Loan Extensions: Bridge to Nowhere?

by: Jeffrey Bernstein
"Hope is not an exit strategy"
Stacey Berger CMBS special servicer 2009

Stalling tactics! Everywhere I look I see them. The Fed accepts shakier and shakier assets as loan collateral, mortgage forbearance programs and, increasingly, bank loan extensions. In fact, the whole TARP/TALF/PPIP monstrosity embodies it.

The supposition behind all of this activity is that asset values are, somehow, temporarily depressed, true fundamentals are much better than what markets are giving them credit for and ......if we just give everyone a little time, things will work themselves out. Unfortunately, we continue to see evidence that the markets have things more wrong than right. Are there some securities that are oversold? Certainly. All you need to look at is the big bouncebacks we are seeing across markets to know certain parts of the market got oversold, yet the breadth of problems related to excessive use of leverage worldwide continues to surprise.

As a result of the number of old maids being exposed with each new turn of the cards, creditors are not generally receptive to the idea that they should just give debtors a little more time. We saw this sentiment on display big time in the spectacle of General Growth's bankruptcy last week. Tom Nolan, the President and COO of General Growth, the largest property company bankruptcy in history, told MSNBC that the only reason the firm was declaring bankruptcy was due to the inability to roll forward debt that is maturing. According to General Growth, the firm's malls are very well occupied, the firm's cash flows are strong and it is current on its debts, and he noted "We have not had to materially re-write leases and we don't expect to." You can see the video here. Now I'm not close enough to the General Growth story to argue the veracity of the content of the video or comments above, and lord knows we have seen people in high places put a lot of lipstick on porcine situations as of late, but away from that debate, the bottom line is that the market participants that have a choice are not in a forbearing or rescuing mood.

In contrast, there is a large group of market participants who don't really have a choice. Those are the banks and other highly levered entities that are already sitting on piles of loans that could potentially go bad and they just can't afford to let that happen without blowing up their own balance sheets (our creditors China, Japan and others included.....fortunately). In many cases they don't want back assets they would have to sell into a bad market. They are not in the business of managing businesses or real estate for the long-term, and they may be best served by extending debt for as long as they can and/or submitting to some form of cram down of their principal in a bankruptcy, if it produces a debt structure that can be supported by the company over time. In this way the bank will at least get a better chunk of its money back than if it foreclosed on the asset and tried to manage it and market it.

Loan extensions to companies that participate in the public markets are highly visible and here is a short list of those that have shown up in the news in recent weeks: Borders (BGP), Chipmos (NASDAQ:IMOS), MGM Mirage (NYSE:MGM), Craig Wireless, Park Plaza, Macerich (NYSE:MAC), Hines REIT, OZ Minerals (OTC:OZMLY), Sky Europe, Canwest Global Communications (OTC:CWGVF), and Centro. But I know from my own business that loans are being extended/restructured right and left in the commercial real estate world. I even ran across an article about a school district, which is trying to rejigger its debt due to cash flow problems and difficulties servicing its debt as currently structured. Reasons for banks to extend loans include the inability of developers of new properties to sell them or get a permanent mortgage to pay back a construction loan or the end of an interest-only or interest reserve period where the anticipated repositioning of a property has improved cash flows enough to support the purchase money mortgage.

Now comes some straight talk by William Mack, Chairman of Mack Cali Realty and Chairman of AREA Partners previously (known as Apollo Real Estate Advisors), who told Bloomberg a couple of weeks ago "Landlords who financed purchases with at least 60 percent debt are now dangerously close to zero equity." FYI purchasing with 60 percent debt was seen as conservative in many circles as recently as.....yesterday.

With banks perilously close to having no equity, property owners perilously close to having no equity and a flood of debt coming due and properties likely for sale, it's no wonder that those who do have money to invest are sitting on their wallets. In acknowledgment of some conflicting opinions by wise men, I will mention that Sam Zell told an NYU conference that real estate values are now "below any rational analysis." I will also mention that while there are very few investors as intrepid as hedge fund manager William Ackman, of Pershing Square Management. He has been buying the equity of companies with maturity default risk and even offering debtor in possession financing to the same firms if/when they go chapters, he believes that equity value will be preserved through the bankruptcy process in many cases.

The General Growth bankruptcy does not augur well for the refinancing of $90.5 billion of CMBS debt coming due this year. We will get another datapoint on the market's willingness to forebear with MGM Mirage seeking financing to forestall a potential bankruptcy filing. The complexities of trying to work out a defaulted CMBS loan as well as the daunting schedule of maturities has prompted many to suggest that there will be significant extensions of these loans as opposed to foreclosures. Stacey Berger, executive vice president at Midland Loan Services, a master and special servicing subsidiary of PNC Financial Services Group (NYSE:PNC) explained the process and mindset of CMBS servicers in a recent Financial Times article

Should a mortgage become delinquent, the servicer will transfer the loan to a special servicer, Berger said. The special servicer will take any action that yields the highest recovery for the CMBS bond holders, he added.

Those actions include a modification, a restructuring, or a liquidation of the asset, Berger said. In less dysfunctional markets, resolutions don’t take too long, but because the current commercial real estate market is so challenging, the resolutions have taken much longer, he said.

Those resolutions could include forbearances on defaults or extensions of the mortgage maturities, Berger said. However, forbearances should not be predicated on the hope that the market turns around and financing becomes available again, he said.

“There is a fairly well-known concept: hope is not an exit strategy,” he warned.

Not to fear though, rumors are rampant that an announcement is coming soon regarding the inclusion of commercial real estate assets in the TALF program. Apparently, the $2 Trillion or so of loans coming due by 2012 and the moribund securitization market has impressed those in Washington that something has to be done. Recently, Jeffrey DeBoer President & CEO of the Real Estate Roundtable was quoted in The Real Deal saying; "“we don't expect the CMBS market to come back in its old ways any time soon. So we said we need a credit facility; in other words -- in effect -- a gigantic credit card that would help finance new loans, new originations."

More stalling tactics?