Special Servicing: How Likely Are Loan Extensions Today?
- Jan 21, 2013
Beware. Rather than “extend and pretend,” special servicers and bank asset recovery groups may have no qualms today about moving to take back underwater properties if they do not see satisfactorily improved circumstances in future.
“Where the property is fully leased but it was over-levered to begin with or because the rents have dropped and there really is no near-term prospect for the rents to rise, we will liquidate, as the situation will not get any better than it is today. There is no reason to (extend the loan),” explained E.J. Burke, executive vice president & group head of KeyBank Real Estate Capital and Corporate Banking Services. Burke was referring to CMBS loans under special servicing.
CPE spoke to leading servicers KeyBank and Berkadia about their views on underwater, delinquent and other problem loans today. Both Berkadia and KeyBank are primary, master and special servicers of CMBS loans. The Mortgage Bankers Association has ranked Berkadia as the nation’s third-largest primary and master servicer, while KeyBank is the fifth largest. As a bank, KeyBank also handles delinquent and other problem commercial real estate loans through its asset recovery group.
As a special servicer, Berkadia is “extending fewer loans today than we did one year ago,” noted Hugh Frater, its CEO. “(Its) extensions—actually, forbearances—are usually just six months.” Of course, that could be because loans are more likely to be resolved, given the lower interest-rate environment and greater capital availability. “The need to extend today is a little less important since more new capital is available,” said Frater, adding that “we want to keep the borrower focused on our refi.”
As some special servicing consultants advise, the borrower’s ability to bring new capital to the table, along with a viable plan of action, may often be a key determinant as to whether an underwater loan will receive an extension. “Our willingness to extend is commensurate with the borrower’s willingness to commit something to the deal—principal paydown, additional reserves, deferred management fees, et cetera,” confirmed Frater. “If the borrower doesn’t have a plan, or the experience to accomplish a plan, we will usually go ahead with the foreclosure—get it over with.”
Burke explained that, typically, when a loan goes to KeyBank special servicing—especially if it is office, retail or industrial—the property has lost a tenant, and there is a need for capital to be injected in order to attract new tenants. In such cases, he said, KeyBank will work with borrowers “if new capital is brought to the table and set aside for tenant improvements or leasing commissions, and you can see where ultimately the borrower can get to a point where they can pay you back.“
As for bank loans that have landed in the bank’s asset recovery unit, a first test of whether to extend an underwater loan that is underperforming in rent is whether the bank can earn “a market rate of return” on the extension. If that is possible and the appraiser believes that the property can be stabilized at a higher value “within a reasonable period of time,” and the borrower will put in fresh capital, “we can then work with them to see if we can get from point A to point B.”
On the other hand, if the property is already fully leased at maximum rent, and it is still under water, the bank may be unlikely to “extend and pretend.” “Those are the circumstances where you say just by waiting, we are not going to improve anything for the bank,” said Burke.
Burke explained that as special servicer KeyBank can engage in a variety of different workout strategies, depending on which strategies yield the highest net present value on behalf of the CMBS trust that owns the loan. “We have done some amendments or extensions. We also have had note sales, and we have also foreclosed. Typically, it is a net present value exercise where we can work with the borrower and we have expectations for certain cash flow to the trust, and if, adjusted for time and risk, it is the best thing to do, we will do it. If, on the other hand, the borrower’s proposal comes up short on a present value basis compared to selling the note or liquidating the real estate, we will go that route.”
With property values improving and interest rates lower than ever, loans may well have a better chance of successful refinancing today. At the same time, it is said that banks and special servicers may be less likely to extend and pretend. One reason is that banks’ balance sheets are in a stronger position and the banks can therefore better afford to take losses on their balance sheets. Another is that they may be more willing to sell the asset because asset values are higher today.
Indeed, Burke objects to the phrase “extend and pretend,” noting, “To me, it is very deceiving.” He suggested that on the bank side, it is not as though there was an indiscriminate extension of loans or a lot of extended loans are still sitting on the books. The level of construction loans held by the top 25 banks in the United States today is less than half of what it was in 2007. That means the loans are either paying off or being liquidated, he pointed out.
Banks were continually receiving offers to sell their loans during the recession, and in many cases, they accepted the offers. “In 2008, I would get literally almost every day a phone call from someone who would say, ‘I raised a fund to buy distressed debt and I want to help you,’ ” said Burke. “What we, and I think a lot of banks, have been doing is, where they get an offer that makes sense, we’ll hit it.” Extend and pretend notwithstanding, Burke said that KeyBank has already liquidated a lot of its portfolio through note sales. “We don’t have a lot left. The level of assets that are managed in our asset recovery group is a fraction of what it once was.”
Burke emphasized that loans were extended only in cases when it made sense. “Where we believe we had a loss, we took it. Where we believe we are better off liquidating, we did it. But there are many cases where a borrower’s loan would come due, they had cash flow, they had a willingness to pay us and they paid us a market rate of return, and we would extend and then eventually they would refinance. If that is extending and pretending, what is wrong with that, right? We are a bank, and we are supposed to lend money.”
In the end, extend and pretend has proven to be beneficial to the lenders, if not also the borrowers. It may have been a win-win strategy that does not deserve the negative connotations of bad loans being held on the balance sheet. “Extend and pretend (has gotten) a bad rap,” said Frater. “If lenders had foreclosed on all the defaults in 2008, 2009 and 2010, they would have suffered unnecessary losses.” Loans were extended in many cases during those years because there was no capital to fund maturities of CMBS and construction loans, said Frater.
“If loans were foreclosed, the lender was likely anxious to sell the REO. Without loans to facilitate, buyers were left to find their own financing, which was rarely more than 60 percent LTV. So recoveries were often further depressed and lenders took bigger losses. Extend and pretend allowed the borrowers and lenders some time for the real estate and debt markets to improve. We chose to extend deals with borrowers (who were) willing to make partial payments or be ‘worthy caretakers.’ As it turns out, extend and pretend wasn’t such a bad thing,” said Frater.
A Q&A with financiers on the availability of capital and other issues today is part of CPE’s February 2013 Special Finance Issue.