General Growth Properties, which about a month ago filed the largest real estate bankruptcy in U.S. history, has seen conflict and drama worthy of The Jerry Springer Show, also based in Chicago.

The latest development involves a ruling by a bankruptcy court judge that has CMBS investors upset.

When General Growth Properties filed for bankruptcy on April 16, it did not go alone. It took about 160 shopping centers with it. A week later, on April 22, it announced that another eight shopping centers had followed suit. The company’s plan: to consolidate and draw upon the income of these mall properties, giving it a more stable revenue stream and helping it move through bankruptcy. Last Wednesday, a bankruptcy court judge ruled General Growth could go ahead with its plan. 

This was a punch in the gut to holders of CMBS that are drawn on these properties. Normally, when a parent company like General Growth files for bankruptcy, the properties it controls do not file as well, unless a particular property is in comparable financial straights. The shopping malls dragged into bankruptcy with GGP were by and large healthy, and CMBS investors bought their securities with the understanding that they were bankruptcy remote. Objecting to the GGP revenue stream consolidation plan, creditors filed suit seeking to block General Growth from bringing healthy properties into bankruptcy. However, U.S. Bankruptcy Court Judge Allen Gropper ruled against them, a decision that leaves investors with doubts.

“I think it’s a big gray area and this case is a test case,” said Craig Guttenplan, an analyst at Credit Sights. “How bankruptcy remote are these entities? Are they bankruptcy proof? CMBS investors have operated under the assumption that the only reason an entity would file for bankruptcy would be if it needed to, not if its corporate parent needed to.” 

The good news for GGP’s CMBS holders is that they will continue to receive revenue, albeit in a consolidated stream. According to Andy Day, an analyst for Morgan Stanley, the preservation of the income stream to the CMBS investors has mitigated many of the concerns they had, though many details have yet to be worked out.

Attorneys representing the Commercial Mortgage Securities Association and the Mortgage Bankers Association filed an amicus curia brief with U.S. Bankruptcy Court, claiming that a decision to allow GGP to take the properties into bankruptcy would have a “catastrophic impact” on bankruptcy precedent and the CMBS market.

The ruling against the creditors or the increased chance of commercial properties being taken into bankruptcy by parent companies could have a lasting effect on the CMBS market. While the ruling may not be as disastrous as some predicted, it adds a level of uncertainty to the market that will change things. “As an investor that wants to restart the CMBS market, I have to consider these uncertainties,” said Tom Zatko, managing director with Babson Capital Management and head of its real estate finance group’s CMBS business. “All these rulings will be looked at very carefully when investors are looking to craft documents that will protect them in the future. We will see tougher documents. … If you think documents leave room for interpretation, that uncertainty will have to be priced in.”

Market observers seem resigned to a permanent change in the way CMBS investors look at investments from now on. “With each rumbling in the CMBS market, whether it is a Stuyvesant Town or a GGP, bond investors are getting affected in ways they neither imagined nor bargained for,” said a monthly market commentary from New York-based Annaly Capital Management. “Maybe this is the ultimate lesson of the downside of a bull market.”

The move to bring the shopping mall properties into bankruptcy with it came after the company had already faced a foreclosure on one of those properties. Lenders filed to foreclose on a shopping mall owned by General Growth as the company was in the midst of a bond consent solicitation that ultimately failed in March. Citibank filed papers with a district court in Louisiana to foreclose on the Oakwood Shopping Center in Gretna, La. outside of New Orleans, after General Growth missed a March 16 payment deadline that had been extended from February (LFN, March 23, 2009).

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