Wednesday, November 11, 2009

Banks Hasten to Adopt New Loan Rules

NOVEMBER 12, 2009

By LINGLING WEI and PETER GRANT, Wall Street Journal

Banks are moving quickly to restructure commercial mortgages under new U.S. guidelines that are more forgiving of battered property values and can help banks avoid bigger losses.

Citigroup Inc., regional bank Whitney Holding Corp. and other lenders around the country are planning to review loans now considered nonperforming to determine if they can be reclassified under the guidelines announced Oct. 30 by bank, thrift and credit-union regulators, according to bank executives and people familiar with the matter. The moves could help the banks absorb fewer losses on troubled real-estate loans and preserve capital.

"It's a positive all the way around," said James Smith, chief credit officer for National Bank of South Carolina, a unit of Synovus Financial Corp.

Matthew Anderson, partner at research firm Foresight Analytics, estimates that about two-thirds of the $800 billion in commercial real-estate loans held by banks that will mature between now and 2014 are underwater, meaning the loan amount exceeds the value of the property. The flexibility extended by regulators will apply to $110 billion to $130 billion of these loans, he said.

The guidelines are controversial, with critics accusing the U.S. government of prolonging the financial crisis by not forcing borrowers and lenders to confront inevitable problems.

Regulators respond that they are being prudent, adding that a crackdown will occur at any banks misinterpreting last month's announcement as an opportunity for leniency.

"We will push banks to be realistic [about losses] and will drag them out of denial if that's what we need to do," Tim Long, senior deputy comptroller at the Office of the Comptroller of the Currency, said in an interview Tuesday.

Regional and small banks are the most likely financial institutions to benefit from the guidelines because of their exposure to commercial real estate. More than 2,600 banks and thrifts have commercial real-estate-loan portfolios that exceed 300% of total risk-based capital, according to an analysis of regulatory filings by The Wall Street Journal. Nearly all of those institutions have less than $5 billion in assets.

Regulators consider the 300% threshold a red flag, though it doesn't necessarily mean the banks are in danger of failing. Risk-based capital is a cushion that banks use to cover losses. Commercial real-estate woes contributed to 100 of the 120 bank failures this year, according to Foresight Analytics.

Supporters of the guidelines note that commercial properties still can generate enough cash to pay debt service on mortgages even if they are underwater. In such cases, banks shouldn't be required to classify the loan as delinquent and reserve capital against it.

"If you're going to take a hit, make sure you're taking a hit for a legitimate reason, not because an examiner is making an immediate judgment on the loan," said Tom Flexner, Citigroup's global head of real estate.

Regulators also suggested ways for banks and borrowers to restructure loans and avoid foreclosure even if the properties can't pay debt service. Banks can carve troubled loans into one performing part and one nonperforming part. That would allow the bank to incur losses on only the nonperforming part, not the entire loan.

In an interview, Joe Exnicios, chief risk officer of Whitney's Whitney National Bank unit, of New Orleans, cited a hypothetical example in which a developer borrows money to develop a small retail center and gets a drugstore chain to sign a lease for one store. If the developer can't sell the other sites, he would be unable to repay the loan. Under the new guidelines, the bank could create a healthy, performing loan supported by the drugstore lease and a nonperforming loan from the rest of the loan. "It may make a difference on whether you need to have additional capital and take additional reserves," he said.

Critics agree that regulatory flexibility might help some banks avoid failure. But the troubled loans remaining on their books will discourage them from lending, reminiscent of Japan's "lost decade" in the 1990s.

A better solution, critics said, would be similar to the approach regulators took during the commercial real-estate crash of the early 1990s.

"Back then, regulators moved aggressively to force banks to take write-offs and sell off their troubled loans, and the market recovered faster," said Mark Edelstein, head of the real-estate group at law firm Morrison & Foerster LLP.

Some observers also worry that the guidance could lead to fewer real-estate transactions.

"The question becomes: Are you going to invest in new properties knowing that there is this overhang [of troubled loans] that could hit you?" said Michael Straneva, global head of Ernst & Young's transaction real-estate practice.

Bankers respond that some critics would prefer that regulators pressure banks to sell assets so they can scoop them up at steep discounts.

"The people who are complaining the loudest are the people who want to buy the real estate," said Pat Goldstein, head of real estate for Emigrant Savings Bank in New York City.

—Maurice Tamman contributed to this article.

Write to Lingling Wei at and Peter Grant at