Bad boys parts I, 2 and 3....

The "Bad Boy" carveouts hang over the heads of real estate investors who sunk their life savings into buying properties and using a conduit loan to finance it...If the ownership enity files BK, then the loan becomes recourse to the guarantor which is typically the principal in the investment. So, you either turn over the keys and walk away, or risk the family farm if you try to save your investment through the courts and fail....that is the choice...Well, GGP proves that you cannot tell a book by its cover and each circumstance needs to be evaluated on the facts and circumstances of the specific transaction....Investors have significant equity investments in properties that are suffering cyclical stress....all you have to look at is the increase in value realized from 1991 to 1996 and beyond to know that the current values are just that - current - which means that they are not reflective of tomorrow's value....We know that without liquidity, property values are going to continue to decline - and where that liquidity comes from is yet to be seen - but we all just know that we have to be close to the bottom, we just have to be....The following article raises the issue of the "bad boy" carveouts.... do they work or don't they, it depends....

Mon 12 Oct, 2009, Commercial real estate's bad boys: Agnes T. Crane, a Reuters columnist. The views expressed are her own -

NEW YORK (Reuters) – The bad boys are back, but whatcha gonna do when they come for you? That’s a song investors in commercial real estate shouldn’t have in their heads thanks to “bad boy” provisions built into loan agreements that aim to protect their interests.

Yet, at least two high-profile cases have quashed the idea that investors in commercial real estate debt can rest easy that the collateral backing non-recourse loans won’t get tied up in messy legal proceedings. When financing finally returns to the beaten-down sector, lenders should demand more concrete concessions from borrowers — like more equity and higher interest rates — rather than rely on personal pledges by borrowers to stay out of court.
Like many assumptions cherished during the credit boom — home prices never fall, credit default swaps can cushion the financial system against shocks and securitization helps minimize risk — personal guarantees in the commercial real estate market could turn out to be just as flimsy.

“Bad boy” provisions are intended to protect lenders from the antics of an irresponsible borrower by making someone — usually a principal — personally responsible for the loan. Most loans funded by bond investors and insurance companies are non-recourse, meaning the borrower can walk away without putting his other assets at risk. The guarantees helped lenders sleep better at night since they’re handing over millions, if not billions, of dollars to fund a project, purchase or development.

The types of behavior deemed bad are many, including failing to properly maintain the property, fraud and environmental liability, and of course, bankruptcy.

Lenders hate bankruptcy. They would rather an underwater borrower turn over the keys and foreclose on a property then force creditors into a protracted battle in court. After the savings and loan crisis, lenders started to demand a no-bankruptcy pledge from borrowers in exchange for the non-recourse loan that often carried with it cheaper financing.

The bankruptcy provision, however, doesn’t look so iron-clad anymore.

Take David Lichtenstein and his attempt to dodge a $100 million personal liability he agreed to when buying Extended Stay. Lichtenstein filed for bankruptcy in June, just two years after he bought the hotel chain from Blackstone Group (BX.N: Quote, Profile, Research) for $2 billion. By striking a deal with some of his creditors, Lichtenstein hopes to wiggle out of his bad boy clause.

The bad boy provisions are just one piece of a larger issue of “bankruptcy remote” — that collateral backing the loans and by extension bonds can be sealed off from bankruptcy proceedings.

The bankruptcy of General Growth Properties, one of the nation’s largest REITs, though upended the whole concept of bankruptcy remote — namely that collateral backing commercial real estate loans would be safe from bankruptcy proceedings if it is tucked away in special purpose entity.

There are likely to be other cases as the commercial real estate sector, unlike other areas of the economy, is extremely weak. Not all borrowers will be successful in shirking their personal pledges, and lawyers note that courts have been sticklers in ruling in favor of lenders when it comes to other bad boy guarantees.

But, it could — and should — have a lasting impact on lending terms.

IRS Gives Servicers Flexibility to Modify CMBS Loans

Important update from Commercial Real Estate Direct Staff Report

The Internal Revenue Service has granted servicers of securitized commercial mortgages greater flexibility to extend those loans and otherwise modify their terms.

Effective Wednesday, servicers can extend and change the interest rates and other payment terms on securitized mortgages more than a year in advance of their maturity dates, if they foresee that the loan will not be paid off at maturity.

The IRS revised a rule that had limited servicers from modifying loans that are performing even though the paralyzed debt markets would make it unlikely for the borrower to get the new financing needed to take out the loan at maturity. Doing so would have caused the trusts that own the loans to lose their real estate investment mortgage conduits, or Remic, status, which exempts their entity-level profits from taxes.

Servicers have not been able to modify performing loans until after determining the borrower would be unable to find new financing or other alternatives to avoid defaulting at maturity.
Under the IRS rule that changes Wednesday, that determination has been difficult to reach in time to grant the extension that could avert default.

In its rule change, the IRS noted, "It may be possible to foresee the risk of foreclosure even when no payment default has yet occurred."

In addition to extending securitized loans more than a year in advance of their maturities, the ruling also allows servicers to change loans' interest rates and amortization schedules, and forgive some of their principal payment. It also sets detailed criteria that servicers must meet in determining that a loan requires modifications.

The Real Estate Roundtable had been lobbying for the change since last year, noting the stalled credit markets has significantly reduced borrowers' access to new financing to take out maturing loans. Extending the maturity of securitized loans was not a major concern while debt markets were free-flowing before 2008.

In addition to the obvious benefit to the CMBS market, the IRS change is also a property-sales issue since the additional flexibility should help servicers avoid being forced to foreclose on loans and ultimately offer the loans or the properties backing them at discounted prices.

"This change removes a significant disincentive for the revision of commercial mortgages," said Sam Chandan, head of the New York research firm Real Estate Econometrics. "By reducing the cost of managing distress in mortgage portfolios, the adjustment has the potential to ameliorate outcomes for legacy CMBS, in particular."

The IRS revision does not address another Remic change sought by special servicers - the ability to originate loans from within existing trusts to facilitate the sale of foreclosed properties that had backed loans that were securitized through those deals.

Comments? E-mail John Covaleski or call him at (215) 504-2860, Ext. 208.

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