional capital availability?Financial status of Borrower/Principals (economic distress/imminent BK?) Additional third party capital investment

1. New equity/mezzanine debt or other takeout financing?2. What is feasibility of raising new third party capital?3. Can property be made attractive for new money?

Borrower Preparation for Presenting Best Case

• Business/Legal Terms of the loan transaction and analysis of lender

Recourse provisions (e.g. bad boy, anti BK recourse, prepayment obligations, environmental

Construction loans (conditions for lender to fund versus withhold draws?)

Default provisions (any default notice outstanding or imminent?, acceleration of loan? Default interest being charged?

Borrower Preparation for Presenting Best Case

•Analysis of Lender(s) and impact on their strategy/objectives

Single versus club/group (syndicated) versus securitized Nature, agenda and philosophy of lender

1. Aggressive or cooperative2. Reputation and relationship considerations with

borrower/principals3. Quick exit (sale of DPO) more important than maximum

recovery?4. Ability of lender/sevicer to take over and manage

Borrower Preparation for Presenting Best Case

• Approach to resolving the issues Team Approach

1. Accountants, financial advisors (including tax), lawyers, mortgage, sales and leasing brokers

2. As needed: tax, bankruptcy and litigation counsel; construction experts

Addressing problems earlier rather than later; comprehensive preparation and early intervention are key.

Creating pragmatic and achievable goals by Borrower under a pragmatic plan that addresses Borrower (as well as lender) needs.

Creating an open and professional dialogue between both parties

Typical Strategies & Options

• Maturity date extension• Additional funding• Interest rate reduction/amortization relief• Principal balance reduction• A/B note split• Relief from personal guaranty• White Knight/Rescue financing• Short sale• Deed-in-lieu of foreclosure• Foreclosure• Bankruptcy

And Now a Few Words From Our Sponsor

Tax Planning Paths

1.Sell/Relinquish the property

• Relief from personal guaranty• Amount realized (gain) if debt is

nonrecourse• Cancellation of indebtedness income if debt

is recourse

Tax Planning Paths

2.Retain property with new debt/capitalization structure

• Recourse v. nonrecourse debt• Forgiveness of principal amount• Debt modification

Extension of maturity date Interest rate reduction A/B note split Relief of personal guaranty White Knight/Rescue financing Additional Funding

Exclusion of COD Income Under IRC sec. 108

• Bankruptcy and insolvency exclusions• Qualified real property business indebtedness• Reduction of tax attributes

What is COD and What Triggers It?

•Whenever a borrower’s debt is satisfied for less than the full amount of the debt, COD income is generated.

• COD income is taxed at ordinary income tax rates.

• Some workout techniques that may cause COD:1. Loan write-downs2. Borrower or affiliate acquires debt at a discount.3. Debt for equity exchange at a discount4. Certain debt modifications

COD Exceptions

•Bankruptcy exception – make sure COD is AFTER filing bankruptcy•Insolvency exception – limited to amount of insolvency•The cost of either exception is the reduction of tax attributes

Insolvency Exception Example

• Facts:• Total outstanding debt before discharge: $60 million• FMV of all assets before discharge: $40 million• Amount of debt after discharge: $35 million

• Results:• $20 million excluded (attributes reduced)• $5 million net taxable COD

Real Property Business Indebtedness Exception

•Allows taxpayer to swap COD for write down of tax basis in property•Limited to 1) excess of debt over FMV of real property and 2) tax basis of depreciable real property• Qualifications:

1. Property must be used in a trade or business

2. Acquisition indebtedness 3. Secured by real property – certain

mezzanine loans may not qualify

New Section 108(i) Deferral

•For debt acquired by the borrower in 2009 and 2010•Recognize income ratably over five year period•Must be elected at the partnership level although individual partners can elect out•Continuing trade or business requirement•Once elected, taxpayer cannot use any of the exclusions (i.e. bankruptcy, insolvency, etc.) •Intensive reporting for partnerships

COD Exceptions Property eligible

Loans eligible Other Limitations or Considerations

Costs of applying exception

Insolvency All All If borrower is partnership, ultimate partner must be insolvent

Reduce tax attributes

Bankruptcy All All If borrower is partnership, ultimate partner must be bankrupt

Reduce tax attributes

Real Property Business Indebtedness

Only depreciable real property

Only acquisition debt and only debt directly secured by real property

If sufficient basis in secured property, can elect to reduce basis in other property; not available for C corporations

Potential ordinary income recapture if later sell the property

Section 108(i) Deferral

All Only loans written down in 2009 or 2010

Not applicable to foreclosure or deed-in-lieu for single property entity; continuing business

Temporary deferral; cannot later use other exceptions; reporting requirements

Take-Aways and Q&As

• If historic lender, understand borrower/debt investor’s economic motivations

• If borrower, know your COD exceptions before you ask for forgiveness

• If still worried, CALL YOUR TAX PERSON!

James D. VincentSenior Managing Director, Reznick Restructuring Solutions

Jim Vincent has 25 years experience from significant business leadership with some of the industry’s leading real estate financiers and financial service firms. Throughout his career, Jim has built multi-million dollar growth platforms, turned around troubled businesses / divisions and achieved significant cost savings at such Fortune 500 industry leaders as GE Capital, Capital One Financial and Bank of New York. Notable positions include: President of BNY Asset Solutions, SVP, Managing Director and group founder of GE Capital Real Estate Capital Markets and VP and founder of Nomura Securities successful conduit program.

Jim’s core expertise includes: new business formation and launch, capital markets and structured finance, commercial real estate lending and investing, corporate development and merger integration, turnarounds and loan / asset workouts. Jim has led numerous transaction teams, which have originated over $2.6B in real estate loans, invested over $800M in mezzanine and high yield CMBS, securitized over $3.5B in CMBS and captured over $200M in annual savings, principally from outsourcing. His due diligence experience includes over 15 corporate acquisitions and over $17B in commercial real estate valuations and purchase due diligence. He has led a number of corporate merger integrations for real estate and finance companies.

Relevant workout experience includes the following: Jim recently led a corporate restructuring engagement by a 45 member unsecured lender group for a $4B commercial finance company involved in the ABS and CMBS market. In addition, he has consulted on over $3B in debt workouts with troubled developers / owners. As a principal at GE / Nomura, he bid on over $8B of non-performing loans and REO assets. Jim turned around a servicing subsidiary for Bank of New York ($16B of servicing rights, six product lines and over 70 institutional clients). Jim has managed a special servicing team which delivered in excess of 25% IRR to an investment banking partner from resolution of troubled loans / assets. He was the Kenneth Leventhal firm expert for troubled financial institutions and directed the $5B “bad-bank” recapitalization plan for First Republic Bank, prior to acquisition by Nations Bank.

Thomas Nice, CPAReznick Group, Principal

Thomas Nice has more than 25 years experience in business consulting—specializing in areas of taxation, strategic planning and computer software development. At Reznick Group, he is responsible for initiating, conducting, supervising and reviewing tax research and planning on behalf of firm clients, as well as being the main tax advisor to his own client base.

Tom has served as an advisor to Fortune 25 clients, as well as owners of closely held businesses. His clients include corporations with domestic and international operations, technology companies, real estate developers and syndicators, closely held companies, and high net worth individuals. He has extensive knowledge and experience concerning a broad range of tax issues relating to corporate and partnership taxation, specializing in high level research, transaction analysis, and structuring.

Prior to joining Reznick Group, Tom spent 10 years at a Big Four accounting firm, working in their National Tax Office and as Director of Tax Compliance Services for the Washington Metropolitan area. He has also worked as a strategic planner for a Fortune 100 company, and has experience as an entrepreneur. His blend of skills gives him a unique ability to assess complex tax situations and provide effective solutions.

In addition to lecturing about REITs, Tax Issues Regarding Commercial Real Estate Transactions, Partnership Structuring, Corporate Merger and Acquisitions, Tom currently serves as an adjunct professor for American University's Masters of Taxation program.

Michael J. Villa, JDReznick Group, Tax Associate

Michael Villa specializes in tax planning and consulting for pass-through entities and real estate developers. At Reznick Group, he assists Thomas Nice in conducting and reviewing high-level tax research and planning for the firm’s clients. He is also responsible for supporting the firm’s State and Local Tax Group. Mike routinely conducts training classes for Reznick Group’s employees on a variety of federal and state tax topics.

Prior to joining Reznick Group, Mike worked for a national accounting firm in its State and Local Tax Practice. He also worked at the Department of Justice directing research for an appellate litigation office.