For more than a year now, multifamily equity funds, owners, and brokers have complained about the “extend and pretend” policy in the banking industry that has allowed owners with troubled loans to keep their assets. At the 2010 ULI Fall Meeting this week, Shelia Bair, chairman of the Federal Deposit Insurance Corporation (FDIC), defended that policy.
“Some have criticized these loan workouts as a policy of extend and pretend,” Bair said. “But the restructuring of these commercial real estate loans around today’s cash flows and today’s interest rates may be preferable to foreclosure and forced sale of distressed property.”
Bair said that FDIC-insured institutions hold half of the $3.5 trillion in outstanding commercial real estate (CRE) loans. Last fall, the FDIC issued guidance designed to provide more clarity to banks on how to report those cases where they have restructured commercial loans, which Bair said was an important step to reduce uncertainty as to how restructuring efforts would be reported.
One attendee asked Bair why a Resolution Trust Corporation (RTC)-type instrument hadn’t been established to clear troubled assets. Bair responded that that even without the RTC, some assets were being cleansed from the system. “There’s plenty of property going into foreclosure,” she said. “I don’t think there’s any shortage there.”
But Bair did remind the audience that even under the RTC there were also a lot of loan restructuring. She says there are a lot of RTC veterans of the FDIC staff who support loan modifications if they make economic sense.
If foreclosure yields the highest return, that would be the best option, though. “If you have the cash flow to keep making payments it will probably be worth it to you to restructure the loan and keep the loan performing versus selling it off as a distressed sale. It’s simple economics,” she said.
Putting Money Back Out
Bair didn’t just field questions about current loans. On the mind of many people was when banks would start extending new loans. Bair answered by saying that regulators were trying to strike a balance.
“There was too much credit out there in the past,” Bair said. “You don’t do borrowers any favors by making them loans that they cannot repay and supporting projects that aren’t viable.”
Bair said that smaller lending institutions were keeping consistent loan balances, but that she was continuing to see declines in large bank loan balances each quarter in spite of borrower demand. “As regulators, you can’t force banks to extend credit, but you can certainly have sound regulatory policy that’s balanced and emphasizes the obligations of banks to do their basic function, which is credit intermediation and to support the economy and continue to drive them to do that,” Bair said.
Regardless of when money starts flowing out of banks again, Bair emphasized that lenders can’t repeat the mistakes of the past. “Going forward, as is the case with residential mortgages as well, we need better risk management and stronger lending standards for bank and loan originators to help prevent a reoccurrence of problems with commercial real estate finance in the future,” Bair says.