The most recent bankruptcy court ruling on May 13 for General Growth Properties' (GGP) Chapter 11 filing have upheld the separate legal structure of U.S. CMBS loan special purpose entities (SPEs).

However, the costs of defending the bondholders' positions will ultimately create higher losses on the subordinate bonds, said Fitch Ratings analysts.

GGP declared bankruptcy in April. Even though the court's May 13 ruling maintains the integrity of the SPE structure, it diminishes the flexibility and control that is typically granted to the special servicer during traditional loan work-outs and reinforces that SPEs are "bankruptcy remote" rather than "bankruptcy proof."

For example, while the voluntary filing of the SPE borrowers is an event of default on the CMBS loans, a bankruptcy court judge could prevent special servicers from foreclosing on the properties involved.

If the properties remain within the bankruptcy proceedings, based on the material equity in many of these high-performing assets, GGP could seek additional leverage secured by the mortgaged properties to help repay their corporate unsecured debt.

The presence of additional debt would put substantial additional stress on the properties and impair the performance of the CMBS transactions. GGP has already requested $375 million of Debtor-in-Possession (DIP) financing, explained Citigroup Global Markets analysts. At a minimum, CMBS trusts that include GGP loans will incur additional servicing fees.

Fitch expects the near-term impact to CMBS bonds to stem primarily from these fees incurred by the trust and also the legal fees associated with defending the bondholders' positions in what it expects to be a long, drawn-out case.

"While servicing and modification fees are clearly identified in the respective deal documents, estimating legal costs will likely prove much more difficult, as they will depend on the length of the proceedings and the extent of the various rulings," analysts said. "These costs could be significant in a case of this size. According to historical data accumulated by Fitch's surveillance group, legal costs on resolved loans averaged approximately 1% in 2008."

To be sure, the bankruptcy court has already postponed a hearing that was set for May 27 to hear a petition by ING Clarion Capital Loan Services, a unit of Dutch financial firm ING Group NV that services loans for lenders that financed eight malls operated by GGP, to exclude these properties from the bankruptcy filing.

ING Clarion claimed that these entities should not be included in the proceedings as the properties backing these loans continue to perform, have positive cash flow and are not in danger of imminent default.

The court has rescheduled this hearing to July 17 to give other lenders time to participate along with ING. It has also granted GGP until June 8 to respond to any additional motions.

"We expect GGP to be successful in leveraging the bankruptcy filing for its benefit, persuading some of the other large real estate related borrowers to try dragging their properties into bankruptcy," said Citigroup analysts.

They added that this is not a new risk for bankruptcy remote vehicles, although CMBS investors still retain their secured mortgage interest.

The complexity that comes along with Chapter 11 is a negotiation tool. However, considering the financing environment, potentially negotiating these mortgages earlier rather than later is not necessarily a bad outcome, Citigroup analysts said.

(c) 2009 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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