CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

There’s a lot of talk these days about the growth of a shadow banking market. Shadow is right! The growth of the commercial lending market outside of the universe of insured depository institutions and life insurance companies is real and its growth is accelerating, yet it is not easy to discern its size, shape and taxonomy. The shadow banking market, which simply means the community of lenders outside of the bank and lifeco cadres, is a logical response to a worldwide tsunami of regulatory activity designed to constrain innumerable facets of financial institutions’ operations which often seems more about retribution than the safety, soundness or integrity of the financial markets life.

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As we have discussed numerous times in this blog (here, here, here and here), the downturn in the commercial real estate market resulted in much litigation as to guarantor liability for non-recourse debt. As a brief refresher, many of the non-recourse loans made during the CMBS boom included an agreement that, in an event of default, the lender would only exercise remedies against the property securing the loan and not against the borrower (or its principals or sponsors), with an exception for certain borrower “bad-acts” (such as misappropriation of rents, fraud, and in certain instances, borrower bankruptcy or insolvency). In the event the borrower perpetuated any of these bad acts, the guarantor agreed to be liable either for the losses incurred by the lender, or for the full amount of the loan, depending on the bad act committed.

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I was entertaining myself early this morning by looking over a joint agency report just released entitled “An Analysis of the Impact of the Commercial Real Estate Concentration Guidance”. This report summarizes the performance of bank CRE portfolios following the issuance of interagency guidance in 2006 entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices”. Everyone will be shocked, shocked to know that through the course of the worst recession in post-war history, banks lost money because of commercial real estate exposure and many smaller and regional banks went casters up. Well, there’s startling news. We taxpayers pay for this sort of thing. Where is the sequester when we really need it?

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Terrorism insurance has been boring for the past several years. It risks becoming not boring. In the lee of the terrorism attack of 9/11, the Terrorism Risk Insurance Act, or TRIA, was rapidly passed by the Congress and signed by the President. TRIA provided a federal backstop for private terrorism insurance responding to the unwillingness of the private insurance market to provide meaningful terrorism insurance in light of the unpredictability of the risk and, therefore, perceived inability to price the insurance. TRIA was initially passed in November 2002 and reauthorized in 2005 and 2007. It expires on December 31, 2014. An extension is far from certain.

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Last month, Federal District Court Judge Milton I. Shadur (a long-time Federal Judge and something of a legal legend in Illinois) held a guarantor liable for a deficiency claim brought in connection with a Georgia foreclosure - notwithstanding the fact that the deficiency could not be pursued under Georgia law. The case – Inland Mortgage Capital Corporation v. Chivas Retail Partners, LLC, et. al., Case No. 1:11-CV-06482 (N.D. Ill. 2012) – arose in connection with a defaulted construction loan relating to a retail shopping center outside of Atlanta and is the latest in a series of decisions shaping the legal landscape for guarantors of real estate loans.

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Do your mortgages in Indiana expressly state the maturity date of the secured obligation? If not, you better take action, quickly -- especially for any mortgage loan that has been outstanding for at least 10 years. Earlier this year, the Indiana legislature enacted certain amendments to current Indiana law that may affect the duration of your mortgage liens. The impact of these amendments is to shorten the effectiveness of a mortgage lien on a recorded mortgage from 20 years to 10 years where the mortgage fails to state the maturity date. The amendments take effect July 1, 2012 and will apply to residential and commercial mortgages. Alarmingly, however, the amendments will even apply retroactively to mortgages recorded prior to July 1, 2012 which do not expressly state a maturity date.

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Rialto Capital – Series 2012-LT1 is a done deal. It represents a huge innovation in commercial real estate structured finance. This is the first liquidating trust vehicle successfully securitized in the United States since the famous RTC N Series and its progeny of the mid-1990s. Briefly, the transaction involved the pooling of sub-performing, non-performing and REO assets pursuant to a plan to liquidate the assets in a measured but reasonably expeditious fashion. The sponsor holds the equity and a single class of debt was sold to investors. The deal has closed; the sponsor has stable, predictable match term financing.   Bond buyers got a transparent and robust structure with strong subordination, management and downside protection. A powerful new tool has been provided to the commercial mortgage finance industry.

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A few weeks ago Crunched Credit previewed a (now enacted) bit of Michigan legislation entitled the “Nonrecourse Mortgage Loan Act”, which, in fewer than 800 words, seeks to ringfence recourse guarantors’ assets from attack in connection with the enforcement of post-closing solvency covenants. The legislation was signed by Governor Rick Snyder in the wake of two controversial Michigan decisions regarding the non-recourse nature of mortgage loans. The Cherryland/Chesterfield decisions garnered two opposing, but equally reasonable, reactions amongst industry folk. The first saw the claim for deficiency as mere sophistry – the enforcement of a loan that was non-recourse only to the extent it was repaid (i.e. “that can’t possibly mean what it says”). The second saw a simple contract case – the imposition of contractual recourse liability for violation of SPE covenants pursuant to contracts that imposed recourse liability for violations of SPE covenants (i.e. “words matter”). A majority of Great Lakes State politicians apparently find themselves in the first camp. This Bay Stater tends to find himself in the second.

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Well, that didn’t take long . . . Flashback to last month, when we highlighted two eye-opening judicial decisions from Michigan that could potentially have a dramatic and costly impact for recourse guarantors of many CMBS loans.  The Cherryland and Chesterfield cases provoked widespread feelings of uncertainty and unease, as well as the belief that the courts had sacrificed the parties’ (and perhaps the entire industry’s) intent in exchange for a strict reading of the loan documents.  Despite the supposedly nonrecourse nature of the loans at issue, guarantors were faced with the possibility that they could be stuck with a whole lot of personal liability, simply because of a borrower’s inability to pay back its loan when due.  If upheld and looked to as persuasive authority in other jurisdictions, some believed the Michigan cases could run a wrecking ball through the foundation of American real estate finance.

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That great whooshing sound you heard a few weeks back may have been the air being sucked out of the room for thousands of warm bodies that penned recourse guaranties on (now) underwater loans during the market’s run-up. The cause: two recent cases coming out of Michigan (Wells Fargo Bank, NA v. Cherryland Mall and  51382 Gratiot Avenue Holdings v. Chesterfield Dev. Co.) sticking recourse guarantors with deficiency judgments on heretofore non-recourse loans based on the interplay of two fundamental tenets of CMBS lending – “bad boy” carve-outs and single purpose entity covenants.

Non-recourse lending is a lynchpin of American real estate finance. The lender is limited in the exercise of its remedies upon default to the collateral – for all intents and purposes, the Borrower gets a check at origination and a put at maturity should things go south. But there are limits – carve outs for fraud, selling the property, stealing rents, filing bankruptcy and other naughtiness will give the lender the right to look to the guarantor to make good on the loan.
 

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Returning from a Labor Day weekend spent cleaning up after Irene, here are some notes as I clean out the desk drawer of Summer 2011: 

• I spent the first week of August with my family on Martha’s Vineyard as the Dow Jones lost 1000 points, bond spreads blew out, securitized lending ground to a halt and the United States lost its triple-A credit rating. Past that, it seems the market held things together pretty well in my absence.
• Not altogether unsurprising, but still notable that during the trading days following the U.S. downgrade, treasury yields decreased, leaving some doomsday investors scratching their heads. Of course, the thing about betting on the end of the world is that you can only be right once.
• The third week of August saw the release of almost simultaneous reports that residential mortgage interest rates hit all-time lows and residential mortgage applications hit 15-year lows.
• Meanwhile, the FHFA is suing 17 or so of the nation’s largest banks for billions in losses incurred during pre-bubble subprime securitizations. Many analysts are asking when (if?) the U.S. will stop punishing banks.

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This might not be man bites dog news, but in the structured finance world, it ranks pretty close. A U.S. bankruptcy court has ruled that a borrower can agree not to file bankruptcy.

It all starts with the development of a high-end condo project in Aspen, Colorado called Dancing Bear Aspen.

In December 2010, the Tenth Circuit Bankruptcy Appellate Panel affirmed a Colorado bankruptcy court order granting a motion to dismiss a bankruptcy petition filed on behalf of DB Capital Holdings, LLC (the “Debtor”) which developed Dancing Bear Aspen. The Court affirmed the lower court’s finding that the Debtor’s LLC Operating Agreement expressly barred the Debtor from filing for bankruptcy.

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Early last decade, two Dechert partners, Tim Stafford and Dave Forti, published Mezzanine Debt: Suggested Standard Form of Intercreditor Agreement (pdf) in CMBS World. The article proposed a standard form of mortgage-mezzanine intercreditor that provided a portion of the bedrock upon which the architecture of CRE mezzanine lending would be built for the years to follow. At the time of its publication, burgeoning demand for mezzanine debt (and mezz lenders' desire to create liquidity in their positions) had created a tension among mezz lenders, bond investors and rating agencies - the absence of a form ICA resulted in mezz debt being an inconsistent and pricey financing alternative. The CMSA (now CREFC) form ICA made mezz lending more predictable, less expensive and easier to trade. 

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