Bankruptcy

Bankruptcy Remote ? Bankruptcy Proof?

By Adam Levitin

"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.

The bankruptcy filing of General Growth, the second largest mall operator and the largest CMBS sponsor in the US is putting bankruptcy remoteness into question.

 General Growth owns 166 mall properties.  It seems that the revenue stream from each on has been separately securitized.  This means that the revenue stream has been sold to an independent entity that paid for the revenue stream by issuing securities (CMBS) to be paid from the revenue stream.  The result is that General Growth got cash now for future revenue.  The CMBS investors, of course, assumed that they were taking on the credit risk from a particular mall, not the overall credit risk of General Growth. 

Imagine their shock when all 166 SPVs filed for bankruptcy along with General Growth.  How did this happen?  Many of the malls are doing just fine.  The trick was that General Growth replaced enough directors on the SPVs' boards to get a filing authorized.  Most of the directors seem to have been from a rent-a-board operation.  The boards were overlapping, so replacing a few board members was sufficient to ensure a compliant board.  (Can you guess what sort of covenants will be in the next round of CMBS deals?) 

The investors and servicers of these SPVs are objecting, and to be sure there are some legal arguments, like the good faith filing doctrine, that might still save them.  But General Growth stands as a reminder that credit risk can be reduced and difused and hedged, but not ever completely eliminated. 

[As an aside:  check out the terms of the General Growth DIP:  LIBOR+1200!  Ouch.]

Full post as published by Credit Slips on May 09, 2009 (boomark / email).