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General Growth bankruptcy could zap credit market recovery Print E-mail
Wednesday, 22 July 2009

By Marine Cole

After a two-year drought in the securitization market since the onset of the economic crisis, off-balance-sheet financing has shown some signs of life lately. Yet the very basis of structured finance -  to isolate assets from the creditors of a company that receives revenue from them - is currently facing a serious court challenge.

Securitization sprouted some green shoots in mid-July. Morgan Stanley helped biotech company Vertex Pharmaceuticals issue a $250 million deal securitizing future income streams from a drug still in development. Just a few days later, American General Finance, the consumer lender arm of American International Group, sold close to a billion in mortgage-backed securities to Credit Suisse. Such deals have eased fears among CFOs that the structured finance market is closed for business.

But now, securitization could be in jeopardy again. Indeed,  a bankruptcy court case involving the Chicago-based real estate investment trust General Growth Properties has triggered serious concerns about the future of structured finance. Even if the court doesn't undermine the basic purpose of structured finance - to isolate assets from creditors - investors in securitized assets will ask for extra protection in new structured finance entities, thanks to the General Growth case.

“This is a very unusual case,” said Peter Dodson, a partner in the restructuring department of Cadwalader, Wickersham and Taft.

General Growth, a huge REIT which manages about 200 shopping malls in 44 states, filed for bankruptcy in April. Complicating matters: So did the 150 or so of GGP’s special-purpose entities, created to hold assets financed with commercial mortgage-backed securities, even though the SPEs were still solvent and their assets supposedly “bankruptcy remote.” That is, their securitization through the SPEs was supposed to keep the assets out of reach of creditors of the sponsoring company.

“So far, the court hasn't done violence to structured finance,” said Michael Gambro, also a partner at Cadwalader and co-chair of the capital markets department at the firm.

While the court gave General Growth's creditors immediate access to the cash of the company's SPEs, it also protected investors in the SPEs by granting them a lien on General Growth's centralized cash management account. It will be senior to the lien granted to the new lenders providing debtor-in-possession financing during the bankruptcy.

But the court could modify its view going forward. “We're waiting to see whether the court is going to dismiss the bankruptcy filings,” said Peter Dodson, also a partner at Cadwalader in the restructuring department.

One of the arguments for accepting the related Chapter 11 filings of the SPEs is that, although the entities are solvent, they may not be able to refinance their mortgages. The court has to decide whether that's a valid reason for filing. (Of course, observers, if not the court, may wonder how the SPEs are solvent if they can’t refinance, or if they are solvent, why they can’t.)

If the court decides that the inability to refinance a mortgage isn't a valid reason for the SPEs to file for Chapter 11, “that would be even better for structured finance,” Dodson added, since it will reinforce the view that SPEs are independent entities.

In determining whether the filings were valid, the court will look especially closely at the role independent directors of the SPEs played.

To file voluntarily for bankruptcy, the vote of one or more independent directors of a special purpose entity is required. The court will have to decide whether these directors voted to file in good faith. That faith may be questionable, given the fact that General Growth replaced each independent director in the SPEs with new ones who supported the filings just weeks before its bankruptcy.

While the securitization world waits to see in which direction the court will go, legal experts are already thinking of ways to protect investors to avoid another situation like that at General Growth.

One possibility: strengthening the role of independent directors when SPEs are structured. Gambro noted that independent directors could be affiliated with a third party, in what he called “outside corporate-type service,” instead of the SPE’s sponsor or its management.

A more drastic measure would be to structure an SPE so it issues a new class of equity. Those holders of the stock would have a fiduciary duty and would have their interest held by a company not connected to the sponsor. The stockholders' vote, instead of the one of independent directors, would be required to file for bankruptcy. Gambro added that the sponsor wouldn't be able to fire the holders of these interests. But equity in the entity might be a tough sell given that it would still share revenue with the sponsoring company.

“We don't want investors to have to worry about their investments,” Gambro said. He added that he's “hopeful that the judgment will not make any decision that will upset the concept of structured finance.”

A lot of CFOs no doubt share that feeling.

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