We’re programmed to believe that lying is bad; telling the truth is good. So two years ago, when the economy was in a tailspin and lenders started employing a strategy disparagingly dubbed “extend and pretend” for struggling commercial property loans, it’s no wonder they got a bad rap.
Critics painted the banks as liars who were doing little more than kicking the can down the road when they gave borrowers extra time to pay their due. By refusing to write down underwater mortgages, they said, banks were only delaying their inevitable losses and masking the true extent of the crisis.
But last month, Moody’s reported that U.S. commercial property prices rose 4.3 percent in September — the largest month-over-month gain in a decade. And as The Real Deal reported, the New York City commercial property sales market has also begun to thaw, with Manhattan building sales volume up 85 percent in the first seven months of 2010, compared with the same period last year.
Of course, the commercial real estate recovery still has a long way to go, but it appears that last year’s apocalyptic predictions were at least somewhat exaggerated. Whatever happened to the proverbial “other shoe” that was supposed to drop?
By many observers’ accounts, it was that oft-derided “extend and pretend” approach — for all of its negative connotations — that has helped prevent economic disaster from striking twice.
For one thing, some analysts say that banks — enabled by the capital they received from government bailouts — prevented a wave of bankruptcies and liquidations that would have resulted from aggressive write-downs.
And in recent months, as credit has become more available, anecdotal evidence suggests that prices for distressed assets have risen, said Matthew Anderson, managing director at Foresight Analytics. For lenders taking back properties from borrowers today, those price increases mean the hit isn’t as damaging as it would have been during the first half of 2009.
“This ‘extend and pretend’ turned out to be a rather wise strategy, especially as it related to New York City, because we’ve seen the most prolific recovery in values out of any other market in the country,” said Dan Fasulo, managing director of Real Capital Analytics. “It’s hard to argue that it hasn’t worked.”
Indeed, some lenders are already starting to see the advantages of waiting out the market.
Speaking on a panel about distressed assets in October, Anglo Irish Bank executive vice president Garrett Thelander described his company — which was nationalized last year amid a souring commercial real estate portfolio and escalating scandal — as “in wind-down mode.” Now facing mounting pressure to raise cash, Anglo has been benefiting from the fact that its New York City investments have begun to rebound in value.
Last month, Anglo completed a foreclosure auction at Yair Levy’s 225 Rector Place and sold the note on a former steel factory in Williamsburg that was once slated for a condo conversion. The bank has also been unloading its debt at Alexico-developed hotels like the Alex, Flatotel and the Mark.
“We’ve already begun to see … a mini, small uptick in banks taking more aggressive action [in selling off debt],” said Dennis Yeskey, a senior advisor specializing in loan workouts in AlixPartners’ New York City office.
In October, Bloomberg News reported that Iron Point Titan Ventures snatched up the distressed $25 million mezzanine loan tied to the W Downtown Hotel & Residences, on which developer Joseph Moinian defaulted last year. As The Real Deal reported, Moinian had been negotiating with special servicer CWCapital Asset Management to work out new loan terms.
But the market remains volatile, so not everyone is ready to call it quits on “extend and pretend.” Since banks aren’t always required to report loan extensions, precise numbers on the popularity of “extend and pretend” are difficult to pin down, but it’s clear the practice is widespread. Foresight Analytics estimates that U.S. banks are currently granting extensions on at least 60 percent of each year’s maturities, which won’t peak until 2013. For smaller banks with particularly high levels of exposure to commercial real estate, extensions may be closer to 100 percent, Anderson said.
Some recent beneficiaries of lenders’ leniency include Moinian, who got his maturing loans at 17 Battery Place North and 180 Maiden Lane restructured early this year, and the Hakimian Organization, which received a two-year extension on its $263 million construction loan at 75 Wall Street from German lender Bayerische Landesbank over the summer.
Critics argue that in the short term, continued extensions of loan maturities means leaving cash-strapped borrowers in charge of buildings they can no longer afford to maintain, while tying up capital that could otherwise be used to make new loans. In the long term, they warn, this could drag down the economy in the same way Japanese banks did when they turned a blind eye to bad real estate loans in the 1990s.
“In one way, it’s a form of providing credit to the market, but it’s sort of an artificial one in the sense that the money is being tied up in specific deals and can’t be made for fresh loans,” Anderson said. “That’s really a factor in zapping transaction volume in the market.”
Still, a sluggish market for new loans may be a small price to pay compared to the alternative, and much of the grumbling is coming from frustrated investors who are disappointed at the lack of discounted inventory that’s up for grabs.
“The ‘pretend’ pejorative came from people who said, ‘I want to buy all this stuff and [banks] are not taking the full hit,'” Yeskey said. “But if they had, we would’ve had another crisis.”