Banks across the country face a bleak and still sinking commercial real estate market. Most experts predict rising loan-loss reserves and more big writeoffs. The problems are particularly severe at community banks, many of which still face FDIC intervention and are least likely to have the in-house skill and experience to work out problem loans.
Typically, community banks still rely on their lending staff to handle workouts. Yet this is almost certainly the least effective way to minimize losses, preserve hard-won relationships and best serve customers or shareholders. Here's why.
The best lenders are people who thrive on developing relationships with borrowers, and very often they have customers, acquaintances from their own communities, whom they have spent months and years cultivating. Lenders see themselves as builders of relationships and businesses; by their nature, they are neither suited nor disposed to the work of untangling problem loans — especially in the volume and bewildering complexity that's being seen in today's market. Loyalty to their customers may prevent them from doing what's prudent and necessary.
Unfortunately and somewhat surprisingly, bank managers often don't realize this until it's too late. I have sat opposite many bank executives who, within days or weeks of insisting they could handle their problems, found themselves shuttered by the FDIC.
While regional and national banks with large portfolios have workout departments that take over distressed commercial loans, community banks do not. It makes sense, then, that community banks should consider workout consultants to help reduce loan losses and retain their commercial customers.
• A $1 billion bank had significant commercial loan problems that were exacerbated by the close relationships between the bank's lenders and borrowers. Troubled borrowers had persuaded lenders to provide additional time and money before renewing their payments, but the payments never came.
A workout consultant reviewed each borrower's situation and determined who could survive and who would not. Where the relationship could be salvaged, the consultant worked with borrowers to help restore their businesses. Some loans required the consultant to perform receivership functions, outside of formal bankruptcy, in order to control the business' cash flow. This bank avoided millions of dollars of losses.
• A $200 million bank had a $2 million participation in an acquisition and development loan. When the lead bank succumbed to the FDIC, the borrower went to the participating bank to convince it to lend another $2 million to complete the development phase and build some model homes. The borrower presented a marketing study showing that the project, with the additional investment, was feasible. Unable to evaluate the study's veracity, the participating bank hired a workout consultant. Its review determined the project was not feasible and that any additional investment would most certainly be lost. The consultant also determined that the lead bank, the borrower and others had misled the participating banks, resulting in an investigation for civil and criminal action.
Whether through miscalculation or overconfidence, many community banks misjudge their ability to recover all the value they can from problem loans.