Big Fish Tantrums

I was dialed into the steering committee meeting yesterday for the post-insolvency / time wasting project , and who should dial in but the COO of the bank!

To put that into context, for those unfamiliar with working in the sector and the sheer size of the big investment banks, imagine a combination of a medieval king and Paris Hilton all rolled into one. Vast power, able to behead on a whim, combined with plenty of preening and a vast ego.

Thus he had not stopped by to listen and learn, only to be heard. Aww, bless him - isn't he cute?

We were treated to a 15min speech, although I wasn't bothered as I am not running this whole affair; it certainly didn't stop me reviewing the latest Court docs from GGP while he rambled on. In short though, he had dropped by to tell us all how pissed off he is that we have been beaten to the punch in delivering our insolvency solution by a major rival (announced in the WSJ on Tuesday).

Never mind the fact that ours will be far superior, applying not just in the US but globally, and crucially enabling Hedge Funds to margin securities rather than having to fully fund their positions - the whole point of Prime Brokerage after all. Nope, at the top this was a big corporate race, picture all the CEO's lined up in their sacks and jumping as fast as they could to the finish line. In his eyes we have lost - the trifling details are an irrelevance.

So the Court decision relating to GGP is going to take more time to reach a conclusion. Given the length of my four legal analysis posts, which in themselves are a hugely condensed summary of the arguments put forwards, I would have been surprised had the Court managed to review all of the submissions that have been flooding in right up until the last minute, much less reach a considered opinion so quickly.

The only public information out there is that the Court could take until the end of June before deciding on whether the proceedings by MetLife, Wells Fargo and ING Clarion Capital to remove their underlying collateral from the GGP bankruptcy filing are upheld. This ruling is important, as it would of course enable GGP to negotiate from a position of greater power with many more creditors, while using the combined cashflow as required, and should be able to secure more favourable extension terms. Regardless of the decision however, it will be useful for GGP to focus on its restructuring plan - expected that some time in August.

In an unrelated announced on Wednesday, Jim Graham, GGP's Director of Public Affairs also announced that the company had "very recently" made the decision not to sell the Bridgeland development as previously planned, and instead develop the site itself. This directly reflects the improvement in GGP's position since it filed for Chapter 11 and received DIP financing.

No longer is the firm desperately seeking ways to avoid Chapter 11, and is instead making considered decisions in-line with both Adam Metz and Bill Ackman's comments about there not being any rash asset sales. An encouraging sign that demonstrates mutually aligned interests with common shareholders.

Other minor points of interest this week:

• Pershing Square submitted a motion on Wednesday for their Chief Legal Officer, Roy Katzovicz, to start receiving paper copies of all notices and papers going forwards. No reason is given, but it suggests that the fund will be taking an increasingly active involvement in GGP's legal maneouvering, planning and positioning over the coming months.
• GGP have settled the DIPS financing claim with Brookfield Financial LLC and Goldman Sachs. The original claim was $5.78m, and the settlement is for $2.75m, and is fully supported by the committee of unsecured creditors.
• Ahead of the deadline for objections by unsecured creditors, various claims have been filed. This includes the occupant at various malls J.C. Penney, filed a limited objection and reservation of their rights to the inclusion of related SPE's into the GGP bankruptcy filing. They add nothing to the actual case beyond suggesting GGP's inclusion of relevant malls "blatantly ignore the due process rights of numerous Lien holders - including J.C. Penney - who have Liens in or on property owned by the Debtors [GGP]".
• A similar limited objection claim has been filed by A&K Endowment Inc, and many others - mostly around proposed amendments to establishing alternative procedures under Chapter 11.

Legal Analysis IV: GGP's Final Response

Okay this is starting to get excessive, but then this run up to the court hearing tomorrow has seen some interesting arguments going on behind the scenes. Yesterday GGP submitted their final response to the creditor's case ahead of the hearing on Wednesday, which is a baby at a mere 100 pages.

One key part of that was a dissection of the motion to dismiss the Chapter 11 case of the Fox River Shopping Center LLC by FRM Funding. FRM Funding had by then already submitted a motion to withdraw its objections to inclusion in Chapter 11. Although no reason was given, the case is covered in GGP's submission, and in all probability it was an assessment by FRM's legal team on the strength of GGP's case that lead to the withdrawal.

A quick review of GGP's final response to the creditor case:

1. MetLife / FRM funding 'bad faith' arguments fundamentally flawed
GGP point out that just because certain GGP subsidiaries are operationally sound with strong cash flows does not mean they could ignore the realities of the credit markets or their duty to maximise value. In other words willfully waiting until default and potentially being forced to liquidate individual entities would be an abuse of their duty to all.

GGP's team reiterate that the wider market problems meant that anticipating future problems refinancing all loans was nothing more than a realistic assessment of the credit markets, and hence the Chapter 11 filing was made in good faith. Additionally they note that the debtors do not even attempt to show that GGP's chances of a successful "reoganization is objectively futile."

GGP also refute that Chapter 11 is being used as a "sword" to gain a tactical advantage in negotiations with secured lenders (note: it is in reality, but let's ignore that), and instead refer to it as a "shield" that will protect the firm as it restructures the debt. In that case is Bill Ackman a knight in shining armour and MetLife the evil dragon?

It does illustrates the highly subjective nature of filing under bad faith. You can argue it both ways, but you need to have definite proof to make the mud stick, and the creditors case is not strong enough. Weil Gotshal & Manges also point out inconsistencies between creditor cases, with MetLife arguing the credit market problems persisting for a year or more is "sheer speculation" by GGP, while ING and Helios agree that the CMBS market has disappeared.

2. GGP filed for Chapter 11 protection for the same reason that ING and Helios debtors filed
This being the collapse of the CRE financing markets and the advantage of "participating now in an integrated, consolidated restructuring of project entities". This makes an effective point by illustrating that other creditors were filing against GGP by this stage, and undermines suggestions by those creditors objecting just because GGP filed first that taking no action was a viable option.

3. GGP filings included loans that had already cross-defaulted
Hence did not give GGP "a reasonable prospect of refinancing before maturity, and certain other loan characteristics that further exacerbated the need for a restructuring." This point is again particularly strong, as it demonstrates the financial stress that GGP was indeed under during the months of financial limbo when it moved into technical default on loans without declaring Chapter 11.

Additionally GGP dismiss this further by arguing: "There exists no basis in law or in fact for overriding these reasonable business judgments made by the Subsidiary Debtors [GGP] on the advice of sophisticated financial, restructuring, and legal experts."

The 'loan characteristics' referred to above are covered in more detail in this WSJ article from yesterday, which shows an increasing recognition by the wider industry and US government now that there are problems with the entire CMBS market. This goes back to the point that ultimately (due to tax reasons, as it turns out), many of GGP's lenders were largely unwilling to even discuss refinancing of any loans not due within a short period of time - a fundamental structural flaw of the credit markets.

GGP has to my mind received a significant boost from these potential plans to amend the tax laws to enable lenders to talk earlier. This gives a powerful argument that GGP really was forced into Chapter 11 due to market failings and exceptional circumstances, and hence should be fast tracked back out.

4. Dismissal for lack of good faith should be granted "sparingly, with great caution."
The defence elaborate further with previous court decisions that support GGP's case, stating that a petition for bad faith should only be granted when: "it is clear that on the filing date there was no reasonable likelihood that the debtor intended to reorganize and no reasonable probability that it would eventually emerge from bankruptcy proceedings."

The defence then go into detail dismissing all of the bad faith arguments that ING, Helios, MetLife and FRM have made in their filings, claiming none have merit.

5. GGP filings for bankruptcy had full corporate authority
GGP move onto FRM's claims around technicalities in the Fox River SPE filing, and rebuff with some telling quotes back from the original derivative contracts.

For those who have read my previous comments on the CMBS industry and how contracts used to be sold, you will know I have long said that nobody did any due diligence in the good old days. It was a zip 'em and sell 'em on mentality, and frankly nobody in the banks cared as long as people bought them. Only now are people running around complaining.

Let's face it, if you did due diligence you would never have sold CMBS contracts with this explicitly in the wording:
"Nothing contained herein or omitted herefrom shall prevent the shareholder(s) of the Company [GGP] from removing an Independent Manager with immediate effect at any time for any reason."

GGP's lawyers state that the loan documents include no legal opinion regarding whether Fox River was bankruptcy remote. Even more damning, and probably the final nail that forced FRM to withdraw their motion was the legal assessment of Fox River, which refutes the notion Chapter 11 would not enable any substantive consolidation (of assets and liabilities).

6. MetLife's 'speculation' on the outcome
In MetLife's recent response, they made a convincing case about GGP acting in bad faith, but a key point was that it was indeed based largely on speculation on their part. At the heart of this was an argument that there was no point moving into Chapter 11 because when it comes time to approve any restructuring plan, "there might not be any other impaired creditors and it [MetLife] might vote against a plan."

This response from GGP is all you need to say on the matter:
"..if creditors could get a bankruptcy dismissed at the start of the case simply by claiming they may not agree to a plan of reorganization, as MetLife claims, then chapter 11 would be rendered useless as creditors can always assert they will not agree to any impairment of their claims."

The defence conclude that all of the creditors seeking dismissal of the bankruptcy petitions are seeking "to impose a requirement that debtors face imminent collapse before seeking chapter 11 protection. But no such requirement appears in the actual text of the Bankruptcy Code."

Everything continues to point towards a favourable outcome for GGP, although law is a hornet's nest, so you never quite know what will come out when you start playing with it.

Legal Analysis III: Creditors Make The Case

Well, L arrives into Heathrow tomorrow morning after her indulgent week of girliness in Chicago at the Bridal Shower. As such I had better spend today tidying up this dump - it's amazing how a week without the missus demotivates me in keeping the place clean.

The final part of this legal analysis series takes a look at the arguments being submitted before the Court next week by the creditors, with respect to having various SPE's (and hence malls) removed from inclusion in GGP's Chapter 11 filing. This gives the other side of the case, and hence an opportunity to assess how convincing this and their chances of overturning the earlier decision really are.

This article focuses on the case being proposed by MetLife, and the investment fund Clarion Capital, which are two of the group of secured creditors being heard on Wednesday 17 June by Judge Gropper. Examing the various arguments proposed by the creditors:

1. Chapter 11 cases not filed 'in good faith' - the specific loans in question were all current and not in default. Upon closer examination, the creditor's claims around the filing are unconvincing in this respect. As GGP's defence team state in their response, calling it 'woefully inadequate' in establishing the burden of proof, I agree having reviewed everything they have put forward.

The creditors give evidence from previous claims to back them up throughout of course, and suggest that GGP is ineligible in this case, due to it being financially healthy and not insolvent:

"..given the enormous powers a chapter 11 debtor is given by virtue of the automatic stay, the exclusive right to file a plan, and the ability to discharge debts, these powers should be limited only to those facing financial stress."

If all GGP's problems due the credit market turmoil of the last 9 months do not equate to financial stress then I am not sure what does! The creditors then go on to cite the recent court ruling that has allowed a construction company to file a lien against General Growth to recoup owed construction costs, despite being in Chapter 11. In that case, the court stated:

"They [GGP] do not need a litigation respite, as do many chapter 11 debtors... Nor are they financially troubled debtors that seek in good faith to avoid a preclusive judgment in State court that would prejudice legitimate efforts to preserve value for the benefit of all of their creditors."

Insolvency is not a requisite for filing Chapter 11 anyway, as the creditors admit. The above Court ruling is quite different from establishing bad faith and I see nothing that suggests proof that GGP are doing anything other than attempting to sort out their problems. The only point worthy of consideration is below, although it is more than debatable that this is an abuse of Chapter 11, since it is precisely what the legal code is there to do - facilitate the move out of bankruptcy:

"The Debtors’ use of chapter 11 as a sword to obtain a tactical advantage in any negotiations to extend the Loan, when such Loan was not in default and does not mature until a year and five months after the Petition Date, is an abuse of chapter 11 that the good faith requirement is designed to prevent."

2. Loans in question were not due to mature for a significant period of time - as such there was "no present need [for] the.. debtors to file for relief under Chapter 11 of the Bankruptcy Code." Additionally MetLife claim that GGP "did not contact MetLife, one of the largest insurance company providers of real estate capital, about a loan extension prior to the Petition Date."

This point has been refuted in evidence submitted by GGP, regarding widespread creditor unwillingness to discuss extensions on all but loans due imminently. This cites that in some cases GGP were even refused the names of underlying creditors to contact. Thus, GGP may in this case have not been able to identify who to contact - either way, this point is secondary in the context of point 4 below.

3. The malls in question do not have any other significant creditors - thus GGP will not be able to cramdown a plan over the Lenders' objections.

This is a particularly weak point; citing dimissal of this SPE because it is primarily comprises a single lender, hence there is no advantage in Chapter 11 inclusions since GGP will still have to fully service them and negotiate with a single lender.

That again is refuted by the evidence submitted by GGP regarding how unwilling many lenders were to renegotiate loan terms and extensions pre-Chapter 11. It also ties back to the point that individually, lenders act within their own interests, which are not directly aligned with those of the company, other creditors (especially unsecured), shareholders or wider credit markets.

This Providence Journal article also suggests MetLife argued that GGP's attempt to 'cramdown' a wholesale reorganization plan for its mall properties will "hurt the insurer's financial interests." I do not see how that can be argued, nor have I found this point being made in the court submissions.

Being negatively financially impacted cannot be realistically argued as a motion to dismiss, beyond it 'hurting' MetLife and other creditors ability to negotiate: they do not wish to be forced to the table without holding all the cards. However all are having their loans fully serviced by GGP throughout the period at pre-bankruptcy rates, thus in theory should not lose out at all financially.

4. Chapter 11 were not filed with any reorganisational purpose - "the Debtors filed bankruptcy to improve their negotiating position by increasing the pressure on the lenders to accept refinancing terms."

Here is the reality of this entire dispute, and the primary reason for arguing for their inclusion is to obtain leverage in efforts to extend the maturity of loans. The rest is largely window dressing, and this is directly opposed by General Growth's claim of operating a centralized business model. I do not hold much credence with GGP's claim in this respect, but it can be very effectively argued and elaborated upon on the day in court, without creditors being able to disprove it.

The heart of the argument is that the creditors will continue to be fully serviced and do not lose out, whilst GGP gain the useful leverage from an automatic stay, and can utilise additional cashflow from the assets while enhancing their ability to restructure and negotiate loans.

Ultimately Judge Gropper has already indicated willingness to agree with the need for keeping GGP's "centralized business model" in tact, and for considering this case in the wider context rather than just those of some self-interested lenders. I see nothing submitted to the Court by MetLife or the creditors that will change that decision, and expect a favourable ruling for GGP next week.

Addendum to original post: late yesterday Wells Fargo issued this direct response to GGP's defence. Here they reiterate the original two points that prove 'bad faith' (inclusion of an SPE that generates sufficient capital to service its creditors, and inclusion of loans not imminently due to mature is unnecessary).

Additional points raised:

• Wells Fargo cite the US government actions and potential expansion of TALF as an unknown, and that should have been relied upon by GGP as a reason to hold off declaring Chapter 11 and certainly including subsidiaries - a bizarre argument that will be rejected.
• The Debtors [GGP] "brazenly replaced their Independent Managers on the eve of their bankruptcy filing in order to obtain a unanimous vote in favour of the bankruptcy filing."
• SPE Operating Agreements require the Independent Managers "consider only the interests of Subsidiary Debtors and, therefore, are precluded from considering the needs or concerns of any entity other than the Subsidiary Debtors."
• GGP's claim that the SPE's were essential as part of the GGP 'family' filings is "completely undercut by the fact that numerous affiliates of the Subsidiary Debtors were not placed into bankruptcy."

Key points here are that General Growth's actions in replacing directors was legal - it is expressly allowed under the terms of the CMBS contracts - and that although filing Chapter 11 is in the wider interest, it is intended for a positive reorganisational purpose that would benefit the entity too, so is therefore not 'bad faith' as interpreted in the spirit of the law.

The final argument around not all subsidiaries being included is the most interesting point, and refers to the joint ventures and other such subsidiaries not able to be placed into Chapter 11. This provides a strong argument against GGP's slightly dubious 'centralized business model' excuse, so it will be interesting seeing how this impacts the Court's decision. I see this as the main factor that could swing a decision against GGP next week.

The latter point is expanded upon by citing that GGP's explanation of the filings being "done to maximize the value for all stakeholders, including the employees, lenders, vendors and equity" is untrue, and instead were "solely for the purpose of maximizing the value of equity." That is correct, although it is arguable that employees, lenders and vendors will also benefit at a collective level from the GGP group having a greater ability to restructure.

In summary, I think the key issue around good versus bad faith is that (as quoted in Wells Fargo's submission), this is "a balancing process between the interests of debtors and creditors which characterizes so many provisions of the bankruptcy laws and is necessary to legitimize the delay and costs imposed upon parties to a bankruptcy."

In other words - was the decision to include GGP subsidiaries in Chapter 11 in the best interests of debtors and creditors, and does that legitimize the delay and costs? The previous Court ruling suggests that this decision has already been made, and in that context despite creditors whinging about it being unfair, it will not be overturned given that the 'cost' to them is actually only in terms of their leverage when negotiating with GGP during restructuring.

Legal Analysis II: GGP's Plans

Well, I will start to get back to posting on topics other than GGP from now on, but it has certainly been an interesting period.

The Court submissions by GGP are lengthy enough to warrant further summary and analysis. Most interesting are the statements outlining the anticipated path through Chapter 11 by Adam Metz, CEO of General Growth Properties, and James A. Mesterharm, the restructuring advisor and MD of AlixPartners.

Thanks to Ryan for pointing out that I forgot to link to the source in my previous post - this can be found here, and as a warning is a weighty 200 page document.

ADAM METZ - Chief Executive of Corporate Propaganda
Metz's lengthy statement is here on Scribd, and it almost feels like Bill Ackman drafted passages, some of it sounds so familiar. There are assurances that GGP has a viable operating model that "is performing well with stable cash flows."

Adam Metz goes into a lot of detail on the circumstances leading up to the filing, which I will not bother to reiterate here. Additionally he repeats many of the points summarised in my previous post. However Metz does so to highlight key facts that the Court may take into account when making its decision, including:

• GGP properties are performing well - certainly this is true relative to peers, with GGP having the second highest occupancy rate in the sector despite its problems. Additionally the firm expects to not be resiliant during the weaker economic environment.
• GGP employs approximately 3,700 people directly - as well as having a significant impact on communities. I am not sure that will pull Judge Gropper's heartstrings, given the same could be said for most large bankruptcies, but you can't blame them for throwing it in there.
• GGP operates a centralized business model - somewhat tenuous, the argument is that the services offered to national client (retail chains) and decision making are out of Chicago, and is an integrated model that would suffer if effectively broken up. This ties in with the case for including SPE's in the Chapter 11 filing.
• GGP has filed to restructure its finances and de-leverage its balance sheet - placing the blame firmly on the collapse of the credit markets: "GGP did not commence these Chapter 11 cases because its operational model is flawed or because its properties are undesirable or performing poorly."
• Credit refinancing problems are market wide and not specific to GGP - "even properties that have been performing well with strong credit quality are unable to attract refinancing" and "GGP's ability to divest assets is severely limited because prospective buyers also have limited or no ability to finance acquisitions."
• Failure to negotiate refinancing terms with lenders was also due to the structure of the CMBS process - specifically that this "impeded those efforts." This goes back to the first post, and that when a single lender acts in its own interest, that is to go bankrupt and claim, despite it not being in the wider interest.
• Chapter 11 will provide a forum for negotiations - GGP envisage this effectively forcing its diverse groups of secured and unsecured lenders to the table, with "the protections necessary for the company to preserve and enhance value by continuing its operations uninterrupted, and the tools necessary to achieve a sustainable, long-term capital structure."

GGP's Chapter 11 Goals
According to Metz, GGP is aiming to achieve the following under Chapter 11 - again none of this is surprising:

• Reduce and restructure GGP's debt - effectively deleveraging the balance sheet as much as possible.
• GGP will present its business plan to the Court and key constituencies "in the next few months", and begin reorganisation negotiations.
• "Seek a consensual plan of reorganisation with its mortgage lenders, bondholders, and other corporate-level creditors." If this is not possible, then apply the Bankruptcy Code to push through an agreement for GGP to "reduce its corporate debt, extend the maturities, adjust rates, or otherwise restructure the company's mortgage debt."
• "Explore strategic alternatives, including sales of assets, and.. available sources of capital", which means they will be open to limited asset sales, particularly offloading joint ventures.
• Proceed through and quickly emerge from Chapter 11 - and there I was thinking they were going to take their time.

JAMES MESTERHARM - Restructuring Tsar
Mesterharm goes into similar details around the causes of GGP filing - namely that it is not a result of the company performance per se, but due to the credit markets. He comments that "there currently is no capacity in the real estate finance markets to refinance the GGP Group's debt on terms that are commercially acceptable."

This section confirms that GGP reported 2008 consolidated revenue of approx $3.4bn, with $29.6bn assets versus $27.3bn in total liabilities, of which $6.58bn is unsecured. I recommend browsing pages 62-66 of the document to give an idea of all the debts that are maturing between now and 2012.

As part of proving the case that GGP have done everything that can reasonably be expected to avoid filing for Chapter 11, Mesterharm highlights the wide ranging operational changes to conserve and improve liquidity, including hiring new management and cost reductions. They even made the sacrifice of "terminating two airplane contracts" - I wonder if poor old Adam has to slum it in cattle class with the chavs these days?

Mesterharm then moves onto how the $375m of DIP financing will be used. One point of note on that is that GGP state they have sufficient cash to not need an interim order to access the DIP funds "prior to entry of a final order" - a good indication of their cashflow strength. Otherwise the DIP loan is intended to provide sufficient working capital during Chapter 11, and repay the Goldman Sachs $225m loan from last year.

Unfortunately there are not yet any actual specifics on that all-important restructuring plan, but overall it has been reassuring to review GGP's submission and not find any skeletons in the closet.

Legal Analysis: GGP Make The Case

I found Goldmans claim for administrative expenses against GGP for making a DIP offer (and having it rejected) highly amusing - if ever you needed an illustration of why they make so much money..

On 31st July, there will be a hearing to determine the extent and value of the lien by the creditor George Reed Inc (GRI), which are secured by the property 'Elk Grove Town Center LP'. What makes this case more unusual is that Elk Grove, and ergo GGP, owe more than $1m in unpaid progress payments (construction costs) to GRI. The deadline is being contested by GGP due to insufficient time to respond, which "failed to comply with procedures".

I have just finished reviewing GGP's court defence, and a summary is below:

1. GGP and its subsidiaries are "a fully integrated organization"
Therefore General Growth requires the revenues generated by the project-level subsidiaries for the servicing of their debts.

2. The CMBS Market GGP Relied Upon To Finance Its Properties Is "Dead"
This point is made to illustrate that it was standard CRE practice to refinance mortgages before they came due and for lenders to sell these onto the CMBS market. This is gone under current conditions, and approximately $9.9 billion of GGP's project-level subsidiary debt matures between now and 2012.

3. Unable To Renegotiate, Each Of The Debtor-Subsidiaries Determined That Chapter 11 Protection Maximized Value
A key point, is that when each of the individual entities acts within its own interest, this does not necessary act within the wider interests of the company or markets:

"When GGP approached several of the master servicers to discuss loan restructurings, it was told that the servicers would not even consider discussions unless the loans were within thirty to sixty days of default."

"Amazingly, in some cases the master servicers were even unwilling to reveal the identity of the special servicers whose consent was required for any loan restructuring."
GGP Court Submission 'OPPOSITION OF THE OFFICIAL COMMITTEE OF UNSECURED CREDITORS TO MOTIONS TO DISMISS OF ING CLARION CAPITAL LOAN SERVICES LLC AND WELLS FARGO BANK'

4. The Debtors Filed For Chapter 11 Protection
Due to the crisis, GGP and its subsidiaries (boards of the entities) met for over a month "to evaluate the data and determine whether filing for bankruptcy was in the best interest of that entity." As expected, the crux of the defence is that this is in everybody's wider interest:

"GGP entities whose mortgages were to mature in the next few years determined that filing was the best way to maximize their company’s value for all stakeholders, including employees, equity holders, and secured and unsecured lenders."

5. The Movants Remain Adequately Protected
In other words, the creditors asking for SPE removal from Chapter 11 should be paid in full anyway, and as even they cannot argue, all have been fully serviced so were not in default. Additionally GGP has "more than sufficient cash flow to service its debts to Movants."

The defence also goes into some detail around how the Movant's secured interests remain intact and protected, given the Court has upheld the need for each Debtor-Subsidiary to continue paying interest on loans at the non-default contract rate.

GGP makes a highly convincing argument in my opinion. It cites that the movants have failed to establish bad faith (a legal term, but ultimately this must be 'proven' by the Movant's to overturn the original decision). The lawyers have a field day shredding the creditor's case:

"Movants thus fall woefully short of discharging their burden of establishing the 'substantial evidence' necessary to prove bad faith. The 'bad fath' standard is meant to weed out bankruptcy petitions that seek to abuse the bankruptcy process."

As I have commented on previously, the industry overstated objections regarding the impact of this case, and stretched credibility. Here GGP's legal defence make the same point that arguing bankruptcy filings by all of the Property Owners will 'wreak havoc on the structured finance markets if permitted to proceed' is baseless:

"Movants offer no evidence that the filings have disrupted markets. Indeed, this Court has acknowledged that their concerns are 'hyperbole.'"

Overall the case seems very strong, and I cannot find anything in the objections that comes close to overturning this. It supports an industry source who confided that the credit industry objections are largely for the cameras (read: the clients). The reality is that CMBS sold to date did not come with adequate legal protection - as such they have too many legal holes for GGP not to win this argument.

Private Insolvency Management

Well I just got back from an amusing trip out to Zurich, where I gave a presentation to senior management in Private Wealth Management. I did a fine job of summoning faux enthusiasm as I ran through an unnecessarily lengthy presentation, explained how our absurd insolvency scheme could benefit them as well:

"And so, this scheme will enable you to provide your clients with full assurances that they will receive their money back, in the event of an insolvency at some point in the future," I pronounced confidently as I finished.

The PWM managers all looked keen, and agreed they would provide funding to have them added to my insolvency circus project, much to the delight of my Boss when I got back today. More funding equals more work for us - and a higher profile for him as he struggles to try and make MD.

As I packed up in the empty board room afterwards, a manager I used to work with came back in for a chat. He explained that the reason for this sudden interest from PWM is down to the exodus of clients in the last few months. As such, half of the room will be fearing for their own necks when this gets out, and have been looking desperately for anything that might give them an edge when trying to pick up more clients.

When I enquired why they had lost so many, he confessed that PWM have been so busy lying to them about portfolio performance for the last year, that when the bad news had to be finally reported at the year-end, it was the final straw for many.

"Look, the first casualty of a recession is honesty", he said seriously. "My problem with all this is that clients don't believe a word we tell them anymore, so I'm not sure this insolvency protection malarky is going to make any difference."

However bad I think my lot are, it was rather refreshing to get out to the most boring place to work in Europe and find out there is another group of bankers with even fewer morals.

Expenses Scandal Highlights Uncomfortable Parallels

Earlier I drafted up a mock client statement for this ridiculous post-insolvency initiative taking place here at the bank. It looks pretty good to me, but a particularly anal MD just replied back to take issue with my naming the example client 'Dodgy Hedgefund Ltd' (located at 1 Hedgefund Alley, Kensington, London).

Christ, if you can't have a sense of humour in this job then it's time to visit a clinic for some colonic irrigation, miserable old bastard.

On the subject of this initiative, to illustrate how absurd the work is - and current estimates are that it is set to cost over $30 million of the bank's resources to implement, and all the major banks are doing the same - the FT reported over the weekend that the Chancellor is preparing to change laws in this area. "Suggestions that the US operated more effectively than the UK are misconceived," a government official said.

In that case why is the US not rushing to change its bankruptcy laws as well? The problem with the government is that they seem incapable of admitting mistakes, even when they are obvious to all. It is rather like their attitude to MP's expenses, although it would be utterly hypocritical of me to criticise them, given what I have claimed over the years.  

A favourite has to be my generously volunteering to pilot a working from home scheme at a previous bank back in 2002. At the time colleagues smirked at my youthful enthusiasm, but I soon had the last laugh. Without any adequate controls, I went ahead and set-up a full 'home office'.  

That meant decking out my second bedroom (designated as my 'office') with an expensive, new PC of course. I also took the opportunity to furnish the room with a new bed, table, wardrobe and - my personal favourite - a 42" flat screen TV, which I categorised as an 'office presentation device'.  

In fact, there were even further parallels with politicians and their second home allowances now, remembering back. I became particularly ingenious at looking at ways of stretching the 'home office expenses' pot. My logic at the time was much like MP's I suspect, and demonstrates human nature: I treated as unacceptable anything that was refused, otherwise it was open game.  

My team quickly went from ridicule, to amusement, to envy, to applying to join the pilot scheme.

I finally reached the zenith when for 6mths (until they ended the scheme), I charged 40% of my rent as 'office rent'. The logic was infallible: apparently I only lived in a 2 bedroom place because I needed an 'office'. My pad at the time consisted of 2 bedrooms, 2 bathrooms and a main room. So 2 of the 5 rooms were 'office', since the en-suite toilet was also clearly an office expense and a necessity.

I know, all the morals of a politican. I was young.. underpaid.. naive.. how is it that they say it? I made several 'errors of judgement' that lead to 'clerical errors' and 'financial oversight'.  

To you, my internet audience of morality, I throw myself on the alter of judgement.. I have sinned!  Fortunately I couldn't care less about public opinion, so only promise not to pay any of it back.

CMBS Industry Gets A Wake Up Call

I have been following recent events in the commercial mortgage backed security market with interest since General Growth Properties filed for Chapter 11 on April 16.

The headlines have recently been around an alternative DIP financier being announced.  This is good news for GGP, because it has improved terms - in particular relating to potential equity dilution, which is the primary threat to common shareholders. Pershing Square had both a 4.9% warrant and a 5% equity conversion clause linked to the DIP repayment.

By contrast the new DIP terms removes the warrant, although replaces the 5% equity conversion with 6% (and demotes DIP financing to a junior lien on cash collateral - in effect making repayment less prioritised versus other secure debt to appease creditors). The equity conversion is considerably less than previously however, and as I said before ought to have minimal impact on the firm, as this could only be exercised upon successful emergence from bankruptcy. By which time the firm capitalisation should be hugely higher.

Of more interest were the recent details around the degree of investigation and preparation that GGP put into their bankruptcy filing, designed to ensure they maximise leverage when negotiating with creditors further down the line.

Firstly, it should be said that the issue here all comes down to one of expectations. Those lenders who entered into the various credit products being sold by the banks over the last 5 years, such as commercial mortgage backed securites, were reassured during the sales pitch by the way they were structured.

I know because I work with credit sales people at the banks, and their oily schmooze would be enough to convince me that they know what they are talking about, were I not familiar with the legal grey area in the detail beneath the surface.  In the event, salesmen just regurgitate a well-honed sales pitch, whether they're selling CMBS's or used cars.

"Debt is tiered by risk and reward, so if you take out the higher grade debt in this product, you will be first in line for repayment in the event of a default" schmoozes the salesman.

"But what about if they go bankrupt, and take the whole thing down with them?" asks the nervous-but-greedy investor. "Surely then being first in line isn't going to be any use."

"Ah but that is all factored into the inherent design of this product", reassures the schmoozy salesman. "Commercial mortgage backed securities from DodgyBank Inc are structured with the issuer to be held through a 'special purpose vehicle'."

"What the hell is that?" asks the nervous-but-curious greedy investor.

"It's a clever legal structuring of the debt, that provides additional insurance. The holder of the security and underlying collateral is not the company that owns the malls, it's an independent legal entity which is bankruptcy remote. That means if they go under, your asset does not, so you are guaranteed to be first in line if they default as all the cash flows towards repaying you."

"Wow, that's awesome - I can't lose! Put me down for $10 million on one of the really big REIT's.. hmm, that fast growing one 'General Growth Properties' looks good."

Of course, had these idiots bothered to do some due diligence, they would have read the finer print and worked out that the companies had far more control over those special purpose vehicles (aka 'special purpose entities' or SPE's) than they realised.

In GGP's case, they had the power to hire or fire the directors of the SPE's for the underlying assets (malls) as they so chose. As such, they did just that in the weeks leading up to bankruptcy. Unsurprisingly all 166 SPE boards then subsequently backed having their malls enter Chapter 11 with GGP, so this was firstly quite legal.

In papers filed Wednesday in U.S. bankruptcy court in New York, General Growth argued the CMBS investors' objections to including the SPEs "appear grounded in the misperception that 'bankruptcy remote' means 'bankruptcy proof'."

Now the battle ground is set between GGP, which wants to strengthen its position, and outraged creditors that wish to prevent the malls which their loans are secured against being included in bankruptcy (and the cashflows going to elsewhere in the business).

Unfortunately for the creditors, as the Wall Street Journal reports yesterday, GGP have prepared a significant argument to the court by pledging "to continue paying interest on its mortgages, possibly making it more difficult for CMBS holders to argue they should be allowed to foreclose. It also pledged to provide its mortgage lenders 'adequate protection,' meaning they will have an administrative claim in any liquidation scenario to cash flow drawn from their properties by the parent company."

Whatever the court decides will have far-reaching implications for the wider credit markets, but the odds are strongly in favour of GGP persuading the courts to go ahead with this, as it is very difficult to argue this is not in the wider interest of the market and commercial real estate industry to allow this to happen.

Otherwise the only news today is that I snapped after nearly 5 hours of wedding related shopping on the Kings Road earlier.  After a row with L about how all she seems to want to do with time off is go shopping, and how I have better things to do (such as finish the functional spec), she has gone off for a hair appointment, and I'm contemplating whether this is what married life is going to be like.

Perhaps I ought to Google 'marriage pre-nup'...

Banking on Bankruptcy

The situation with my GGP trade is continuing to progress (slowly), and looks to be gradually moving towards some significant news. That will bring a resolution to this period of financial limbo, which has seen continual loan extensions that only prolong the uncertainty and depressed share price.

On Friday, GGP announced that they were cancelling their quarterly analyst call outright, and postponed their earnings release by a fortnight.

There are a range of possibilities why, but this article gives some detail into one - namely the expiry this week on a forebearance agreement (this is an effective extension to a loan while the lender promises not to force a default and the borrower negotiates and is unable to comment in public). If GGP were to file for Chapter 11 this week, its quaterly earnings becomes "a sideshow" by comparison.

Hopefully GGP will file for Chapter 11 bankruptcy protection. As I have said before, I believe this scenario will also work well for GGP and its shareholders. It just may take 3-12mths before I start to realise the gains, which is unfortunate but as I have said - a key rule of investing is patience.

As this article illustrates in some detail, the prospects from an REIT going under are considerably different from a normal company - particularly one with assets that exceed liabilities. To quote an unnamed source from a Reuters article: "General Growth has problems with liquidity [i.e. servicing refinancing its debts] rather than solvency [i.e. operating cashflow]." With assets that exceed liabilities on its balance sheet (ignoring marking to market that should improve that further), and a positive cashflow, it all points to this being very profitable for shareholders when it emerges from Chapter 11 in the future.

Two interesting quotes:

"Bankruptcy experts, however, say that many of the worries may be unfounded. The sector may not have been tested by a big bankruptcy yet, but enough is known about how the companies are structured and how a bankruptcy proceeds that experts think the industry should emerge fine, even from a series of bankruptcies. Further, there is reason to believe that because REITs control a tangible base of assets through large portfolios of real estate, these firms may be more likely to survive bankruptcies than other companies that’s value is harder to pin down or could be subject to liquidation."

"Experts say REIT shareholders are more likely to retain some value simply because of a REIT’s underlying assets. “Most shareholders get nothing in a bankruptcy because most companies have no assets, and that’s not the case with REITs,” Jerome says. “It all comes down to valuation of the real estate assets. Even if those valuations have decreased, it’s going to come back up. And, if the REIT has to go into bankruptcy, it’s not the end of the story for shareholders as long as the company still has something of value.”"

I remain confident that GGP is hugely undervalued. Its share price is so depressed at present due to shareholder fears that Chapter 11 would wipe out the value of their holdings. However given that GGP ought to have a share price of around $20/share by my valuation (half what it was at its peak in the summer), and is currently at a mere 80 cents, you get a sense of just how low it is right now. Certainly $10/share within 2 years is very realistic.

Therefore it will not require even much excess value of assets versus liabilities to remain on its balance sheet for common shareholders to see a huge increase in the stock price and their returns. Another possibility would also be that GGP is bought out during the process, which again would mean big returns for me as it would doubtless be at a share price upwards of $7/share. To put that into context, I would be looking at a £250k profit in such a scenario.

There are other factors to stir into the mix - opportunisim and political. There remains a distinct possibility that one of its rivals will take advantage of the huge discount to merge (or buy outright) GGP. One candidate would be Developers Diversified Realty Corp (DDR), which has a market capitalisation approximately twice that of GGP at present, due to it having less issues around solvency. A combined entity would instil all-importance confidence in lenders and would realistically lead to GGP shareholders receiving a shareprice in the $5-10 range I would estimate.

The political element comes from the extension of the TARP for funding commercial real estate lending, and the progress of Barack Obama's current funding bill through the Senate. I need to complete more research into this as I am not particularly up to date, but it is possible that lenders are receiving indications that funding will be made available at some point in the future, which would enable refinancing.

That would certainly explain why there have been continual extensions without apparent resolution - an effective delay until the TARP situation is clarified, as that is obviously the preferred solution for all parties. If so then there may be another extension again with regards to loans due on 12 February for the two Las Vegas malls mentioned in the Forbes article.

So much to consider, and all you can do with a trade of this complexity is complete analysis, stick to your strategy and remain detached from emotion throughout. If I were to lose my entire stake on this trade (around £80,000) then so be it and I will have learned a huge amount along the way. However all my analysis points towards my acceptance of this risk yielding a significant reward in the future.

Investing for a Recession (Part II)

Having outlined how I have made some useful money from the recession to date, it would be worth now moving to my current main investment at present, so that there is some context when I update on this going forwards.

Apart from putting a proportion of my funds into a gold ETF, which is an excellent hedge both against recessionary worries, a devaluing dollar and future inflationary concerns from all the quantitive easing taking place, I have also placed a significant sum into something that is much less obvious in these turbulent times: US commercial property.

You might think that is insane, and is totally contrary to what everybody else is putting their money into at the moment. But part of investing is looking for value, and sometimes that means looking beyond the conventional wisdom. I have bought into something called a Real Estate Investment Trust (REIT) - these are essentially US commercial property companies, which by and large have plunged by enormous amounts in the last 6 months.

As such, several are rumoured to be on the verge of bankruptcy, and one in particular is down a staggering 97% since the summer of 2008. When you factor in a fall of that magnitude, you have to start looking at the price and ask why, and whether this is rational or fueled by other factors. The underlying reason is the credit crunch, combined with investor fear of a Chapter 11 bankruptcy filing.

To give some background here, REIT's have by and large used a previously acceptable business model, whereby they were highly leveraged and routinely took out large levels of debt to increase their asset base and buy up more property. They then serviced this debt, steadily paying it off while periodicially refinancing this - without problems in a normally functioning credit market. Of course, everybody now sees US property as having been in a huge bubble, and all associated loans as necessarily toxic. As such, suddenly some enormous commercial property companies are on the brink of bankruptcy - including the particular REIT I have invested in called General Growth Properties (GGP).

To put it into context, GGP is the second largest mall owner in the US. That is not an insignificant statistic in itself, and should it fold there would be enormous ramifications for the US retail sector, not to mention a political backlash. I would actually not mind if it did file for Chapter 11 within the next few weeks, for reasons summarised well in this Reuters article.

Estimates suggest that GGP's assets exceed liabilities on the balance sheet by several billion dollars already. Additionally it has no problems servicing its actual debts, just refinancing them. In effect the problems of GGP are not with solvency, as with normal bankruptcy risk, but liquidity - this is a direct result of the banks own liquidity issues that have made them more risk averse.

What is most interesting with GGP is also that the balance sheet is not fully marked to market, which means that if its assets are valued at today's prices instead of when purchased there will be a change. Many properties on its books were bought years ago and have never been revalued, so it is reasonable to expect many will be worth more than marked, even with the current woes of the US property market. As such, assuming GGP were to go bust, what does that mean for ordinary shareholders? Normally it is a disaster and means no money, but in this case it should mean that the US courts would order the banks to agree refinancing terms, after which GGP would emerge out on the other side without that perceived stigma. Meantime the shares will continue trading on the stock exchange.

Since the Reuters article, all indications are that GGP will not file for Chapter 11 however, with its banking consortium of lenders bending over to give multiple loan extensions (including one over the weekend through to mid-March). There are many factors at play in whether full refinancing of the loans due in 2009 will take place - that is what would remove the market risk of bankruptcy that has so severely depressed the share price.

The main sticking point for lenders is several billion dollars of loans that are currently unsecured (i.e. have no assets backing them up), which are due for refinancing. Understandably the banks want assurances they would have some collateral to offset should GGP go under at a later date, and at present the unsecured loans are not acceptable to them. As such GGP is looking to either sell assets to pay those off, or negotiate terms. Both are possibilities, but at this stage it is unclear which is the more likely.

Another factor is the recent extension of uses for the Troubled Asset Relief Program (TARP) by Barack Obama, to now explicitly include money for Commercial Real Estate. This bill has passed through congress, and the campaign is continuing - again it provides political pressure on the banks to lend and not push under a company as significant as GGP.

Once terms are agreed, or GGP manages to sell off a number of assets to enable refinancing, I expect there to be significant upwards movement on the stock price. I have gradually increased my long position on GGP from $1.61 down to $1.03 in the last 2 months, although it is worth adding that a recent sell off last week on fears ahead of the loan deadline (prior to extension again) lead to a sharp fall back to around 55 cents a share. As of yesterday, GGP's share price bounced up 30% on the news of the loan extension, and is now currently at around 80 cents a share as I type.

So I am sitting on an unrealised loss at present. Since I bought into this REIT in December, the share price has risen by 80% at its peak, and fallen by 50% from where I entered at its lows. I turned down the chance to cash in a £50k profit in early January because I am more interested in the bigger picture here. That's how trading works - I have a strategy which does not include day trading this stock, because I do not know when the news will be announced that will make the crucial difference.

To give you an idea of the potential rewards at stake here, if the share price were to rise back to just $3.50, where it was in October, I would make in the region of £150k from the trade.

I should add a cautionary note that this is considered a speculative play. I am speculating on the most likely outcome based on extensive research - what makes this unusual is that there appears to be significant upside regardless of whether GGP files for bankruptcy protection or not. To me the share price of GGP is significantly undervalued, and at some point the market is going to realise that.

Most people are not prepared to accept this level of risk, and that is entirely right, although it is worth pointing out that you can take a zero off the figures and it could easily be you making (or losing) these amounts. In my case, if everything goes as well as I expect, I could make over £1 million from the trade. Admittedly that is unlikely and would require me holding for a couple of years. I am looking at cashing in £250k as a more realistic profit, but it gives you an idea of how risk vs reward works in the markets.

I will keep you updated on the progress of this particular hot potato in the coming months. Anyway back to work.