CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

Earlier this month, the New York Supreme Court issued a decision upholding the enforceability of a springing recourse guaranty given in connection with a commercial real estate loan that provided for a full "blow-up" upon voluntary bankruptcy. [Author's Note: the decision can still be appealed: New Yorkers tend to call their trial court the "Supreme Court", their supreme court the "Court of Appeals", their front steps the "Stoop" and their minor league team the "Mets".] Most of our readers are, at this point, intimately familiar with the "bad boy" guaranty and the leverage it provides a lender once the loan hits the fan. Conversely, our readers are also keenly aware of the degree to which sponsors were able to erode the scope of recourse carve outs and isolate liability in poorly capitalized shell entities during the go-go years. The most famous example, of course, being GGP’s ability to run an end-around the bad boy guaranty by filing borrowers and gurantors alike into bankruptcy in 2009 – leaving the holders of $ billions of CMBS paper without practical recourse.

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A few weeks ago, I wrote that it was manifest destiny that the CRE CDO would return to the commercial real estate space.  A lot of people took the time to tell me that I was delusional, at best. I thought I would take a moment to return to the topic and try to establish my bona fides as something other than a knave, a fool, or a foolish knave.

Let’s start with the question of need.  Do we really need this?  Portfolio lenders in need of yield and securitization lenders in need of warehouse capacity are in a day-in, day-out search for leverage. The problem, of course, is that almost all leverage available in the commercial market tends to be short term, creating a durational mismatch against the underlying financial assets.  That situation is bad.  That mismatch killed a lot of players last time.  The CRE CDO addresses this problem with durationally matched financing.  It is also blessedly bereft of the repo mark-to-market.

So that’s the need. It’s real.

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It looks like our recap on covered bonds came not a moment too soon. Representatives Scott Garrett (R-NJ) and Carolyn Maloney (D-NY) teamed up this week to co-sponsor the bipartisan H.R. 940 (pdf), the United States Covered Bond Act of 2011. The new bill is much in keeping with the recently distributed discussion draft (examined in a recent Dechert OnPoint (pdf)). Currently, it is in committee before both the House Committees on Financial Services and on Ways and Means.

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Recently, while visiting my in-laws, I took a break from college basketball and the Daytona 500 and caught up on the latest developments in the quest for covered bond legislation in the United States.  Not surprisingly, I quickly found that the quest for covered bond legislation is, well, still a quest.

We have discussed the possibility of covered bond legislation numerous times on this blog (see here, here, here, here, here, here, here and here).  As you may recall, 2010 ushered in optimism for proponents of covered bond legislation, as both the House and Senate at least entertained the possibility.  Representative Scott Garrett (R-NJ), who has long been a strong proponent, led the charge in the 111th Congress pushing a bill out of the House Financial Services Committee and in front of the full House for consideration.  The Senate Banking, Housing and Urban Affairs Committee even went so far as to hold a hearing on the topic.  Despite the attention, the elections and then other distractions took priority, and a lame-duck session came and went without further movement on the topic.  However, the bells ringing in the new year also rung in a new round of this fight, as all interested parties are gearing up for yet another attempt to pass this legislation.

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Near the epicenter of the late unpleasantness was that wonder of complex engineering, the CRE CDO. It has been blamed for near everything that went wrong or was wrong in the commercial real estate space. It probably is responsible for the winters of 2010 and 2011.

The CRE CDO, as it was initially designed, was an on-balance sheet term financing facility which was designed to be free of the vicissitudes of traditional bank warehousing restrictions and, of course, the dread mark to market of the repo market. The transactions were often dynamic and had substantial term, often up to 7 years. Whole loans (as well as other stuff) which met the elaborate and complex (more on this later) eligibility criteria could be financed on a rolling basis with the proceeds from the disposition of assets reinvested for a substantial portion of the term. CRE CDO paper was customarily rated. The average cost of funds was substantially lower than what could be obtained on a straight bank facility. 

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