‘Extend and Pretend’ Taken Further

The Wall Street Journal reports on a December court decision that is causing a stir because of the drastic treatment a secured loan was given in a bankruptcy case. The decision, handed down by Judge Eileen W. Hollowell from the U.S. Bankruptcy Court for the District of Arizona, concerns a $207 million securitized loan on a pair of Westin hotels being administered as part of the Transwestern bankruptcy case. The court ordered that the loan be extended 15 years, to 2033, and the principal amount increased by $40 million. The judge also reduced the interest rate to zero. The ruling has resulted in a new level of uncertainty among investors who have not seen such a lengthy extension before. “It’s one of the longest extensions we’ve seen for a CMBS loan,” Richard Hill, a CMBS strategist at RBS Securities, told the Journal. He added that loan extensions typically max out around five years. A servicing document recently made available to bondholders got the attention of Bank of America analysts, who noted this week that the interest rate cut would add to shortfalls in interest payments that are already affecting the two CMBS offerings that include the Westin loan, according to the Journal report. LNR, the servicer for the two CMBS trusts, is trying to appeal the modification. The "extend and pretend" approach to loan modifications has faced criticism in recent months for preventing the real estate market from bottoming out -- which some argue the market must do before it can begin a true recovery -- and for the use of the approach by banks to mask the damage done to their balance sheets by real estate assets that have lost substantial value. The loan extension in the Transwestern case is a bit different because it has been ordered by the bankruptcy court and not implemented by a bank as a strategy to disguise losses. However, the decision comes at a time when the CMBS market has struggled to achieve a sustained recovery, and buyers already wary of diving back into the market could be further spooked by the ruling.