Commercial Investors Fear New Precedent Set for ‘Extend and Pretend’

May 10, 2012

Commercial real-estate investors thought they had it bad before, but the fallout from a December court decision is causing a new level of uncertainty.

The turmoil stems from a decision dealing with a $207 million loan on a pair of Westin hotels. A bankruptcy court ordered that the loan’s maturity be extended by an unusually lengthy period and its interest-rate slashed to zero, according to analysts.

U.S. Bankruptcy Court Judge Eileen W. Hollowell in Tucson, Ariz., as part of a reorganization of borrower Transwest Resort Properties in December, ordered the troubled loan be extended by 15 years, to 2033, and increased the principal by $40 million. The judge also cut the interest rate to zero.

The problem for investors is that this extension is far longer than anything they’ve seen before.

“It’s one of the longest extensions we’ve seen for a CMBS loan,” said Richard Hill, a CMBS strategist at RBS Securities, who added that loan extensions are typically capped around five years.

Concern about the decision arose this week when Bank of America analysts, based on a servicing document recently made available to bondholders, noted that the interest-rate cut, if finalized, would exacerbate shortfalls in interest payments already suffered in the two J.P. Morgan Chase CMBS
offerings that included the Westin loan. LNR Property, the firm servicing the loan for two CMBS trusts, is trying to appeal the modification, which sets a “truly bad precedent” for lenders, said Toby Cobb, LNR’s co-chief executive.

The modification comes as investors have increasingly doubted the benefits of extending maturities on CMBS loans, especially those made at the height of the real-estate boom when many lenders were offering excessive debt under rosy assumptions. The $600 billion CMBS market has begun to recover with more conservative lending but the specter of the losses stemming from loose underwriting of the past is still tainting investor demand.

The loan on the Westin La Paloma Resort and Spa in Tucson and Westin Hilton Head Island Resort and Spa, in Hilton Head, S.C., first shook the market in October 2008 as a designation of “imminent default” less than a year after it was originated pushed it into the hands of a delinquent loan specialist. The bankruptcy court valued the two properties at $92.5 million.

LNR took over as special servicer after it bought some bonds, according to information in Bank of America’s note.

Randal Dix, a partner at Transwest Partners, parent of Transwest Resort Properties, and Susan Boswell, Transwest’s attorney, didn’t return calls for comment.

The new borrower on the transaction is San Diego-based Southwest Value Partners, according to the loan servicing document. Mark Schlossberg, a managing partner at Southwest Value Partners, didn’t return a call for comment.