"They are kicking the can down the road, hoping things will be better soon," said Barry Ritholtz, head of the financial research firm FusionIQ and author of the new book "Bailout Nation."
This maneuvering is being called "extend and pretend" in financial circles, reflecting banks' willingness to extend loan maturities because they believe
- or hope- rental rates and building values could come back to levels seen during the peak of the real-estate market in 2007.
Ritholtz and other financial experts worry that banks are just delaying the inevitable by not dealing with troubled loans now. And since commercial loans are such an important part of the portfolio of many small and midsized banks, it also could constrain their ability to make other new loans. An average of 20 percent of local and regional banks' loan exposure is in commercial real estate vs 4 percent for the nation's biggest banks, according to data from Deutsche Bank.
"This is a bad strategy," said Bryan Marsal, CEO of the corporate restructuring firm Alvarez & Marsal. "It is really about not facing up to where you are today."
Unlike fixed-rate home mortgages, most commercial property loans are structured as balloon notes. Borrowers pay only interest for the first five or 10 years until the loans mature, and then the entire amount must be paid back.
In the boom years, rising rents and property values made it easy for borrowers to find multiple lenders willing to roll over these loans into new and often larger principal amounts that allowed owners to take out millions of dollars in cash to buy other properties.
That game has come to a crashing halt. Cash flows are down on many properties as rental and occupancy rates have fallen, causing the value of many properties to drop significantly. That's made it tougher for owners to refinance their loans.
Delinquency rates on commercial loans have doubled in the past year to 7 percent as more companies downsize and retailers close their doors, according to the Federal Reserve.
In some cases, banks are offering a temporary fix by granting borrowers an extension on loan maturities. On paper, that looks like a plus for the bank because the borrower pays a fee or agrees to pay a higher interest rate, or both. This allows banks to avoid having to foreclose or write down these loans as impaired assets. They also can keep the loans on their books as if nothing were amiss.
"This lets the banks post results that are misleading because the loans have more risk to them than they are disclosing," said Len Blum, managing partner at the investment-bank Westwood Capital. "They can pretend things are better than they are."
That's just what banks in Japan did back in the 1990s. After its debt-fed real estate bubble burst, Japan slid into what has come to be known the "lost decade" because of its drawn out economic and financial malaise.
Even though the Japanese government injected trillions of yen into its banking system, new lending was constrained because troubled loans clogged banks' balance sheets. In some cases, banks refused to foreclose when owners couldn't even pay the interest. Instead, they added the unpaid interest to the loan's principal in the hope that borrowers' problems would be alleviated by an improving economic climate, which never materialized.
What's worrisome is the lack of transparency about how often this is happening now in the United States. Due to privacy issues, banks aren't required to disclose details of specific loan extensions, and most news that does trickle out comes from public companies announcing that they have reached accommodations with their lenders.
