Let’s assume you are in the market to acquire some distressed real estate debt at what you hope will be a favorable price, and you think you have examined all the angles. You ran the numbers, studied the underlying property, reviewed financials on the borrower and guarantors, analyzed the debt service coverage and loan to value for the asset and had your counsel carefully review the mortgage loan documents. You also received advice from your attorney about the time frame and costs for the enforcement of remedies, should that become necessary.

In determining your bid on the debt, you learned the loan has been kept current throughout its term, matures in six months and is troubled-but not in default. It is unlikely the borrower will be able to refinance the debt, given the dearth of credit in the market, and in such an event, it typically takes four months to foreclose on the collateral in the jurisdiction the asset is located.

The owner is set up in a typical bankruptcy-remote special purpose entity (SPE), an entity formed to develop, own and operate a special project. So you figure it will take no more than four months to take title of your collateral once the mortgage loan matures. Since you did a valuation of the property at the end of this four-month period, you feel comfortable running the numbers and submitting a bid that will provide optimal returns.

What if you learn that the borrower/ bankruptcy-remote entity that owns the property is not so bankruptcy remote after all? And if it files for bankruptcy, the term on the loan may no longer be six months, but might get crammed down and also dragged out for, say, five to seven years?

This possibility, as crazy as it might have sounded a few months ago, is not so crazy today. Of course, clipping a coupon on debt at, say 4%, for five to seven years was not exactly the type of return you were looking for when you decided to purchase distressed debt.

Well, welcome to the post-General-Growth – Properties-bankruptcy- filing world. You see, as it stands now, all those entities that CMBS lenders, rating agencies and others had thought were insulated from the bankruptcy of their parent entities may not be. The lockbox and cash management arrangements protecting property cash flows for the mortgage lender may be re-directed from that entity and sent to the parent company to keep it afloat as the entire firm attempts to reorganize.

If that parent company obtains a loan in bankruptcy (a debtor-in-possession loan), that debt may require collateral security to entice the DIP lender to make its loan. The proceeds of that loan, again, would be used to run the larger enterprise in an attempt to reorganize. Perhaps worst of all-and this story is still unfolding-the mortgage loans of the SPEs, just like the one you are seeking to bid on, may be dragged through the bankruptcy process in a way that might affect both the coupon on the loan and the maturity. While several lenders and special servicers fought to have the bankruptcy filings of several of GGP’s SPE subsidiaries dismissed, the bankruptcy judge denied their motions. Plus, the vast majority of SPE filings in GGP were not even challenged by the lenders. So as long as they are in bankruptcy, they remain under the cloud of having the terms of the loans extended well beyond their stated maturity dates. All of this should leave a sour taste in the mouths of investors who are now faced with significant uncertainty about pricing a bid on distressed real estate loans. An offer that makes sense for a loan maturing in six months might not if the debt matures in six years. This uncertainty will have a considerable effect on bidding, at least until some clarity arises out of the GGP case and/or investors feel comfortable in how to further discount their offers to factor in these new risks. Until then, buyers of distressed mortgage debt should remember the old legal expression-caveat emptor.


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