Wednesday, August 05, 2009

GGP And The End Of Securitization; Threats Of Substantive Consolidation Gain Momentum

We have been watching the GGP bankruptcy evolve from a distance over the past several months for a variety of reasons. Prior posts have laid out Bill Ackman's long thesis on the bankrupt equity and Thomas Kirchner's rebuttal. Also lurking for several months have been the threat of substantive consolidation of GGP related entities. For those that have never heard of "substantive consolidation" and thus assume it is part of legal esoterica, you should understand it is the basis for the entire securitization market.

In essence, a securitization has historically been "bankruptcy remote" from its owner. This works in both directions, so to speak. In direction one (such as GGP's case), if the owner goes bankrupt, the remote entity's securitized lenders are protected and the bankruptcy has no impact on their ability to collect payments or takeover the underlying assets if the securitization began trigger relevant covenants. However, if the remote entity turned out not to be remote and were instead "substantively consolidated" with its bankrupt parent, the bankruptcy judge would have the ability to dictate terms and otherwise change the deal within the securitization, making it hard for the ABS lenders to get comfort they'll receive full value.

In the second direction of remoteness, the parent is protected from a default of the securitization. Basically, if TILB & Co. were to sponsor/create a mortgage securitization in which it owns the equity tranche (say, the bottom 5% of the structure) and fund the balance of the securitization with 95% debt (ABS), TILB & Co. stands to lose the money it put in the securitization and no more (making it "bankruptcy remote" from TILB's other assets). Substantive consolidation would change that and put TILB & Co's other assets that are outside that securitization at risk (e.g., if the collateral in the securitization did not cover the securitization's liabilities, the ABS lenders could come after TILB & Co's assets that are outside the securitization structure). In essence, substantive consolidation would take away the limited liability nature of securitizations.

This would of course end private securitizations forever and obliterate the balance sheets of most large banks and insurance companies.

An article from Reuters yesterday addresses the issue and GGP's attempts to utilize substantive consolidation in its bankruptcy proceedings.

General Growth keeps securities markets on edge
Mon Aug 3, 2009 2:45pm EDT
By Al Yoon

NEW YORK, Aug 3 (Reuters) - General Growth Properties last week, possibly in a shrewd negotiating tactic, said it may yet pursue a controversial strategy in its bankruptcy that could upset the legal basis for thousands of asset securitizations.

The second-largest U.S. shopping mall owner at a hearing said it was considering ways to treat some of its subsidiaries as a single debtor and override their status as separate companies, according to a transcript of the hearing.

Potential for such a move is raising concern among investors because borrowing against commercial real estate and other assets is tied to the notion that borrowers are isolated from external events at a parent or other units. It is enough to sound alarms over the credibility of billions of dollars in bond agreements, even though a "substantive consolidation" is tough to achieve, analysts said.

"This was a surprising development that was probably saber-rattling on General Growth's part," said Daniel Rubock, a senior vice president at Moody's, who attended the hearing.

Chicago-based General Growth (GGWPQ.PK: Quote, Profile, Research, Stock Buzz) filed for bankruptcy in April after the credit crunch choked off financing for commercial property mortgages, challenging the company as it confronted maturities on billions of dollars in loans. It shocked analysts by naming some three-quarters of its 200-plus shopping malls in its filing, even though many of the corporate subsidiaries are in good shape.

Consolidating the special-purpose entities (SPEs) would hit at the heart of asset securitizations, which helped fund more than $600 billion for office buildings, apartments and shopping malls in 2005 and 2006. The threat comes as Federal Reserve and Treasury officials have focused on restarting lending to commercial properties in a bid to reduce the sector's drag on the U.S. economy.

Addressing concerns at a hearing last week, General Growth attorney Marcia Goldstein affirmed the judge's understanding that consolidation was not in court papers but noted the company needs to assess "inter-relationships" of the debtors.

"And one of the things we're looking at is whether there are some subgroups that should be appropriately substantively consolidated," Goldstein said at the hearing, and confirmed to Reuters on Monday. "We have not reached any conclusions on that at this point."

General Growth may be looking to negotiate a "global settlement" that rewrites all loans to easier terms with its creditors, said Richard Jones, co-chair of Dechert LLP's finance and real estate group.

What is more, getting a judge's approval for a substantive consolidation would be extremely difficult. Jones said. And the judge has "gone out of his way" to say that he does not expect proceedings to move in that direction, Jones added.

"It makes sense for the GGP counsel to mutter the words periodically to keep it at a low boil," Jones said. "It keeps the risk very clearly on the table." (Editing by Andrea Ricci)
As the author of Directive 10-289 (the best named blog in the blogosphere) said to us via email, "Novel bk strategies have been envogue lately but the Fed/Treas etc. do not want this Scud going off in the oil field. Talk about a credit crunch lingering a lot longer. whoa. If judge doesnt want to end up in Peoples Court he had better stick to his guns"