With the Troubled Asset Relief Program oversight panel warning that many banks face threats to their stability from commercial real estate losses, financial institutions, regulators, credit rating agencies and other industry participants have sharpened their focus on real estate workouts and refinancings.
Bank executives generally focus on the loans they must restructure, reschedule or foreclose on.
We suggest a broader view: This is an opportunity to comprehensively examine how CRE fits within a bank's overall business in light of credit and operational risk, return on capital and bank resources. This includes considering how carefully nurtured commercial and banking relationships that are crucial to long-term success can suffer if a high degree of care is not exercised when tightening lending standards and improving loan quality.
Attempting to avoid unnecessary hardships for affected clients is important. Equally important is managing regulatory mandates and expectations at a time when regulators are signaling their intent to revisit CRE in terms of concentrations, wholesale funding and underwriting standards.
An overarching regulatory standard is the use of risk-based analyses in the administration of financial institutions. In terms of CRE, this analysis extends beyond a review of market conditions, value of collateral and loan exit strategy to how CRE loans fit within a bank's core business strategy (including Community Reinvestment Act concerns). The analysis should include an honest look at the strengths and weaknesses in the bank's workout plan, including people, processes and systems in place, and adequate budgeting for internal cash-flow demands, including writeoffs, loan-loss provisions and unrecoverable restructuring fees and costs.
This is also an opportunity for a bit of introspection: Can the institution build internal mechanisms to prevent underwriting failings from recurring during the next business cycle? For example, should the bank require that modifications of credit standards be done only at a senior level and be reported to the audit committee?
Analysis should lead to a top-down project tailored to the needs of the bank. As this plan is completed, executives should consider both current and future staffing levels. In times of stress, existing resources alone will almost always fall short of the skills, objectivity, global vision and, most importantly, time needed to do the job.
Interim staff can help create the systems and processes for a short-term program and fill in staffing during the execution phase. For example, employees familiar with a loan portfolio might maintain a role in workouts, but additional specialists may play a role in both short-term tactical needs (borrower's business plans, auction collateral appraisals) and long-term strategic needs, such as analyses of market or possible tax and equity investment structures.