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Federal regulators say banks should include short-term accommodations in their toolkits for dealing with distressed commercial real estate loans.
The Federal Reserve, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and National Credit Union Administration issued a joint statement on commercial real estate accommodations and workouts on Thursday. The missive updates guidance first released by the regulators in 2009, amid a rash of bank failures driven by — among other things — bad real estate loans.
The statement notes that banks should step in to address distressed loans before lenders default or have to go through a so-called “workout” process, which can entail renewing or extending loan terms, extending additional credit or restructuring credit with or without concessions. The agencies noted that short-term modifications — which suspend, extend or defer repayment terms — can be an effective way to address issues before more significant accommodations are needed.
“These actions can mitigate long-term adverse effects on borrowers by allowing them to address the issues affecting repayment ability and are often in the best interest of financial institutions and their borrowers,” the statement reads.
The new policy statement also updates the 2009 guidance to incorporate accounting changes that have taken place during the intervening years, including requirements that banks estimate current expected credit losses for all their assets.
It also gives examples for how loans should be classified and accounted for once they have entered a workout process.
The inclusion of guidance around short-term accommodations and accounting best practices was the result of public commentary fielded by regulators since proposing rule changes last August. In total, the agencies received 22 comments from banking organizations and credit unions, state and national trade associations and individuals.
Otherwise, the finalized guidelines are largely similar to the policy proposed more than a decade ago. The statement urges banks to engage with troubled commercial real estate borrowers early and have policies in place for dealing with accommodations in a safe and sound manner.
Regulators also note that examiners won’t punish banks for working with borrowers in this way. Similarly, borrowers will not be criticized for engaging in these types of pre-workout remedies.
The guidelines for handling distressed commercial real estate loans have been in the works for years, but they have taken on a renewed importance in the current market, as rising interest rates and falling occupancy rates squeeze some commercial property owners — especially for offices in central business districts. Last summer, the FDIC said it would more thoroughly scrutinize banks’ commercial real estate loans.
The issue is acute for smaller and midsize banks, which tend to have higher concentrations of commercial real estate debt on their balance sheets. Analysis by the property advisory firm CBRE suggests that more than 300 banks in these size categories have enough commercial real estate loan exposure to wipe out their tier 1 capital.
Large banks also have significant commercial real estate exposures, albeit not as concentrated. In its annual stress test report, released this week, the Federal Reserve noted that the 23 large banks examined in this year’s test hold roughly 20% of office and downtown retail debt in the country. Under the Fed’s severe stress scenario, the banks were projected to lose $65 billion on their commercial real estate loans, or 8.8% of average balances.
“The large projected decline in commercial real estate prices, combined with the substantial increase in office vacancies, contributes to projected loss rates on office properties that are roughly triple the levels reached during the 2008 financial crisis,” the Fed wrote in a statement accompanying the stress-test results.
Despite the forecasted losses, all the banks examined passed this year’s stress test. Still, the scenario demonstrated the magnitude of distress banks could face.
Source: nationalmortgagenews.com