Exploiting Loopholes

The golden rule with tennis, as with finance, is to always put your money on the Swiss. Tough luck on poor old Andy Roddick though, the guy was rightly gutted and is too good to only win a single major in his career so let's hope he comes back and wins another.

So the final legal submissions have now been made - this includes General Growth's post-hearing submissions against MetLife and against ING Clarion and Wells Fargo. The Committee of Unsecured Creditors, and the unsecured lenders ING Clarion, Helios AMC, and of course MetLife. They are really just summarising the arguments already put forwards, although additionally MetLife submitted a motion to dismiss evidence submitted by GGP because the "Movants [MetLife] were not provided with a copy to review."

The evidence itself is a summary of the MetLife Debtor groups that own the two malls in question in this appeal. Ultimately they were included to provide evidence of the consolidation benefit to GGP that would come about from their inclusion in Chapter 11. Again, whether this is accepted or rejected is arbitrary and will have little bearing on the overall decision.

Additionally I recommend reviewing two interesting analysis papers discussing the impact of the GGP bankruptcy on the CMBS industry. The first is entitled The GGP Bankruptcy So Far: Grounds for Concern, Sources for Hope, (thanks to GGP Freak for bringing that to my attention - you mentioned it is from a post on one of the boards so perhaps you could post the link). Either way, the article provides an interesting additional summary from legal experts.

It agrees that the notion of 'bad faith' is unlikely to stand up to analysis and sway the impending decision, although here the authors focus on the eleventh hour dismissal of independent directors as the other key factor instead of GGP's ability to prove its decentralised structure and hence requirement to include SPE's in Chapter 11 not directly in default. As I have said previously, many of the arguments being made in this case are being made for the cameras, and this view is clearly shared:

"in the GGP bankruptcy, it seems that the independent director issue may not be fully pursued because of the practicalities of the situation. In the view of some, even if the motions to dismiss are not granted, it is important that these arguments are made, if only to force a decision that will at least provide a benchmark against which lenders can attempt to structure and price transactions going forward."

Also interesting is this observation on the impact of the agreed DIP financing loan from Farallon Capital Management, part of which will be used to pay off the Goldman Sachs loan: "Using the $400 million DIP loan to retire the Goldman Sachs facility effectively increases the leverage on these assets by almost 100 percent."

The second article 'CMBS Bankruptcy Remote Structuring and the Recession: Revisiting the Benefits', was published last week by the Bureau of National Affairs. It provides a much more detailed analysis of CMBS structuring, and crucially an analysis on how the GGP rulings to date are impacting the industry. One telling remark is that the SPE bankruptcy remote structure has been "largely untested" to date, and only once these are resolved will the credit markets be able to move forwards with confidence and accurately rate and price risk into credit investments.

Where this article is useful is in summarising key ways in which SPE's "theoretically mitigates" risks:

1. Independent Directors to vote/approve the commencement of bankruptcy proceedings - the controversial one that we know about from its alleged 'misuse' during GGP's filing, which illustrated contractual holes.
2. Limits Debt that an entity can incur - both secured and unsecured, the court rulings have upheld this concept and ensured that GGP will not be able to load them up with additional debt as a result of their inclusion in Chapter 11.
3. Ensure that SPE assets/liabilities are not consolidated with those of a parent or affiliate that is involved in a bankruptcy - in reality this has not taken place in GGP's case from their inclusion in Chapter 11 either, although there would be a significant benefit from consolidation of net cash flows and of course negotiations.

As if anybody needed confirmation that the markets were being presumptuous about CMBS's, the article comments: "CMBS sponsors and lenders, supported by many of the credit rating agencies, relied heavily on the assumption that the remote bankruptcy provisions, specifically the independent director provisions, in the SPE’s governing documents would provide protection against an SPE borrower filing for voluntary bankruptcy."

Where the article becomes much more interesting is an examination of the circumstances in which GGP has been able to utilise cash flows as a collateral. Normally it would not be allowed, unless the lender consents, or the debtor convinces the court that "the lender’s interest in the cash collateral is ‘adequately protected.' "

This notion of 'adequate protection' means proving to the court that "the collateral is not being dissipated to the ultimate detriment of the lender. Typically this condition is satisfied if the property continues to generate cash flow and the lender is given a lien on post-petition income to replace the cash collateral that is expended." Despite the turbulence in commercial real estate valuations, it is fair to assume that the value of the assets exceeds debt in all cases before the court at present.

As such this is precisely what the Courts have awarded all of GGP's lenders who have appealed for their respective malls to be removed from Chapter 11. Despite a lien on cash collateral not being as appealing to lenders than instant access to the cash flows from the malls, income is safeguarded by the decisions made by Judge Gropper, by ensuring they are serviced and repaid in the event of liquidation.

The article concludes a summary of ways in which the GGP rulings to date are impacting the industry and a realistic assessment of the next steps relating to restructuring. Ultimately the ability of GGP to control the independent directors of its SPE's is seen as a key weakness in the current structure of SPE's. The legal authors point out that despite this it is very much legal, :

"Despite the fact that the removal and replacement of the independent directors may have violated the spirit of the original agreement with the lenders, GGP’s actions were permitted under state law and do not appear to have been prohibited by the organizational documents of the SPE borrowers."

In fact, the article even advises lenders able to who have the opportunity to "revisit the governance terms of borrower SPEs, would be well advised to consider modifying the 'remove and replace' provisions relating to the independent directors."

In many ways this suggests that GGP's bankruptcy is unique in another sense, due to timing and its ability to exploit weaknesses in the contracts that will be closed in the future. That being the case, any investors contemplating on taking positions in other REIT's in a similar position to GGP should exercise caution. It would be unwise to simplistically assume that other companies will necessarily be able to exploit this loophole for long, and so need to investigate the underlying SPE structures and contracts.

And finally:

"As the GGP bankruptcy progresses, given the uncertainties in the valuation of commercial real estate in the current markets, it will be interesting to see whether GGP attempts to reduce required interest payments based on the current market value of its properties and, if it does, how the bankruptcy court will determine the valuations of these properties and how reduced values will affect the commingled use of cash collateral."

Bear in mind how early into the bankruptcy process this all is - decisions made now can be amended throughout GGP's period in Chapter 11 on appeal. Meantime all of the information is before the court, suggesting a ruling is impending.

Addendum: just tidied up this post - you could tell I wrote and posted it during the Wimbledon Final, what a bloody mess it was...

Round 1 To GGP As CMBS Industry Overplays Its Hand

I will move off so many updates on GGP soon, not least as I am busy looking into other investment opportunities. However there was enough news late yesterday to warrant an update.

Firstly on DIP financing, after swinging between bidders (and worth noting that bidding for DIP financing is in itself a rarity), GGP turned down both Pershing Square and a consortium lead by Goldman Sachs, and instead opted for the group lead by hedge fund Farallon Capital Management.

Details seem largely unchanged from before at $400m of funding with a 12% interest rate and no warrants, apart from a lower exit fee and now a potential 8% equity repayment option - that is subject to GGP's equity value upon emerging from bankruptcy.

At present the exact details of the DIP financing are not available, although The Washington Post quotes Ackman as saying: "This is the best DIP loan that has been done since the beginning of the recession, and it could be the best DIP loan ever in terms of the structural features that are favorable to the company."

All indications had been that the Court hearing yesterday was going to rule in GGP's favour. So it proved, with both DIP Financing approved, and Judge Gropper, presiding over GGP's case, ruling for the SPE's inclusion in the Chapter 11 filing.

This brings the inital phase of proceedings to a conclusion, after much legal wrangling (and whinging) on both sides. Various lobby groups representing the CMBS industry, fearing the ramifications from investors if their products did not deliver on the promised bankruptcy protection, launched into the most hilarious claims.

The end result was that they stretched credibility and overplayed their hand.

"The GGP bankruptcy filing could - if passed - be disastrous for the CMBS [industry] in the US" warned Conor Downey, a partner at Paul Hastings. He then went on to claim that such a ruling would somehow lead to an enormous downgrade of CMBS debt and that none could attain triple-A rating again.

The highly impartial Mortgage Bankers Association also added their voice, stating grave concerns over the 'catastrophic' impact of such a precedent.

An official from the CMSA (Commercial Mortgage Securities Association) also over-exaggerated the situation by stating: "It is not an exaggeration to say that if a CMBS lender cannot get comfortable with the isolation of the real property asset to be financed and hence the cashflows derived from the operation of such asset, then no such financing will occur."

Yes, except that this does not mean CMBS lenders could not get comfortable with isolating the asset being financed. Fortunately the seasoned Judge Gropper was unimpressed with such overstatement. Even earlier in the week, such claims had been dismissed as "hyperbole".

Judge Gropper overruled the objections yesterday, rightly saying that lenders rights were protected and General Growth should have access to cash collected at its subsidiaries. The notion that commercial mortgage backed securites somehow mean lenders have a legal right to control the cashflow is clearly wrong. It would hinder a viable company, capable of fully servicing its debts to those creditors, from moving out of bankruptcy.

Where GGP had been out of line was an implicit suggestion in the bankruptcy loan that the underlying collateral for the existing CMBS loans (i.e. malls) could be used as collateral for the new DIP loan. That illustrates what CMBS do provide - a guarantee that the asset cannot be misused, and will always be there to enable repayment for the creditors, even in a bankruptcy.

Matt Reid, a senior financial analyst at DBRS made a telling observation, by stating that "the GGP bankruptcy is unique in that most of its CMBS loans are performing reasonably well with strong debt service coverage and likely equity value above the mortgage debt."

Additionally Reid concurs with my previous analysis into the motives for including SPE's: "After reviewing the bankruptcy filing documents, we think the motivation for the filing of the SPEs is to generate better negotiating leverage with the special servicer to extract the value above the CMBS mortgages, while keeping such debt current. The plan is to use this cashflow as working capital during the reorganisation process, which could be several years. Such a ruling would be positive for unsecured creditors."

Round 1 to GGP and unsecured creditors then. It will be interesting how (or if) this impacts the share price later today upon opening.