Picking Up the Pieces (2/5)
Feb 5, 2009 10:45 AM, By Jennifer Popovec
SIDE BAR
One Bad Apple
A single mortgage default can bring down an entire company.
As the credit freeze continues, many retail property owners might be forced into bankruptcy or pushed into giving back properties to lenders because their portfolios are cross-collateralized.
Cross-collateralization has become the real estate industry’s double-edged sword, according to many bankruptcy experts. The concept of cross-collateralization—where several properties are used to guarantee loans for other properties—was initially presented as a solution to make lenders feel more comfortable about lending money.
Essentially, lenders saw cross-collateralization as a way to reduce risk and diversify. And, as long as the borrower didn’t default on the mortgage, cross-collateralization wasn’t a problem. It becomes dangerous when a mortgage goes into default. Lenders have the right not only to foreclosure on the property with the mortgage, but also the properties that collateralize the mortgage.
“If the properties are cross-collateralized, it’s like a house of cards—they all collapse,” says Janis Schiff, section leader for Washington, D.C.–based Holland & Knight’s real estate practice group.
Lakewood, N.J.–based Lightstone Group LLC is one company that has lost assets because of cross-collateralization. In October 2008, the company defaulted on a $141 million loan for Macon Mall in Macon, Ga. The loan was collateralized by the 1.4-million-square-foot mall, as well as the 431,000-square-foot Burlington Mall in Burlington, N.C.
Both malls were turned over to lenders. And, recent reports suggest that another four malls will likely be returned to lenders because Lightstone is in danger of “imminent default” on a $73.6 million mortgage that is cross-collateralized by: Martinsburg Mall in Martinsburg, W. Va.; Mount Berry Square Mall in Rome, Ga.; Shenango Valley Mall in Hermitage, Pa.; and Bradley Square Mall in Cleveland, Tenn.
In Lightstone’s case, foreclosure is the only option because the mortgages are structured in such a way that prevents the company from seeking bankruptcy protection. The mortgages were securitized as commercial mortgage-backed securities (CMBS), and CMBS mortgages are structured as bankruptcy remote vehicles. As such, if a borrower defaults on the mortgage, he has no option but to let the property (and any other properties that collateralize the mortgage) go back to the lender.
Bankruptcy is an option for REITs like General Growth Properties because they usually chose to finance their properties with balance sheet lenders rather than CMBS, experts explain. A REIT could choose to seek bankruptcy protection just for the subsidiary or entity that holds the mortgage, but might be forced to put the parent company and all its subsidiaries into bankruptcy if the parent company guarantees any of the loans.
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