They are here! US commercial real estate loan workouts!
And they’ve already garnered their fair share of criticism. To start with though, here’s the basic idea from the FDIC and the Fed:
The regulators have found that prudent CRE loan workouts are often in the best interest of the financial institution and the borrower. Examiners are expected to take a balanced approach in assessing the adequacy of an institution’s risk management practices for loan workout activity. Financial institutions that implement prudent CRE loan workout arrangements after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for engaging in these efforts even if the restructured loans have weaknesses that result in adverse credit classification. In addition, renewed or restructured loans to borrowers who have the ability to repay their debts according to reasonable modified terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the loan balance.
Which means banks will not have to classify restructured loans (to the Troubled Debt Restructured [TDR] or `substandard’, `doubtful’, etc. categories) if the value of the underlying property has fallen to less than the loan balance. The idea, as the Wall Street Journal notes, is to target loans that are coming due but perhaps can’t be refinanced because the value of the property has fallen below the loan amount. In many of those instances, the properties are still generating enough rental income to pay debt service.
So for example, if a $15m loan on an office building valued at $20m becomes a $15m loan on an office building valued at $13.1m, but the borrower hasn’t been delinquent and stable rental income is expected, then the lender can internally grade the loan a `pass’, maintain it on an accrual basis and not report it as TDR. Everything is relatively fine.
If, however, future declines in rental income are expected or the borrower has been sporadically delinquent or whatever — the loan might still be classified as substandard or TDR.
Whether you think rental incomes and property values are likely to recover or continue declining then, will really dictate what you think of these kinds of loan workouts. For sure, they are a way of giving banks some time, allowing them to restructure loans and hold onto them until values recover. If commercial property values and rents do pick-up then it will have been a gamble which worked. If, however, rental incomes and values continue to decline then they really are just a procrastinating tactic — merely allowing banks to delay the inevitable.
Related links:
All aboard the commercial real estate bailout train - FT Alphaville
You can’t possibly be serious (CRE) - The Market Ticker
Ballooning CMBS payments - FT Alphaville
