Wednesday, July 15, 2009

"Pretend and Extend."

There is an interesting article in the website, RetailTraffic, which uses a couple of new but pithy terms:

Wary Of Realizing Losses, Lenders "Pretend and Extend" (7/14)

Jul 14, 2009 1:02 PM, By Elaine Misonzhnik

"Two new phrases have entered the commercial real estate industry lexicon in recent months: "Pretend and extend" and "A rolling loan gathers no loss." Both witticisms describe an ongoing phenomenon in commercial real estate finance: as the level of distress mounts, lenders have been loath to seize properties from troubled borrowers.

Instead, in many cases banks are generously granting extensions or other modifications even in situations where it appears unlikely that borrowers will be able to pay back the loans."

"Pretend and extend" and "A rolling loan gathers no loss."

Obviously, this applies to Bend. I think the commercial overbuilding in Bend (which I have always felt was as big or bigger than the housing bubble) is just now coming home to roost. (Of course, our city council in it's infinite foresight has chosen now to try to sell a couple of big commercial properties....)

There is a couple of years lag in commercial, because of the timing of decisions and planning and building. The big hotel downtown, for instance, will be coming onto the market in November -- good timing, eh?

More from the article:

"What's at work is that lenders are attempting to avoid recognizing writedowns and losses on their commercial real estate loan books. Loans originated at the height of the market were done at near 100 percent loan-to-value ratios and underwritten with generous assumptions on increasing occupancies and rents. But in the past two years commercial real estate values have dropped considerably and fundamentals have weakened. Rents and occupancies are now dropping quickly, not rising. On top of everything, a major source of financing, the commercial mortgage-backed securities (CMBS) market, remains locked down."

As I mentioned a year or so ago, commercial real estate loans all but ceased around January, 2008. What you see being built right now was approved before that.

I think the game that will be played in Bend, from a retail and commercial standpoint, is to wait, to hope for a turnaround, to keep the losses off the books as long as possible....

"Many banks hope that if they stave off foreclosure for a year or two, even if a distressed sale becomes inevitable, they will be able to recover more of their investment than they would if they sold right now. In the case of multi-family or office buildings, that might turn out to be the case, according to Christopher Grey, managing partner with Third Wave Partners, LLC, an El Segundo, Calif.-based advisory firm. But the likelihood of a significant increase in the value of retail properties, in his estimation, remains low.

"The reason is not only do you have extremely negative fundamentals, there’s a tremendous overhang of properties that are distressed and very little investor interest," Grey notes. "Retail is tied to the consumer, which is in a position of long-term damage. People are going to expect income declines [for the foreseeable future], so they will want a very high cap rate."

Sound familiar?

At least Bend got lucky enough to have most of the commercial property either finished or never started. Go visit places like Crescent City, CA, and it looks like they tore down a bunch of buildings in preparation of building new ones and got caught with their pants down and their rubble showing...

"So lenders are playing a waiting game. Foreclosing on assets today means they would have to manage properties in a treacherous economic climate. The alternative would be to sell. But the investment sales scene is not encouraging. Distressed assets are trading at steep discounts to peak market prices..."

Commercial real estate is its own little world; hugely important, but kind of under the radar for most people. The reason I bring up this article is because I believe the phrase "Pretend and extend" probably applies to housing, as well.

Here's where RDC will pop up and tell me banks can't legally hide losses. But, well, I just don't believe that. There are ways and there are ways.

I had a discussion yesterday with a young man who was looking to buy a house. He had put in several bids on short sales and had been turned down.

From what I'm hearing, the whole short sale thing is a big of an illusion. The banks really want to keep these properties, but don't want to take losses on them, and are hoping to pick them up cheap and sell them for more.

I guessing, and I admit it's a guess, that banks like Bank of the Cascades and Umpqua are sitting on a huge load of bad debts they aren't quite acknowledging. Commercial properties they can "Pretend and Extend," and I'm betting that's going on all down the line.

"The question today is how long can this delicate balance hold? In the long term some market observers worry this strategy, employed on a wide scale, might delay the process of price discovery, prolong the freeze in the investment sales market and negatively impact the cash flows for individual properties as they remain in the hands of owners unmotivated to increase their value."

So let's have a big chorus of Whistling Dixie, as we skip past the graveyard with a stiff upper lip and blinders over our eyes and hands over our ears saying, nah, nah, nah while Micheal Jackson sneaks up behind us, eyes glowing and tiny little nose twitching and we feel a cold chill but yell out "I can't hear you!"


RDC said...

I have mentioned in the past that one of the reasons why banks are not in a hurry to foreclose or to otherwise take action is because it forces them to recognize the value and absorb the write downs. As such they will try to delay such recognition and spread out the rates downs.

Bryan Marsal (the person tasked with liquidating Lehman) has basically indicated that there will be three phases:

1. Extend and Pretend
2. Extend and Amend
3. Send (as in capitualte and send in the keys)

We are still in phase I thought may be starting to move into phase II.

Duncan McGeary said...

I suppose in some ways I'm not even panning the "Pretend and extend..." idea.

I certainly used it enough times over the years. In fact, I used the imagery of wearing blinders during the dark debt days of the '90's, hoping that I could just keep playing it out until it turned around and that no one would come lock my doors.

I certainly haven't survived all these years because I never made mistakes or got in trouble.

I survived all these years despite the mistakes and getting in trouble, by bulling through, both working on the problems and ignoring them. Just hanging in there.

Back in the dark days before Marvel's bankruptcy, I used to think, "If they would just quit doing ANYTHING, just quit making stupidly bold dunderheaded choices, they might make it."

You don't want to panic and start making huge choices that are overreactions, and where you don't know the consequences.

I'm keeping faith with Obama, though I wish he had been bolder and I wish I didn't get the sense he's just muddling through.

RDC said...

Bolder ?????

Exactly how. The spending level already done is going to generate a deficit of 2-3 times the largest in history (probably in the range of 1.7 trillion when the previos maximum was in the range of 500 billion). The Fed has already tripled their balance sheet.

Anything bolder and the country will be ham strung by a debt load, as if it is not already that will hamstring growth for decades.

For every dollar of stimulus spent today that adds to the debt one can expect 1.25 in braking effect on the economy at some point in the future.

Duncan McGeary said...

Yeah, bolder.

Bigger stimulus, more money to the states and localities, nationalize the frikken banks, create a civilian conservation corp, shove a good health plan down congress's throat with a 50% majority, windfall profits tax to Goldman's, line up all the bankers and shoot them...that kind of thing.

Jeff said...

"The spending level already done is going to generate a deficit of 2-3 times the largest in history."

I'm not sure RDC's figures are relevant. The most appropriate measure is the share that public debt has of GDP. In 1946 the gross public debt was 121% of GDP. By the 1970s it was in the low 30% range. That should comfort RDC a bit. . . . it is possible to reduce federal debt.

But, of course, back then there was phenomenol economic growth: rapid industrialization driven by new technologies and cheap energy (oil). This allowed us to pay down debts.

What will be our future source of economic growth? I'd put my money on biotechnology, nanotechnology, etc.

RDC said...

At that time the US had a positive balance of trade and the national debt could be funded out of the savings rate of US citizens (basically it was funded by the sale of war bonds to citizens). Neither of those are the case today. The balance of trade is steeply negative and we are dependent upon other countries to fund the debt.

Not anywhere close to the WWII situation.