New lender motto: ‘Extend and pretend’

Commercial lenders are facing reality — but not all at once. In addition to reluctance to admit they have bad loans on commercial properties, lenders have been trying to avoid taking large losses in a single quarter, industry experts said.

In many cases, they are holding onto underwater real estate loans not only because they don’t want to accept low-ball offers, but also because they cannot afford the appearance of a large single-quarter loss, said real estate insiders.

Alan Miller, senior director of commercial real estate brokerage Eastern Consolidated, offered a wry phrase to describe lenders extending a loan past its maturity date to keep it from being considered non-performing: “extend and pretend.”

That’s a riff on the popular leasing jargon “blend and extend,” which refers to common renewal strategy with leases with a few years remaining.

Also, since banks are wary of reporting large writedowns in a single quarter, they are instead marking properties down little by little, with the expectation that by this fall or next spring the loans will finally be marked down to true market values, said Peter Hauspurg, Eastern Consolidated’s chairman and CEO.

At that point they can be sold without a large hit to the bank’s quarterly report, or may even be able to be sold at a profit.

“A lot of times [with] that kind of writedown, a bank may not be able to take it that quarter because it will kill their numbers,” said Hauspurg, who also is a board member of the mortgage review committee of Buffalo-based M&T Bank, referring to a bank’s quarterly profit report.

“So they chip away a little at it each quarter until you are finally at the quarter when you are at the market level.”

He expected a flood of sales starting in 2010, in part because the values will have been written down significantly by then.

Hauspurg used 475 Fifth Avenue as an example of a lender appearing reluctant to sell after taking over the loan. A division of Barclays Capital lent $157 million to developer Moinian Group and investors Westbrook Partners to buy the building, but in March it was reported it would take back the property in a deed in lieu of foreclosure.

Hauspurg said it was unlikely Barclays would sell the property because they could get only about $60 million in today’s market, forcing them to write down nearly $100 million at once.

“That is a huge hit that Barclays may not want to take in one quarter,” Hauspurg said.

A spokesman for Barclays declined to comment for this article.

Blackrock announced last month that it would purchase Barclays for $13.5 billion. Banks do not want to be caught selling too cheaply either, Hauspurg noted.

In fact, some banks are asking why they should sell now and let others reap profits when they can just hold the loan until the market recovers.

“Why sell and take a writedown? [Banks] will just hold” the loans, said Andrew Jagoda, a partner at law firm Katten Muchin Rosenman.

“Instead of dumping them, they will foreclose. We are doing a bunch of foreclosures.”

Once a loan is sold, the sale price of the note is deducted from the original value, and the difference is deducted from the bank’s capital account, said Jagoda.

So a loss is not only charged against earnings, hurting profit numbers, but it also thins the bank’s capital account — and federal banking guidelines require banks to maintain a certain amount of capital in relation to their loans.

“So that [the loss] is deducted from the capital they raised and the earnings they haven’t paid out to shareholders, which is additional capital,” Jagoda said. Meanwhile, regulators are looking to make sure banks maintain capital levels, he added.

Leonard Boxer, a partner and chairman of the real estate practice at Stroock & Stroock & Lavan, said in the last downturn, lenders profited mightily after writing down loans and then selling them at prices higher than the written-down valuation.

“If they have taken the writedowns already, they can make a deal — hopefully — at the amount they have written it down to and probably in excess of that amount the following year, and they can make a profit,” he said.

Banks also view the financial strength of their own assets differently from assets of other lenders, said Patrick O’Malley, managing director for capital markets at DTZ Rockwood, a real estate finance firm.

“One bank will say, ‘Our portfolio is fine but XYZ [lender] has a problem.’ But then when you ask XYZ, they say, ‘No, we are fine, but ABC has a problem,'” he said.