The loan was hurtling toward default. Anybody could’ve seen it coming.

The troubled borrower was a client of Frederick Pittaro, an attorney with Mintz Levin. The property was a three-unit retail center. The center’s anchor tenant had gone bankrupt, and another had just decided, unilaterally, to lower its rent. The third tenant was still standing, albeit on shaky financial ground.

“They’re going to have trouble paying that loan,” Pittaro said. And yet, he said, it took months of dead-end phone calls to initiate loan modification talks and stave off default proceedings.

“It took three months to get anybody to talk to us about doing anything,” Pittaro said. “You’d think, as the economy gets worse, they’d be proactive, but we’ve seen the opposite. We can’t get anybody to deal with it.”

Nearly $15 billion in securitized commercial debt comes due this year. That figure doubles in 2010, with significant exposure to 5-year interest-only bullet loans. Mounting vacancies, eroding property values, steep terms and strict underwriting all mean many borrowers will be hard-pressed to refinance those loans when they come due.

In the absence of a functional refinancing market, borrowers and investors skittishly eyeing billions in looming securitized loan maturities are increasingly leaning on two concepts: imminent default and maximized net present value recovery.

Imminent Danger

Taken together, these two crutches, culled from the phone-book-thick pooling and securitization agreements that govern commercial mortgage-backed securities, provide the clearest path away from a tsunami of commercial property foreclosures.

And that clearest path is wracked with doubt and uncertainty.

The master servicer for a securitized loan pool isn’t empowered to alter the terms of a loan. That power is reserved for the special servicer. For a loan to even land on a special servicer’s plate, it has to either be in default, or in imminent danger of default.

So, to get into extension talks, borrowers have begun arguing that the crippled credit markets have put virtually all maturing loans in danger of default.

“We’ve seen a marked increase in requests for extensions,” said Brian Hanson, a director at the special servicing firm CWCapital. Industry observers have pegged next year, when loan maturities spike, as the year to watch.

“Our observation is, it’s already happening, and it will probably continue to happen, unless there’s some unforeseen availability of credit and liquidity to borrowers. We are seeing lots of them now in our portfolio,” Hanson said.

Richard Toelke, an attorney with Bingham McCutchen, has been advising developer clients with approaching loan maturities to reach out to loan servicers and initiate loan modification discussions well in advance of the loans’ maturation dates. Thus far, he has had mixed results.

“Reactions have been scattered,” Toelke said. “We don’t always meet with success.” Special servicers have been willing to entertain extensions on loans that are less than three months away from maturity, Toelke said. “That’s enough to be imminent. Further out, there’s more reluctance. It’s such a volatile market, and the servicers are inundated with this stuff.”

Foreclosure Woes

Once loans come before a special servicer, borrowers of both performing and nonperforming loans have been arguing that the commercial real estate sales market’s doldrums make foreclosure auction a losing exit strategy – at least right now. The special servicers are bound to maximize investors’ returns on a net present value basis. Borrowers are arguing that, with values down and few potential buyers able to access financing, the returns on foreclosure sales will be miserable.

Pooling and service agreements “seem to give the special servicer discretion,” Toelke said. “They need to be able to show [net present value recovery], but it’s not like there’s a black and white definition of what that means.

“It could involve prognostication on their end. There’s definitely a little play within that standard. We don’t know where the mindset is yet. We can speculate that the fact we’re in a down real estate market means that they’ll say we won’t get maximum recovery, but it’s really speculation on our part. We haven’t seen enough to know where it’s going to end up,” Toelke said.

“We’re fully cognizant in this market, there’s a lack of liquidity, an inability of buyers to obtain financing,” Hanson said. “We’re willing to have discussions with borrowers and talk to them, more so now than a year or two ago. We were taking properties to market in 2007 and getting paid par. That isn’t happening now.”

The argument that certificate holders stand to benefit more by extending loans, rather than forcing property liquidations upon an illiquid marketplace, “is not an unusual view for a defaulting borrower to take,” said Beth Mitchell, an attorney with Nutter McClennan & Fish.

“The challenge for the lender is, are you better taking a loss now, or delaying action and potentially taking a loss later? At which point is it worse for the overall portfolio? The expectation of the borrower is that, if they extend the loan, they’ll end up with a better market down the road. That’s not necessarily the case.”

“We’re seeing arguments over what to do to satisfy different constituencies,” said Pittaro. “The servicing standard is timely recovery of principal and interest on present value basis. How do you rationalize all those? Do you get the money today? Or wait for the market to improve? It’s an impossible standard. What the senior holders would like is, by definition, different than what the juniors would like. If you’re at the top, you get paid if you foreclose.”