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SAN FRANCISCO-Mervyns, which entered Chapter 11 bankruptcy at the end of July, recently gained some breathing room for deciding which of 172 leaseholds it will retain and which it will let go. It also hired a third party to review the leases and negotiate with landlords in advance of any decisions.

The extension of the leasehold review–to Feb. 23, 2009 from Nov. 25, 2008–was granted earlier this month by US Bankruptcy Judge Kevin Gross. This week, Gross was scheduled to sign off on the hiring of Hilco Hilco Real Estate LLC of Northbrook, IL to review Mervyn’s leases and negotiate discounts with landlords where appropriate. Hilco is currently handling the going-out-of-business sales now occurring at 26 Mervyns locations.

In arguing for the extension of the leasehold review period, a transcript made available online last week lays out the reasons for Mervyn’s request. The first is that Hilco, whose hiring was to be approved by the court late last week, has only recently begun its review process.

“The debtors need time to review the appraisals, to discuss it with the Committee and the banks, and to have Hilco engage in substantive discussions with the landlords,” Mervyns’ lawyers told the judge. “This process is large and time consuming and is unlikely to be completed by November of ‘08.”

The complexity of its real estate holdings is part of the reason. As part of a 2004 acquisition, all of Mervyns’ real estate property were removed and transferred to 24 related entities, known as the MDS entities, which then leased or subleased such properties back to Mervyns pursuant to several master or unitary leases.

“[Mervyns] needs time to review the master leases and to negotiate with the MDS entities and perhaps to even litigate some of these issues which will be fact intensive and time consuming if no resolution can be had on consent with MDS,” according to Mervyns lawyers. “Moreover, since 2004, many of the stores were carved out of the master leases and sold by MDS to a large number of existing landlords. These leases also need to be reviewed, [as do] approximately 40 leases which did not get assigned to MDS due to prohibitions on assignment in those leases.”

And just in case those arguments weren’t sufficient, Mervyn’s lawyers saved the best reason for last: Its debtor-in-possession loan allows Wachovia to take a reserve against the inventory at any store if the lease for such store has not been assumed at least 10 weeks prior to the assumption or rejection deadline. Without the extension, that deadline would have been this week.

“If the reserve were taken…this would significantly reduce the debtors’ borrowing availability and would dramatically undermine the debtors’ efforts to restore vendor confidence and trade terms, to restore customer confidence and employee morale at a critical early stage in the Chapter 11 cases,” Mervyns argued successfully.

In order to overcome objections to the extension, three Bay Area properties were held out of the Judge’s order approving the 90-day time extension for accepting or rejecting the leases. One is the company’s 336,000-sf headquarters–located at 22301 Foothill Blvd. in Hayward, CA—which was acquired last year by an entity of Capmark Financial (North 3 Holdings LLC) for $60 million. North 3 Holdings retains the right to compel Mervyns to accept or reject the lease at any time and Mervyns retains the right to object.

The other two Bay Area properties not included in the decision are store locations in Cupertino and Santa Clara that are owned by Byer Properties. These were omitted from the decision because unlike the other leases, MDS is directly responsible for the lease, not Mervyns.

Mervyns filed Chapter 11 at the end of July. Wachovia Capital Finance arranged for a $465 million debtor-in-possession facility for Mervyns, which is being used to fund the company’s ongoing operations.

The 26 stores already slated for closure include 11 in California [Antioch, Canoga Park, Fairfield, Foothill Ranch, Huntington Beach, Irvine, Laguna Niguel, Livermore, Napa, Palm Desert, and Thousand Oaks]; four in Arizona [Phoenix (3) and Scottsdale]; six in Texas [San Antonio(3), Lubbock, Midland and Odessa]; four in Nevada [Carson City, Las Vegas, Reno and Sparks] and one in Boise, ID.

In seeking the extension for its decision on leases, Mervyns alluded to the re-trading of Mervyns-leased buildings by the MDS entities. In the most well-known of those deals, a joint venture between Developers Diversified Realty and Macquarie Trust in mid 2005 acquired 36 open and operating Mervyns stores for $396.2 million. The stores total 2.74 million sf and are located primarily in California and are generally leased to Mervyns for the next 15 years. DDR president/COO Dan Hurwitz spoke about the portfolio and speculation regarding Mervyns in a second quarter conference call held just days before Mervyns bankruptcy filing.

“We acquired 36 of our 38 Mervyns stores in 2005. Notably we bought the first portfolio they sold post LBO and were able to select what we believe are the most attractive locations,” he said. “Approximately 70% of the assets are based in California including nearly one million sf in and around Los Angeles and over 500,000 square feet in the Bay Area. If our Mervyns locations should become available to release, we believe there will be significant retailer interest in the sites we own, based on their desirable West Coast locations with high barriers to entry, infill locations and strong demographics.”

In addition, Hurwitz said that DDR holds a $25 million letter of credit that it can access if Mervyns files for bankruptcy or if Mervyns defaults and we terminate all the leases, and also holds three other letters of credit totaling $8 million that it can tap should Mervyns default on individual leases. “The combination of quality locations, and significant credit enhancement coupled with already known tenant interest clearly minimizes any risk we have should Mervyns file Chapter 11 or Chapter 7,” he said.

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