CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

To be clear, this is a financing tool, not a sales tool. Depending, of course, on the depths of ugliness in the pool, this is 35-55% leverage with a sponsor holding the risk piece. Nonetheless, it is peerless, durationally matched leverage that is terrifically useful for buyers of the distressed debt inventory. As the holders of non- and underperforming debt have increasingly fessed up to their marks, we’re now at a point where these transactions can be done without creating massive capital charge problems for the banks and other financial institutions holding this paper.

These structures are designed to allow an active, dynamic manager to liquidate a portfolio of loans, hence: liquidating trusts. The manager anticipates selling and resolving all of these loans and reducing them to cash in a finite and relatively short period of time. The ratings models work off individual business plans for each loan, taking into account current period income, liquidation proceeds and haircutting the bankers’ views both on the level of achievable proceeds and the time required to resolve the assets. 

But these are not easy deals and we haven’t found the magic bullet to make them easy. First, these are management intensive transactions that are dependent upon the investors’ confidence in the quality and performance capabilities of the manager. Second, the quality of data available on seasoned non- or under-performing loans tends to be a bit dodgy, and that impacts the quality of disclosure and the difficulty of delivering high quality information to manager and investor. Finally, and most frustrating, is what needs to be done to achieve tax transparency. The assets typically can’t be subjected to a REMIC election because they’re not performing. For reasons, which for the life of me I cannot fathom, our Internal Revenue Code punishes pools of mortgage loans with corporate level taxation. Why are mortgages treated as the bad boys of the financial neighborhood such that they need to be rousted by the tax cop when they gather together on the street corner? The Code doesn’t pick on other asset classes in the same way. It’s inexplicable.

When mortgage loans are pooled, the so-called taxable mortgage pool rules (TMP) apply and these rules make it nigh unto impossible, in many cases, to issue more than one time-tranched class of debt. Therefore, these vehicles tend to be somewhat inefficient with only one class of equity and one class of debt. Seriously better pricing could be obtained if the debt could be both credit- and time-tranched like in most other structured finance products. Now there are ways around these problems, but none of these fixes work terribly well. So, for instance, if the loans are really bad, so that a large enough portion can be treated effectively as equity interests in the underlying collateral rather than as mortgage loans for tax purposes, you may be OK. If somehow you can be sure the loans will all be liquidated in 3 years, you may be OK. If the vehicle can be structured as a Qualified REIT Subsidiary (although watch out for dealer income that is bad REIT income in a liquidation strategy), or if the structure is entirely offshore, the TMP problems can be avoided. Each of these fixes, though, has, shall we say, material negative externalities which limit their use.

With all that said, this structure is very useful in the right situation. It’s going to be used, and it’s going to be used extensively in 2012. It is a way to move assets that one party does not want, or cannot hold, into the hands of those who want the exposure. It’s a way to tidy up the balance sheets for financial institutions, create market velocity, move risk to investors who want it and set the table for more capital creation.

Now that’s a good news story.

By: Rick Jones

The story of Bay Colony, distressed-debt case study, begins with Beacon Capital Partners purchasing the property in 2005 for $272.5 million. (You’ll note this week's price was a 33% discount to this figure and see where this is going.) Two years later, the property was acquired as part of Broadway’s buy-out of Beacon (a transaction that included the Hancock Tower, itself a distressed-debt story covered here). The deal was completed at the height of the market – the buyer leveraging upwards of $450 million on an increasing rental stream that never materialized. Just four months after losing Hancock, with maturity looming and hopelessly underwater, Broadway turned the keys over to its mortgage lender, Lehman Brothers, in July of 2009.

As we all know, and in a twist worthy of good soap opera writing, Lehman was bankrupt by the time it seized the property and was unable to bear the debt-load. Eastern Financial, which itself had obtained a portion of the Broadway mezz package at a discount, foreclosed and succeeded to ownership of Bay Colony. For Eastern, the deal looked like an opportunistic loan-to-own play; until the moribund, jobless recovery saw one 30,000 sq. ft. big-pharma tenant into bankruptcy and caused another (200,000 sq. ft.) to reduce its space by half. Unable to stabilize the property, Eastern turned the keys over the Prudential earlier this year, which took control subject to the $140 million securitized-first that Boston Properties agreed to assume this week.

A staple of American radio and, later, television programming for the better part of the 20th century, the midday serial was conceived by salesmen (soap salesmen - think Proctor & Gamble, Colgate-Palmolive) as a means of entry to the burgeoning post-war middle-class household. And it's leaving us, the victim of myriad cultural phenomena (dual-income households, cable television, the internet, TiVo); and with it, a vaudevillian bridge to a small piece of our past. Absent a catalyst for (a lot) of new jobs and cars to fill the parking spaces at places like Bay Colony, however, the story of distressed real estate will continue to run for years to come.

By Matt Clark.