News Analysis
Auction action
Innkeepers case underlines CMBS creditors' protections
The conclusion of the Innkeepers case will be very different from the onerous cramdown initially proposed under its Chapter 11 filing, thanks to the result of the 2 May bankruptcy auction. While the episode emphasises the growing risk of CMBS investors becoming entangled in bankruptcies, it also demonstrates that CMBS creditors have strong protections even in Chapter 11 scenarios.
"One observation from recent court rulings in StuyTown, GGP and Innkeepers is that the mortgage holders and securitised trusts get strong protections even in bankruptcy court," confirms Malay Bansal, md at CapitalFusion Partners.
He points out that changes have been made to the documentation in new transactions that lower the risk of becoming embroiled in a Chapter 11 case. "Newer loans address issues raised by the GGP bankruptcy by including additional provisions, such as: requiring directors to be experienced and employees of firms that provide independent directors; requiring borrowers to provide lenders with at least 30 days notice before replacing an independent director; and requiring stricter cash management and hard-lock boxes. Still, bankruptcy risk cannot be completely ruled out, even in new CMBS."
However, a positive factor in the Innkeepers case was the auction, according to Bansal, because multiple bids - which are often required in CMBS documents - allow the true value of an asset to emerge. It also resulted in a significant overbid, which should reduce the losses for the associated CMBS.
A Cerberus Capital Management/Chatham Lodging Trust joint venture won the auction with a US$1.125bn offer, compared to the US$970.7m opening bid by Lehman Ali and Five Mile Capital Partners. The auction was for 64 of Innkeepers' 72 hotels, which secure a US$825.4m mortgage securitised in LBUBS 2007-C6 and LBUBS 2007-C7. Chatham also won a separate bid for five of the other properties - three Residence Inn hotels, Doubletree in DC and Homewood Suites - for US$195m.
It is not yet clear what the ultimate principal reduction on the mortgage will be. But the reduction will be less than the US$275m proposed on Innkeepers' filing date back in July 2010 or the US$203m reduction proposed in the Lehman/Five Mile opening bid.
MBS analysts at Citi suggest that a principal reduction of around US$79m could be expected, judging from court documents. They note that the allocation of the overbid proceeds involves a two-step process, the first of which involves an allocation percentage based on how much greater the overbid is compared to the US$970.7m opening bid. As a US$100m overbid is 10.3% greater than the opening bid, the fixed-rate mortgage receives a US$64.1m allocation in the first step.
The court documents lay out the allocation rules under the second step less clearly, according to the Citi analysts. The language may leave some room for interpretation or court's judgment, but it is likely that the fixed-rate mortgage would get 70.2% of the remaining allocation. Whatever the ultimate result, the AM tranches of both LBUBS deals aren't expected to experience any principal losses.
Away from the auction, the Innkeepers case has other implications for CMBS investors. Given the precedent set by the inclusion of CMBS loans in the GGP bankruptcy, for example, Midland - the special servicer on the two LBUBS deals - did not argue against inclusion of loans in bankruptcy. Its arguments were focused more on adequate protection and other terms impacting treatment of the trust during the bankruptcy process.
Another positive outcome from recent precedents set by Innkeepers and other cases is that courts have been supportive of maintaining the structure of CMBS and upholding the enforcement of provisions in PSAs and other documents. Bansal explains: "For example, Midland was successful in preventing Appaloosa Management from becoming a 'party in interest' - in other words from letting it have a say in the decision-making on the basis that it owns bonds. This is true to the concept of CMBS in that the trustee and servicer speak for investors, not any single individual investor."
Motivations for CMBS borrowers to file for bankruptcy are to avoid being foreclosed and to achieve leverage in negotiations with the special servicer on loan modifications. The risk for CMBS lenders, especially in legacy deals, is cramdown or forced principal reduction. But a CMBS loan can end up in bankruptcy, even if the borrower does not file for bankruptcy - as happened in the case of the CNL Resort loan, which was driven by the mezzanine holders.
Nevertheless, Bansal says that - from the outcomes of the cases so far - it seems servicers have done a good job of representing CMBS trusts as a whole in court and obtaining results that are probably no worse than could have been expected without a bankruptcy filing. He indicates that in the Innkeepers case the auction process will likely result in a recovery of about 88% - better than the 75% recovery in the Five Mile/Lehman plan and the 67% recovery in the original proposal from Innkeepers.
Bansal suggests that some small differences can be expected in future bankruptcies involving CMBS, but - given that the market has seen a number of cases being resolved - precedents have been set. "Every case may have its own twist, but the main take-away is that - even though it introduces uncertainty - creditors in CMBS do have strong protections even in Chapter 11 cases."
16/05/2011 13:05:13
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