The effects of not selling at fire-sale prices were evident even earlier in the cycle. As a July 2010 article in DAI pointed out, lenders who were selling office buildings at that time were getting significantly better prices than they would have realized a year before. At the time, Kevin Shannon, a vice chairman at CB Richard Ellis who is one of the country's top brokers in the office sales arena, pointed out, "If lenders didn't sell last year, they're looking real smart this year because prices have appreciated substantially. Lenders are being patient and waiting for a better time to sell, and their patience is being rewarded."

Not all assets are created equal, of course, so no amount of extending will help some of them, notes Manny de Zarraga, executive managing director in the Miami office of HFF, who is responsible for the execution and expansion of the firm's debt placement, property investment sales and joint venture equity services. Despite cases where loan extensions did not prevent the eventual loan default, de Zarraga says, "Lenders' efforts to modify and extend loans have more oft en than not proven to be a step toward improving recovery value."

One of the biggest reasons that lenders have been able to extend loans and haven't unleashed a flood of distressed assets at bargain-basement prices is that interest rates have remained low. Obviously, low rates have enabled borrowers to stay current on their loans despite market conditions that have dragged property values below loan balances. "The interest rate environment greatly helps to restructure loans as performing," says de Zarraga, who points out that any dramatic increase in rates would push many more loans into the non-performing category.

Grinis says that the Fed, by creating this leverage-friendly environment, "preserves asset prices and debt service requirements. Our government and our policymakers were correctly counseled to not create a real estate crisis on top of a stock market crisis."

Even with low interest rates, however, a change is on the horizon that could push lenders into writing down a higher percentage of their loans and disposing of them. The change is in the form of new guidance from the Financial Accounting Standards Board regarding troubled debt restructurings. The new FASB guidance won't stop lenders from extending loans, but it is likely to cause them not to extend certain debt that they otherwise might have.

Under the new guidance, as Grinis explains, "When a financial institution modifies an existing borrower's loan, and they change the terms in such a way that a third-party lender would never make that same loan, that is called a troubled debt restructure." The designation "troubled debt restructure" is key, Grinis says, because once a loan falls into the TDR category, it is subject to accounting rules that require it to be written down. The guidance now seems to say, "If no other lender would make this loan, then it is probably a troubled debt restructure."

Grinis provides a hypothetical example: Suppose a big loan is secured by a property that has fallen in value by 25% to 30%, as many properties have. With the decline in values, the loan-to-value ratio has risen to maybe 95%. Previously, a lender might have determined that it didn't need to write that loan down to market value. But since, "There aren't a lot of lenders who will do a 90%-to-95% loan-to value," Grinis says, the lender would be more likely to write it down under the new FASB guidance. The new rules regarding troubled debt restructurings "make you look at that piece of collateral and ask what the real fair value of the underlying asset is and compare that with the loan balance. The new guidance will put more pressure on certain deals, so there will be more write-downs." Once the lenders have written those deals down, they will be more likely to sell them, and at prices closer to what note-buyers are willing to pay.

On the other hand, Grinis and de Zarraga both point out that improving fundamentals have brightened the picture for some borrowers. "For responsible borrowers, there should be improved conditions for loan extensions, whereby improved property performance allows a lender to classify a larger portion of a loan as performing," de Zarraga says. But for poorly capitalized borrowers with highly underperforming assets, he adds, the opportunities for extensions will be fewer.

A primary reason that lenders have been willing to extend loans and have not written them down thus far is the impact of write-downs on their capital structure. While all lenders generally will consider loan modifications and extensions, it's the smaller banks "that can at least afford the capital-reserve requirements for non-performing loans and REO," says de Zarraga.

Grinis adds that the smaller and regional banks also generally have a higher percentage of commercial real estate on their balance sheets than the money center banks. "If you look at commercial real estate as a percentage of the big money center banks' balance sheets, it's important but not nearly as important as it is at the regionals," he says. As a result, "The money center banks generally have been able to take the write-downs, but for the regionals-with their balance sheets having much more exposure to commercial real estate-any write-downs have a much more material impact on their capital."

In the case of smaller banks, Mark Bolour, principal and CEO at Los Angeles- based Bolour Associates, foresees more takeovers of troubled institutions. "Before the takeovers, there is going to be a period when the troubled banks are going to unload assets to raise capital," he says. "There'll be a lot of opportunity when they start that unloading process."

According to a survey that E&Y is preparing, a significant percentage of the industry agrees with Bolour, Grinis and de Zarraga; the opportunities in distress will lie with regional banks and the FDIC as opposed to the large money center banks. Full results of the survey have yet to be tallied, but preliminary findings show that 43% of the marketplace thinks that the opportunity is with regional banks, and 30% is with the FDIC, which has shut down mainly regional banks.

"So 73% of the market believes the opportunities are going to come from regional banks, or regional banks that have been closed by government agencies," Grinis says. "There are opportunities with money center banks, although they will be different than in past cycles." The practice of extending and pretending -or kicking the can down the road, if you prefer a less cynical phrase-has prevented any sort of a wave of distress hitting the market like that of the RTC days. The RTC eventually disappeared when it disposed of most of the troubled assets under its purview, and its duties were transferred to the Savings Association Insurance Fund of the FDIC. When, and whether, extend-and- pretend will disappear remains to be seen. Lenders are always modifying and extending some loans, in good times and bad, but it will be a sign of the recovery when loan modifications and extensions go back to normal and extend-and-pretend plays less of a role.

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