Economic conditions continue to severely stress the commercial real estate (CRE) market. The CRE market is experiencing increasing delinquencies, value deterioration due to rising cap rates, and substantial refinancing risk over the next several years. The magnitude of the challenge is driven home by the fact that U.S. banks held $1.8 trillion in outstanding CRE debt as of May 2010.
In response to tremendous losses in CRE, the federal banking supervisors issued in October the Interagency Policy Statement on Prudent CRE Loan Workouts. The purpose was to promote supervisory consistency, enhance the transparency of CRE workout transactions, and ensure that supervisory policies and actions do not inadvertently curtail the availability of credit to sound borrowers.
When problems with CRE loans arise, bankers and borrowers often work together to restructure the loan. But CRE loan workout situations can present unique considerations, leaving bankers with more questions than answers under the federal guidance. So, on May 5, the Fed’s experts held a nationwide teleconference call to explain the guidance to bankers and to answer their questions. More than 1,300 financial institutions joined the call, submitting 60 questions for consideration.
The program was presented by Sabeth Siddique, assistant director of credit risk at the Federal Reserve’s Board of Governors, and his team, consisting of Robert Walker, Virginia Gibbs and Brian Valenti.
“The guidance is not a panacea for solving all of the challenges of management and resolution of troubled loans,” explained Siddique. “And it’s not meant to be any form of forbearance, but rather a reiteration of existing principles.”
The general guidance focuses on the following:
In addition, financial institutions that implement prudent loan workout arrangements after performing comprehensive reviews of borrowers’ financial conditions will not be subject to criticism for engaging in these efforts, even if the restructured loans have weaknesses that result in adverse credit classifications.
“We’re sure you’ve heard this many times: ‘Prudent workouts’ means that each loan should be judged on its own merits and not on trends,” Siddique noted. “Prudent workouts are in everyone’s interest, but not all loans can be worked out. And bankers should keep in mind that ‘pretend and extend’ is not a prudent loan workout.”
Essentially, cash flow is king on loan workouts. Siddique urged his listeners to “decide whether a loan to a sound borrower should be adversely classified by determining whether well-defined weaknesses exist that jeopardize repayment.”
The federal guidance provides some detailed examples of loan workouts. As a general rule, banks should contact their chartering authority and/or their primary federal supervisor for answers to specific CRE loan workout questions. Bankers interested in listening to the online recording of this special “Ask the Fed” program may do so by contacting the Federal Reserve Bank of St. Louis at firstname.lastname@example.org.
Policy Statement on Prudent CRE Loan Workouts