Mall operator bait and switch

The WSJ says that “When General Growth Properties Inc. sought Chapter 11 protection last month, it took a step its biggest debt holders had believed was impossible: It took 166 of its malls into bankruptcy with it.

The surprised debt holders had believed the malls would be insulated from the parent’s bankruptcy because of the way General Growth had structured the assets.

General Growth’s action has rattled investors throughout the $700 billion market for securities backed by commercial mortgages, or CMBS. Investors in other deals had also figured their investment was insulated from a parent company’s bankruptcy. Now they’re worried that General Growth’s move will set a precedent that could affect them.”

The WSJ goes on to explain that “In past years, to get the malls’ mortgages, General Growth had set up 166 “special purpose entities” whose sole purpose was to borrow money. SPEs are attractive to lenders because, according to legal experts, they are “bankruptcy remote,” meaning their cash flows are dedicated to paying debt service. The lenders issued securities backed by the SPEs. Holders of securities expect the structure would ensure they’d be paid even if the parent company went bust.

General Growth had to get approval from the board of each SPE before the malls could file for Chapter 11, legal experts say. In the weeks before the bankruptcy filings, General Growth replaced directors — originally selected by Corporation Service Co., which specializes in staffing such boards — on roughly 90% of its SPE boards.”

So GGP is yanking the rug out from under CMBS claims by using puppet boards of directors installed at the last minute.  I can follow the logic that this is technically legal.   Credit Slips explains that “General Growth stands as a reminder that credit risk can be reduced and difused and hedged, but not ever completely eliminated.”   This same piece tells us that ‘”Bankruptcy remoteness” is the bedrock of asset securitization.  Bankruptcy remoteness means both that the assets will not be part of the originator’s bankruptcy estate and that the securitization vehicle (SPV) will not itself file for bankruptcy.  The former is achieved by a true sale of the assets from the originator to the SPV; the later by ensuring that the board of the SPV will not authorize a bankruptcy petition and that there will not be outside, creditors who might file an involuntary petition.”‘

This is going to torpedo the value of all the CMBS out there while investors scurry to find out if this might happen to their  holdings.  Also it will ensure that the commercial MBS creation market as it has existed will not return anytime soon.

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