To Fix Sour Property Deals, Lenders 'Extend and Pretend

Discussion in 'Economics' started by misterno, Jul 8, 2010.



    Note where it says

    Banks hold some $176 billion of souring commercial-real-estate loans, according to an estimate
    by research firm Foresight Analytics. About two-thirds of bank commercial real-estate loans
    maturing between now and 2014 are underwater, meaning the property is worth less than the
    loan on it, Foresight data show. U.S. commercial-real-estate values remain 42% below their
    October 2007 peak and only slightly above the low they hit in October 2009, according to
    Moody's Investors Service.

    Some banks have a special technique for dealing with business borrowers who can't repay loans
    coming due: Give them more time, hoping things improve and they can repay later.
    Banks call it a wise strategy. Skeptics call it "extend and pretend."
    Banks are applying it, in particular, to
    commercial real-estate lending, where, during
    the boom, optimistic borrowers got in over their
    heads to the tune of tens of billions of dollars.
    A big push by banks in recent months to modify
    such loans—by stretching out maturities or
    allowing below-market interest rates—has
    slowed a spike in defaults. It also has helped
    preserve banks' capital, by keeping some dicey
    loans classified as "performing" and thus
    minimizing the amount of cash banks must set
    aside in reserves for future losses.
    Restructurings of nonresidential loans stood at
    $23.9 billion at the end of the first quarter, more than three times the level a year earlier and
    seven times the level two years earlier. While not all were for commercial real estate, the total
    makes clear that large numbers of commercial-property borrowers got some leeway.
    But the practice is creating uncertainties about the health of both the commercial-property
    market and some banks. The concern is that rampant modification of souring loans masks the
    true scope of the commercial property market weakness, as well as the damage ultimately in store
    for bank balance sheets.
    In Atlanta, Georgian Bank lent $13.5 million to a company in late 2007, some of it to buy land for
    a 53-story luxury Mandarin Oriental hotel and condo development. The loan came due in
    November 2008, but the bank extended its maturity date by a year. The bank extended it again to
    May 2010, with an option for a further extension to November 2010, according to court
    Georgia's banking regulator shut down the bank last September. A subsequent U.S. regulatory
    review cited "lax" loan underwriting and "an aggressive growth strategy…that coincided with
    declining economic conditions in the Atlanta metropolitan area." Some of Georgian Bank's assets
    were assumed by First Citizens Bank and Trust Co. of Columbia, S.C., which began foreclosure
    Darryl James for The Wall Street Journal
    A Portland, Ore., bank has extended the original 2007
    loans taken out to purchase this lot. The planned
    residential community remains undeveloped.
    View Full Image
    Bank Fix for Unpaid Commercial Property Loans: 'Extend and Pretend' - Page 1 of 5 7/8/2010
    proceedings on the still-unbuilt luxury development. The borrowers contested the move, and
    settlement talks are in progress.
    Also in Atlanta, Bank of America Corp. has extended a loan
    twice for a high-end shopping and residential project. Three
    years after a developer launched the Streets of Buckhead
    project as a European-style shopping district, all there is to
    show for it is a covey of silent cranes and a fence. The
    developer, Ben Carter, says he is in final negotiations for an
    investor to come in and inject $200 million into the
    languishing development.
    Regulators helped spur banks' recent approach to commercial
    real estate by crafting new guidelines last October. They gave
    banks a variety of ways to restructure loans. And they allowed
    banks to record loans still operating under the original terms
    as "performing" even if the value of the underlying property
    had fallen below the loan amount—which is an ominous sign
    for ultimate repayment. Although regulators say banks
    shouldn't take the guidelines as a signal to cut borrowers more slack, it appears some did.
    Banks hold some $176 billion of souring commercial-real-estate loans, according to an estimate
    by research firm Foresight Analytics. About two-thirds of bank commercial real-estate loans
    maturing between now and 2014 are underwater, meaning the property is worth less than the
    loan on it, Foresight data show. U.S. commercial-real-estate values remain 42% below their
    October 2007 peak and only slightly above the low they hit in October 2009, according to
    Moody's Investors Service.
    In the first quarter, 9.1% of commercial-property loans held by banks were delinquent, compared
    with 7% a year earlier and just 1.5% in the first quarter of 2007, according to Foresight.
    Holding off on foreclosing is often good business, says Mark Tenhundfeld, senior vice president
    at the American Bankers Association. "It can be better for a bank to extend a loan and increase
    the chance that the bank will be repaid in full rather than call the loan due now and dump more
    property on an already-depressed market," he says.
    But continuing to extend loans and otherwise modify them, rather than foreclosing, amounts to a
    bet that the economy will rebound enough to enable clients to find new demand for the plethora
    of offices, hotels, condos and other property on which they borrowed. If it doesn't work out this
    way, the banks will end up having to write off the loans anyway.
    At that point, if they haven't been setting aside sufficient cash all along for potential losses on
    such loans, the banks will face a hit to their earnings.
    Banks' reluctance to bite the bullet on some deteriorating commercial real estate can have
    economic repercussions. The readiness to stretch out loans puts a floor under commercial real
    estate and keeps it from hitting bottom, which may be a precondition for a robust revival.
    More broadly, the failure to
    get the loans off banks' books
    tends to deter new lending to
    others. It's a pattern
    somewhat reminiscent,
    although on a lesser scale, of
    Bank Fix for Unpaid Commercial Property Loans: 'Extend and Pretend' - Page 2 of 5 7/8/2010
    the way Japanese banks'
    failure to write off souring
    loans in the 1990s
    contributed to years of
    It's a Catch-22 for banks. As
    long as some of their capital
    is tied up in real-estate loans
    that are struggling—and as
    the banks see a pipeline of
    still-more sour real-estate
    debt that will mature soon—
    their lending is likely to
    remain constricted. But to
    wipe the slate clean by
    writing off many more loans
    would mean an even bigger
    hit to their capital.
    "It does not take much of a write-down to wipe out capital," says

  2. Christopher Marinac, managing
    principal at FIG Partners LLC, a bank research and investment firm.
    Federal bank regulators tackled the issues in October with a 33-page set of guidelines. Bank
    regulators have said they were concerned about commercial-property losses and debts coming
    due on commercial property.
    Another problem they sought to resolve was that banks and their examiners weren't always on
    the same page. In some cases banks weren't recognizing loan problems, while in other cases,
    tough bank examiners were forcing banks to downgrade loans the bankers believed were still
    The guidance was intended "to promote both prudent commercial real-estate loan workouts by
    banks and balanced and consistent reviews of these loans by the supervisory agencies," said
    Elizabeth Duke, a Federal Reserve governor, in a March speech. The guidelines came from the
    Federal Financial Institutions Examination Council, which includes the Fed, the Federal Deposit
    Insurance Corp. and the Comptroller of the Currency.
    Although one goal was greater consistency in the treatment of commercial real-estate loans, in
    practice, the guidelines appear to have fed confusion in the markets about how banks are dealing
    with commercial real-estate debt. "I just don't believe that the standard is being applied
    consistently across the industry," says Edward Wehmer, chief executive of Wintrust Financial
    Corp. in Lake Forest, Ill.
    In a May conference call with 1,400 bank executives, regulators sought to clear up confusion.
    "We don't want banks to pretend and extend," Sabeth Siddique, Federal Reserve assistant
    director of credit risk, said on the call. "We did hear from investors and some bankers
    interpreting this guidance as a form of forbearance, and let me assure you it's not."
    Restructurings increased at some banks, like BB&T Corp. of Winston-Salem, N.C. Its total of one
    type of restructured commercial loan hit $969 million in recent months, the bank reported in
    April. That was a huge jump from six months earlier, when the figure was just $68 million.
    Bank Fix for Unpaid Commercial Property Loans: 'Extend and Pretend' - Page 3 of 5 7/8/2010
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    The increase was "basically a function of implementing the new regulatory guidance," the bank's
    finance chief, Daryl Bible, told investors in May. "We are working with our customers trying to
    keep them in the loans."
    BB&T's report showed a significant number of cases where it was extending loan maturities and
    allowing interest rates not widely available in the market for loans of similar risk.
    Banks don't have to disclose how terms on their loans have changed, making it hard to know
    whether they are setting aside enough cash for possible losses.
    In a large proportion of cases, modifying the terms of loans ultimately isn't enough to save them.
    At the end of the first quarter, 44.5% of debt restructurings were 30 days or more delinquent or
    weren't accruing interest, up from 28% the first quarter of 2008.
    A case in Portland, Ore., shows how banks can keep treating a commercial loan as current,
    despite the difficulties of the underlying project.
    A client called Touchmark Living Centers Inc. in 2007 borrowed $15.9 million, in two loans, to
    buy land for a development. The borrower planned to retire the loans at the end of the year by
    obtaining construction financing to build the Touchmark Heights community for empty-nesters.
    Because the raw land produced no income, the lender, Umpqua Bank, had provided "interest
    reserves" with which the developer could cover interest payments while obtaining permits and
    preparing to build. The bank extended Touchmark a $350,000 interest reserve—in effect
    increasing what Touchmark owed by that amount.
    In December 2007, the U.S. economy slipped into recession. When the loans came due that
    month, Touchmark didn't pay them off. Umpqua extended the maturity to May 31, 2008.
    The bank also added $600,000 to the interest reserves. Though supplying interest reserves is
    common at the outset of a loan, when an unbuilt project can't produce any income with which to
    pay debt service, replenishing interest reserves is frowned on by regulators.
    Asked to comment, a spokeswoman for the bank said, "Umpqua and Touchmark had determined
    that the project was still viable but not yet ready for development." Touchmark said it didn't
    pursue construction financing at that time because "it was not prudent to proceed with
    developing the property until the economy improves," as a spokeswoman put it.
    In 2008 the bank extended the loans again, to April 2009. During this time, Touchmark began
    paying interest on the loans out of its own pocket.
    Then in May 2009, Umpqua restructured the loans, lumping what was owed into one $15 million
    loan that required regular payments on both interest and principal. Touchmark paid down the
    principal a little and Umpqua set a new maturity date—May 5, 2012.
    Meanwhile, the value of the land Touchmark
    had borrowed to purchase has been eroding.
    The bank says it was worth $23.5 million by the
    most recent independent appraisal, but that was
    in 2008. The county assessment and taxation
    department pegged the land's value at about
    $20 million at the start of 2009. An appraiser
    for the department estimates raw-land values in
    the area fell by another 25% to 30% last year,
    Bank Fix for Unpaid Commercial Property Loans: 'Extend and Pretend' - Page 4 of 5 7/8/2010
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    Touchmark executives declined to estimate the
    land's value. They said the property has retained
    "significant" value, partly because of its location,
    with a view of 11,240-foot Mount Hood.
    Umpqua Bank says the loan is accruing interest, and it expects the loan to be repaid.
    Write to Carrick Mollenkamp at and Lingling Wei at
    Bank Fix for Unpaid Commercial Property Loans: 'Extend and Pretend' - Page 5 of 5 7/8/2010
  3. Can anybody out here imagine any other industry that would try to lie like this to investors AND GET AWAY with it? Can somebody here imagine Boeing saying something like, "Yeah, we just got an order for 200 planes!" But then a day later you read a press release that says the order was canceled...but Boeing leaves it on the books for investors to think there is a legit order for 200 planes on the books? Would there not be people going to jail for such crap?