Delaying the moment of truth

August 21, 2009

Procrastination is not a virtue, except when it involves billions of dollars of debt.

A mantra has taken hold of lenders sitting on loan piles: amend and extend. Or as lawyers involved in negotiations between borrowers and lenders say: delay and pray.

The $6.7 trillion U.S. commercial real estate market has been a standout for such tactics and in part explains why, despite the rapid deterioration in property prices and cash flow, delinquencies and defaults so far have been relatively low.

In the smaller but once-powerful leveraged loan market, such tactics have also allowed some companies, many of whom tapped this market to finance some of the biggest leveraged buyouts this decade, to avoid default this year. That’s a good thing because rapid-fire defaults could have kept credit markets clogged for longer and the financial system on precarious footing.

But such tactics just postpone the day of reckoning. They don’t avoid it.

Amend and extend is essentially a short-term deal that allows a company to extend loan maturities that it can’t possibly pay off in the current climate, while it agrees to stiffer terms such as adopting tougher loan covenants and paying higher interest payments.

Though areas of the credit markets are cranking out new debt deals, the leveraged loan market is a shadow of its former self. Collateralized debt obligations, which had accounted for roughly 60 percent of loan demand during the years of LBO madness, have vanished, as have hedge funds that used a healthy amount of leverage to snap up this secured debt.

That has left many companies with little choice but to go back to lenders and ask for more time to pay off debt that saddled many leverage buyout targets with debt ratios well above 6 to 1 — traditionally seen as the do-or-die threshold.

The trouble is, the extensions have dumped many of these companies into the 2012 to 2014 hot zone when competition will be fiercest for refinancing dollars.

Bank of America Merrill Lynch analysts have found that the bulk of loans getting a new lease on life are now slated to mature between 2012 and 2014, when 85 percent of outstanding loans are due to mature.

Yet, the leveraged loan market is unlikely to return to its former glory, given the moribund state of CLOs, so borrowers will have to find the funding elsewhere. The lucky ones this year have found some solace in the high-yield bond market, where they’ve been able to refinance about $40 billion. But there’s a wall of $545 billion of loans coming due between 2012 and 2014, according to Thomson Reuters data. It’s going to take a strong economic recovery to get investors interested in snapping up the debt that needs to be refinanced in addition to the new loans that companies will need to fuel the expansion.

“If the economic recovery is not strong and these companies can’t refinance, you’re going to see an increase in defaults,” said King Penniman, president and high-yield debt analyst at bond research shop KDP Investment Advisors.

So far, markets don’t seem too bothered by the prospect but they should be. Such an overhang could mean the excesses of the credit boom will take much longer to wring out. And the road to recovery will be much longer than investors currently believe.


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It’s also referred to as “extend & pretend”

Posted by StevenKs | Report as abusive

Crane is usually on the money, and much of AC’s analysis is spot on this time, with the exception of the starting assumption. The delinquency rate for mortgages on commercial real estate is running at about 2.5% and, as the WSJ said back in March when the delinquency rate was (just?) 1.8%, these loans “are going sour at an accelerating pace.” A couple of years ago the rate was less than 0.5%. The thrust of Agnes’ argument is right however, property owners will have a very difficult time refunding there mortgages. Recently Calpers walked away from a huge investment in a prominent tower in downtown Portland Oregon. Look for more of the same. We haven’t seen the bottom in the real estate market.

I can follow most reporting on the credit crisis and am interested in what role a decline in the commercial real estate market will play in the recovery from both the financial crash and the recession. So I really wanted to understand this article.

But after reading most sentences twice, and not really understanding the context or jargon, I found it one of the most frustrating, opaque, and useless Reuters articles I’ve ever read. Please continue to report on the commercial real estate market, but do a better job making the subject accessible.

Posted by Chris Chan | Report as abusive

I do not believe America has achieved any credit card reform. I personally do not put much on plastic and have a negligible amount owed. The interest rates from what I can see that the banks charge on their credit cards are actually going up, they are just as difficult to deal with and there are hindering rules for millions of Americans who unfortunately cannot possibly amortize at 20%. We have to standardize at 8% or lower to right these debts. Lets have some compassion for people who made a mistake and fix it so they cannot repeat.

[...] such tactics just postpone the day of reckoning. They don’t avoid it.  To see full Reuters article….click here. This entry was posted in Market News. Bookmark the permalink. Comments are closed, but you can [...]

What are you talking about Chan? This is one of the easier articles to understand on this important, yet often ignored topic. Just because you don’t understand it doesn’t mean it’s “opaque and useless”.

Posted by Paul Alexander | Report as abusive

Get the picture folks? The manure pile is deeper than we think.
We just keep putting off the day of financial reckoning, whether it be credit cards or loans, or mortgages. But with so many job losses, what else can be done? No job = no money.
So while thousands face financial ruin, many others are like the proverbial ostrich, burying our head in the sand, thinking all will be fine.
Our western society is like the Titanic, having hit one iceberg, already sinking, and yet unlike the Titanic still managing to steam full speed toward the next.
I hate to sound so negative, but it looks like the first class passengers are going to survive while the steerage passengers will go down with the ship.

Posted by John Martin | Report as abusive

This article provides valuable information to investors and thank you Reuters for pointing it out. With reference to Mr. Chan’s comment, all I can say is that the article is as clear as can be and cuts straight to the point.

My view of “extend and pretend” is that the policy is underlined by hope which is good to have- hope that from here the economic situation will improve to 2012 at which point property values will have recovered some lost ground. If this is the case then closing out of property deals could be achieved by sale of property if it is necessary to do.

However the alternate scenario is scary. It is also possible that we could see a coninuing bounce in the stock markets and incremental upward movement in the property market that may hit a wall in the latter part of this year or in early 2010 and then reverse back towards one of the lower points of the 2007-2009 decline. If this is the case then come 2012 could be a serious moment of reckoning for extend and pretend reasoning.

Having seen the emergency response to 2007-2009, it seems that there is more probability that the extend and pretend will prevail. What has been demonstrated is that th economic system is a system constructed on premises of what people can be made to believe. It is a world of “make belief”. Accounting “rules” can be “amended”, money can be created out of thin air and loaned with interest. Anything goes. People still believe that shiny metal has “monetary value” when all it is good for is jewellery. There is about 100 000 000 kilograms of gold stock on the planet and it sells at $950 an ounce.

In the financial world money is a serious matter but it seems that in the big picture we are all playing the game Monopoly, except that there are no fixed rules. The “Bank” amends the rules when it sees fit to do so. Have fun.

Posted by Gregory | Report as abusive

Delay and pray is not just being used for the commercial reat estate. It’s just about the whole US economy isn’t it? Can anyone name one segment of the economy that’s not on life support? Just keep that printing press running Ben. Can you believe that people think he is doing a great job, how difficult is it to say keep printing, keep printing, keep printing………

Posted by gd | Report as abusive


Posted by ROBERT PELTIER | Report as abusive

“There is a certain poiginant inevitability in indecision.”

Posted by Voltaire | Report as abusive

I have become an Agnes Crane follower in a remarkably short time. However, one of the most important lessons I have learned in business is to have faith in the opportunities, and I think she hasn’t learned that yet – too focused on the visible results of her analysis.

Opportunities are not usually visible, but they are always there. Always.

Day one, week one, of Business school (circa 1976) my prof told us “At all times, in all places people have needs, and other people can profit from filling those needs.” That is all you really need to know about business.

We ain’t dead yet, kiddo.

Posted by ARJTurgot | Report as abusive

Don’t worry Chris Chan, read it once only, it will make perfect sense: “And the road to recovery will be much longer than investors currently believe.” Only investors ? There will only be one winner if at all: The Environment…

Posted by Hour glass | Report as abusive