The Real Deal New York

A comeback for “unrecognized” loans?

Negative pledge financing, popular during the boom, is now creeping back into the high-end residential market — albeit slowly

June 01, 2012
By Katherine Clarke

Record-low interest rates have caused mortgage application volume to skyrocket across the U.S. recently. But in the drawing rooms of white-glove Park Avenue co-ops, that means very little.

The city’s priciest co-ops have long restricted the use of mortgages to purchase apartments in their buildings, requiring buyers to plunk down a high percentage, if not all, of the purchase price in cash.

But now, after all but disappearing in the wake of the credit crisis, negative-pledge loans — mortgages specially structured to allow the borrower to finance what looks like an all-cash deal without the knowledge or approval of the board — are slowly being seen in the market again.

The loans, which were popular during the 1990s and early aughts, are completely legal and only violate contracts with the co-op board. And they are an attractive proposition for wealthy buyers who don’t want to unload a vast amount of cash into real estate, preferring to invest in the stock market or other assets.

Some mortgage brokers say they are starting to see an uptick in demand for the loans, which are also called “unrecognized loans,” prompted by low interest rates and the recovering economy.

“I just had a phone call about one the other day,” said Rolan Shnayder, director of new development lending at the mortgage bank H.O.M.E. “It was the first call I’d received about it in a long time. The person saw that rates were so low and wanted to take equity out of his property and invest it.”

Shnayder said he is now in the process of helping the client secure a negative-pledge loan for the deal, which is a refinancing at an Upper East Side co-op.

Still, the environment for these loans — which are not recognized by building boards, but which still use the property as collateral — was significantly altered during the downturn.

Not only did banks tighten their lending restrictions, but high-end buildings — some of which knew about the practice but were turning a blind eye to it — clamped down for fear that the borrower would end up in foreclosure, which would damage the reputation of the building. Such an instance notoriously surfaced last year, when it was revealed that high-profile developer Kent Swig took out two loans on a unit he owned at the exclusive co-op 740 Park Avenue, an all-cash building. In August 2011, Bank of America sued Swig over an unpaid loan at the property.

Blind eye during boom

And while some brokers say they are seeing more unrecognized loans, they are still nowhere near their boom-time popularity.

Mortgage broker Alan Goldberg, CEO of Welkin Capital Group, said he now receives one or two inquiries about them per month, compared with 10 to 15 before the 2008 financial crisis. Still, that’s an increase over the number of calls he was getting during the recession, which was zero.

And there are currently only two or three New York City banks that offer unrecognized loans, compared to approximately 10 during the boom, he said. Goldberg declined to specify the banks for fear of giving away his secrets, but other sources said Citibank and Bank of New York have been known to issue them.

Besides 740 Park Avenue (the building where Jacqueline Kennedy Onassis grew up), brokers said other all-cash Manhattan buildings include the pricey white-glove co-ops 2 East 67th Street as well as several Fifth Avenue buildings at the 812, 1030, 998, 834 and 1020 addresses. Buildings such as 1125 Park Avenue, 50 Sutton Place South and 1185 Park Avenue, meanwhile, only allow financing up to 50 percent of the sale price.

Buildings such as these don’t want to face the threat of foreclosure that can come if a borrower fails to make good on loan payments. “Co-ops don’t want that kind of encumbrance or lien against their property,” Goldberg said.

And of course, they want to ensure that those who buy in their buildings can do so with financial ease.

“They only want legitimately rich people,” explained Michael Gross, author of “740 Park: The Story of the World’s Richest Apartment Building.”

But those rich people don’t always want to put their money into real estate.

During the boom, co-op boards likely knew the loans were issued to their shareholders; after all, mortgage documents are public record. But as the loans gained popularity, board members often looked the other way, brokers said. The building’s management company — and even buyers’ brokers — were often unaware of the loans, however.

Last year, press reports suggested that Brown Harris Stevens’s building management arm had been aware of Swig’s loan at 740 Park and had allowed it because Swig is part owner of the brokerage. In response, BHS told the New York Observer that the firm had no knowledge “of any borrowings regarding the Swig apartment prior to Bank of America’s initiation of collection proceedings in 2011.”

The statement continued: “The suggestion that Brown Harris Stevens would somehow violate the rules of a building it manages, and thus its fiduciary duties, in order to accommodate a principal is absolutely untrue and very damaging to Brown Harris Stevens’ nearly 140-year-old-sterling reputation.”

Recognizing unrecognized loans

During the recession, meanwhile, some boards began insisting that buyers have cash reserves on hand equal to the price of the apartment. Others began requiring prospective buyers to sign an affidavit swearing they had not obtained financing for the purchase.

Banks, in turn, tightened up their requirements. Some banks that did negative-pledge loans in the past now refuse to lend without a recognition agreement from the co-op board for at least some part of the loan. These recognition agreements ensure that the bank has a valid lien against the property if the borrower defaults, lowering its exposure.
“The banks want to make sure that [at least a part of their loan] is recorded,” Goldberg said. “A negative-pledge loan [in an all-cash situation] is essentially a personal loan. There’s really no security for that loan.”

Michele Kleier, president and chairman of residential brokerage Gumley Haft Kleier, said while she regularly saw unrecognized loans in the past, she has not seen them reappear today.

“If my clients are getting them, they’re not telling me,” she said.

Neil Garfinkel, an attorney and legal counsel for the Real Estate Board of New York, also said he has not seen “an unrecognized loan in a long, long time.”

“Lenders are just being more careful about who they’re lending to,” he said.

Yet some mortgage brokers said low interest rates have piqued borrowers’ interest in these loans, though buyers and banks alike are still cautious about them.

Shnayder’s client, for example, inquired about a negative-pledge loan, but was still hesitant about the practice and wanted to make sure his mortgage would not come with a pre-payment penalty. That way if he changed his mind, he could pay back the entire balance at once without incurring additional fees, Shnayder said.

Richard Martin, vice president of Gibraltar Private Bank & Trust, said the bank recently began gearing up to begin reissuing negative-pledge loans for the first time in three years, though the program is currently on hold pending a legal opinion.

“The market’s improving, and we feel the demand [for unrecognized loans] is still there,” Martin said. “We feel more comfortable with them than we did when the market was at its low point.”