Spooky Halloween: FDIC Passes Out OREO Cookies For Banks
As reported here earlier, FDIC bank regulators were recently in the process of re-writing the guidelines for commercial real estate loan workouts. Well they did. These new guidelines were released on Friday just in time for Halloween. The end result is a 33 page policy statement on prudent commercial loan workouts (emphasis added). In a nutshell, this policy statement calls for a continuation of the so-called “extend and pretend” practice of extending loans upon maturity even while the value of the property has fallen below the loan amount. The FDIC is obviously concerned about bank failures which have cost the FDIC’s fund that insures deposits an estimated $25 billion so far this year and are expected to cost another $100 billion through 2013.
Regulators have now provided more explicit guidelines for commercial banks dealing with troubled commercial real estate loans. It appears likely that if the property is producing income sufficient to cover the debt and the borrower shows a strong likelihood of continuing ability to pay, the loan will be extended or re-worked. In fact, in the introduction on page one of the policy statement, the FDIC says “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.” In other words loans made to creditworthy borrowers that have been extended or restructured won’t be classified as high risk by bank regulators when the assets backing them have declined to a value that is below the loan balance. This is the strongest indication we have seen to date that the floodgates are not ready to be unleashed as far as OREO properties are concerned. However, delinquent loans still comprise around 9% of total commercial real estate loans outstanding and some 16% of all construction and development loans were considered delinquent at the end of the second quarter of 2009. This places delinquent commercial real estate loans at some $150 billion out of a total loan pool of $1.7 trillion held by commercial banks. If the loan is delinquent, what does this say about the borrowers ability to repay? And this says nothing of the $900 billion in securitized real estate loans, many of which will be seeking a new home over the next several years. I don’t see special servicers and hundreds of individual bondholders being willing to employ the same strategy as commercial banks. Regardless, it appears we may have to wait a bit longer for some significant OREO opportunities and there is so much dry powder out there sitting on the sidelines that some REITs are now talking about using it to pay down debt in 2010 if buying opportunities do not emerge.
This whole process sets up another dilemma just down the road. Valuations are actually coming back down to historical norms. Too many people have forgotten that cap rates were 10% earlier in this decade. At the same time as these loans are being extended, both occupancy and rents are continuing to drop. This trend is set to continue throughout 2010 for most real estate asset classes. The fact is we still have too much office space, too many apartments and too many shopping centers for the demand. Until we see some serious and sustained job growth this trend will not reverse. And then interest rates are expect to start rising soon…I still see someone eating OREO’s in the future.
Tags: bank reo, commerical real estate loans, FDIC Posted in
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