|Brother, would you take a lease? (July 2010)|
With lenders resorting to “hope notes” to help them through the commercial real estate trough, the window of flexibility under 2009’s CRE Guidance may be closing. There are signs of progress, too.
By Steve Cocheo, executive editor,
“There is a sense of a lot of deals being kicked down the road,” says Korologos, in hopes that prosperity will return and pull them back up before they have to be marked down, “and there’s not a lot of transparency.”
Mixed picture in all senses
Usage of the regulators’ guidance and the results of using it appear to be mixed. Some bankers say it’s been helpful with examiners, and that regulatory teams have been applying the often-complex guidance. Other bankers still scoff that there’s not much there that’s new, just some willingness to be flexible. One regulatory analyst notes that the regulators never thought they were doing the industry any huge favors, but at least bringing some clarity and modern-era examples to the mix. “Eventually all bleeding stops,” quips this analyst with gallows humor, summarizing the views of some veteran lenders he’s talked with.
But then, the entire commercial real estate picture is a blend of differing outlooks among markets and among types of properties.
Georgia Bankers Association head Joe Brannen notes that each sector in his state differs. Residential development shows “some glimmers” because banks wrote down their values. Some are even bringing in builders to finish off incomplete subdivisions. In retail, on the other hand, he says, “there’s lots of vacancy, and a lot of strip malls are bank-owned now. It’s a great time to be a tenant.”
Clearly CRE remains a major problem—especially for community banks. At the end of the first quarter, FDIC figures indicate, banks and savings institutions held 29% of their assets in nonfarm, nonresidential real estate loans and another 10% in construction loans. Industry wide, FDIC reported, noncurrent CRE loans rose by nearly 9% over yearend 2009, and chargeoffs in the category shot up by nearly 156%. The percentage of past-due CRE loans came in highest among smaller banks.
Management versus circumstances
The utility of the federal guidance remains the subject of debate, but management ability seems key. Walt Mix, managing director for global financial services at consultancy LECG and former commissioner for the California Department of Financial Institutions, says that how heavily a bank can lean on the guidance very much depends on regulators’ perception of its credit risk management skills. But even if those are strong, that’s not the whole deal.
“You still need good appraisals, and markets where values won’t crater,” says Mix. “So the guidance has been of mixed benefit.”
Richard Ormond, a CRE lender attorney at Buchalter Nemer, PLC, Los Angeles, says he initially agreed with those who felt the guidance merely abetted those postponing the inevitable. But he’s had a change of heart.
“The guidance allowed many servicers and lenders to control the flow of the assets and the underlying properties to the market,” says Ormond. “This may have prevented a waterfall of assets onto the market.” An even more drastic deterioration in prices may have been prevented, he says, or, at least, spread over more time.
A slamming window?
It may be that the CRE guidance was a window of opportunity, not an open-ended strategy.
From around the country, indications are that commercial tenants have been forcing the issue of rent reductions, or even insisting on some free rent, and threatening to move otherwise. Landlords have caved.
“They feel it’s better to have somebody in there than not,” says George Mann, managing director of Collateral Evaluation Services, LLC, Cincinnati, a review appraisal consulting firm to banks.
However, Mann sees this pushing income down further. “Anybody who was marginally covering their debt will be in trouble this year,” Mann predicts. He believes this will further increase nonperforming credits. The CRE guidance worked when loans were still performing even though with some difficulty—“that’s why they told the examiners to lighten up.” Increased deterioration due to income problems will remove justification for examiners to accommodate lenders because it will be less likely they can work with troubled borrowers, Mann argues.
“Many owners are looking at 10-15% declines in net income this year,” says Mann, “especially in retail, where things are brutal.”
Attorney Ormond points out that he’s seen managements with regulators breathing down their necks get tough on troubled borrowers, cutting off lines of credit, for instance. That saves capital and other ratios in the short-run. “But it becomes a self-fulfilling prophecy that eventually drives both the borrowers and the bank into distress.”
A community banker in the Southeast says that he’s found that some of his colleagues that complain about examiners’ treatment just won’t face reality and do what needs doing.
“The examiners hassle you when they come in and have to do your job for you,” this banker says. His bank recently saw FDIC examiners and made out well (relatively speaking). “We had been aggressive on it,” and examiners pretty much went with the bank’s decisions, he says.
Regulatory rethink needed?
Something that drives consultant Don Musso to distraction is regulators’ treatment of CRE as a homogenous mass. The current regulatory approach treats all property types identically, “and it’s all leprosy,” says Musso, who is with FinPro, Inc. Yet that ignores the trends in chargeoffs. Construction lending has taken the largest hit, followed by other types of CRE, and then by multifamily lending. “The data show that these categories are completely different animals,” says Musso.
A particular thorn for Musso is multifamily. “The country hasn’t had one bank failure caused by multifamily lending,” he says. Yet those banks which make a specialty of this—frequently those in urban centers—see their loans treated much the same as any CRE credit.
“We’ve got to get the regulators to break these categories down,” declares Musso. “The regulators have an obligation to get this right.”
Accelerating to the bottom
Appraisal expert George Mann says CRE properties are moving again, as property owners bite the bullet, acknowledge that property values have dropped, and no longer forestall sales. But he’s convinced that this will still be one of the worst-ever years for CRE.
“I don’t see any bright spots,” he says. “We’re at the acceleration phase towards the bottom of the cycle. Where residential lending was a year ago, that’s where CRE is headed now.”
Yet some see reason for hope—and not just hope notes.
“On the optimism scale, things are more optimistic than they were six months ago,” says Deloitte’s Tino Korologos. “That’s not saying much, but transactions are occurring and there is some liquidity coming back into the commercial mortgage-backed securities market.”
He says life insurance companies and conduits have been coming back into commercial real estate. In time this will help.
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