Regulatory Policy on Commercial Real Estate Loan Workouts04/09/2010 | Spring 2010 Newsletter
Complying with federal bank regulatory policies on commercial mortgage loan modifications may be as important as reaching an agreement between the bank and the borrower when fashioning a loan workout. Ignoring the regulators’ policy statement issued in late 2009 may doom workouts before they start.
What core principles must banks and troubled borrowers remember?
- The borrower must be “creditworthy,” with the “willingness” and “ability” to repay.A bank should not deal with a borrower that refuses to provide current financial information. Borrowers who fail to provide that information should expect the bank to show no flexibility in return.
- A bank must do a “global” cash flow analysis of all borrower and guarantor debts to determine if they are creditworthy. The borrower and guarantors must provide information to the bank so it can complete the analysis.
- The collateral must support the workout, but a workout is not doomed just because the borrower is upside down. The collateral value plus the financial ability of the borrower must combine to justify any modification. If the borrower has the ability to repay the debt on modified terms, then the loan “will not be subject to adverse classification” just because the value of the collateral exceeds the loan amount.
- The bank must have support for its current estimate of collateral value. The bank must internally adjust the appraisal to reflect market conditions. If the property is rented, the bank must collect rent data and consider the strength of tenants to evaluate collateral values. If special conditions indicate a value decline more than surrounding property, a new appraisal should be considered.
- Satisfactory payment history indicates future payment ability. Borrowers should not be tricked by “loan modification experts” who tell them that defaults gain leverage and sympathy. Defaults make workouts more difficult. Borrowers with difficulties should approach the bank sooner, rather than later. Once repayment under modified terms becomes unlikely, the bank should consider liquidation of collateral by foreclosure.