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Friday, October 1, 2010

Heading Off Trouble

Source: ICBA Independent Banker
By Katie Kuehner- Hebert

Preparing to closely manage commercial loans, even performing ones, for the long haul


Now that the crisis in residential construction lending has likely peaked, many community banks are gearing up to deal with what could be a lingering headache: problems with commercial mortgages. "It is a concern even for projects that are cash-flow performing," says Robert Gordon, a partner at the Chicago law firm Mayer Brown LLP, "because it is difficult to refinance if there is a still a high level of debt on a project that exceeds the fair market value."

According to Foresight Analytics LLC, a market research firm in Oakland, Calif., $785 billion in commercial mortgages are set to mature between now and 2014. Of those, $425 billion, or 54 percent, are underwater?their loan-to-value ratios exceed 100 percent. For the total commercial mortgage market that includes nonbanks, $1.5 trillion in commercial mortgages will mature by 2014, and of those, $771 billion, or 52 percent, are underwater.

Moreover, the delinquency rate on commercial mortgages continues to increase as borrowers grapple with rising vacancies in their properties, according to Foresight. In the first quarter, 5.7 percent of commercial mortgages were delinquent, up from 4.1 percent a year earlier. By the fourth quarter, Foresight projects delinquencies to rise to 7.1 percent.

"The more immediate problem is loan performance, particularly if the borrower doesn't have the ability to continue to make debt service," says Matthew Anderson, a Foresight partner. "They have a much greater risk of going into default if real estate prices don't recover. It will be a problem for the next few years, at least."

Community banks are tackling problem loans early and finding constructive ways to deal with underwater mortgages before they mature, lending consultants say. First and foremost, banks must correspond with their borrowers?and regularly, says Joseph Ori, senior vice president at NRC Realty and Capital Advisors LLC in Chicago. "You have to contact the borrower and find out where they are, even if they are making payments on time," Ori says. "Ask about their cash flow on the property: Is everything leased?" If a loan problem surfaces, he says, first consider lowering the interest rate or deferring some of the payment to prevent a more serious problem.

Communication with the borrower should be a normal part of the lending arrangement and should be done by the loan o