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Thursday, February 18, 2010

Viewpoint: Get Aggressive with Bad CRE Loans

Source: American Banker
By Joseph Ori

By Joseph Ori

Many commercial banks are having significant issues in dealing with their commercial real estate portfolios. Many loans are in default, are nonperforming or the market value of the asset is less than the loan balance. Last year the accounting rulemakers suspended the mark-to-market rule for commercial banks and the FDIC promulgated new rules for commercial real estate loans that allow banks to keep a loan as performing even though the value of the property is less than the loan balance.

The current balance of commercial real estate loans held by commercial banks and in commercial-mortgage-backed security pools is approximately $1.45 trillion. It is widely agreed that the value of commercial property has fallen approximately 50% from its peak of three years ago. Assuming that the $1.45 trillion loan balance represents a 75% loan to original value, then the mark-to-market value of commercial real estate loans is approximately $967 billion, or a discount of $483 billion. A markdown of this magnitude would be disastrous for many institutions and the whole banking industry.

However, many banks are missing an opportunity to be aggressive and deal with distressed commercial real estate loans.

A bank has three main options when it comes to troubled commercial real estate loans: restructure the loan with the borrower, sell the loan in the market or foreclose on the real estate and dispose of the real estate collateral.

Many banks have not pursued the above three options but have instead been in a state of denial about their commercial real estate problems. Banks need to be more agressive to achieve the highest return on these troubled assets while at the same time protecting their capital ratios and balance sheet. First, they should meet with the borrower and explore ways to restructure the loan, including lowering the interest rate, extending the maturity date or waiving some restrictive loan covenants. I have talked to many colleagues who own commercial real estate, and it is amazing how many have not heard from or spoken with their lender about ways to restructure their loans or head off a looming default issue. One company in particular developed a small office condominium building in California that went into default when the units didn't sell.

The lender, a small community bank, has not corresponded with the borrower for months.

A number of banks have extended loan maturity dates for defaulted loans, but this has mostly been done to defe