Didn't banks learn from the savings and loan crisis in the early 1990s?
In the past few years, many banks and other commercial property lenders have attempted to avoid the impact of commercial real property defaults by granting loan extensions for troubled loans unlikely to return full value on principal and accrued interest.
Proponents of "extend and pretend" cite a myriad of benefits for continuing this controversial practice, such as delaying write-offs, avoiding losses on foreclosed real property and minimizing the harm to the commercial real property market by not flooding the market with REO properties.
The refrain for these lenders is that their efforts are better rewarded by focusing on their expertise, namely lending against commercial real property, as opposed to dealing with distressed commercial real property.
Recently, however, a growing trend of banks and other commercial real property lenders are coming to the realization that delaying the inevitable may lead to more severe problems in the long run, especially in a tenuous economy.
As an attorney representing banks and other commercial real property lenders, I am seeing lenders adopting a more aggressive approach to handling troubled loans that focuses on addressing the core issues concerning the cause of the loan default.
Rather than ignoring these problems and merely extending the loan maturity dates in hope that a better economy may minimize future losses, banks are greatly concerned about the potentially devastating impact that they may face as more and more of their capital is used to fund reserves for an ever increasing troubled loan portfolio, especially as the weight of bloated trouble loan portfolios continues to be a substantial cause in the recent closures of so many banks.
As the commercial real property market continues to struggle, blind optimism in a better economic future is being replaced with concerns about the long-term implications of "kicking troubled loans to the curb."
In short, commercial property lenders have come to the realization that the continued practice of "extend and pretend" without investigating and coming to grips with the underlying problems of the troubled loan is, in the words of one of my lender clients, like "rearranging the chairs on the deck of the Titanic."
Banks are still extending the maturity dates of many commercial real property loans, as they should. However, rather than limiting their alternatives in handling troubled loans to loan extensions, commercial real property lenders are becoming much more engaged in workout negotiations as a tool of assessing the causes of the loan defaults and not shying away from more aggressive recovery strategies if loan extension, in and of itself, will not correct the cause of the loan default.
Replacing the philosophy of extend and pretend are new and creative strategies better designed to stabilize the commercial real property values. For example, if the financial condition of an increasing number of borrowers is deteriorating to such an extent that they cannot afford to maintain their current tenant base and maintain the real property let alone attract new tenants, many banks are realizing that extending the maturity dates of the loans will ultimately provide little benefit to them or the underlying property.
On the other hand, implementing more aggressive policies will not only enhance the retention of existing tenants but also attract new tenants looking for better property management.
It is undisputed that the primary business of commercial real property lenders is to lend money. However, in this difficult economy, banks are being forced to expand their energies and expertise to efficiently handle the many issues surrounding distressed real property. And banks are no longer waiting until after foreclosure to adopt such aggressive practices to enhance their real property collateral. Instead, banks are developing pre-foreclosure strategies often utilizing receiverships and other state law remedies to preserve the value of the real property collateral and prevent the hemorrhaging of rental income. These practices not only enhance the banks' own balance sheets, but also strengthen the commercial real property market by not burdening the commercial real property market with poorly performing properties.
Given the present state of commercial real property market and the gloomy predictions for the future, replacing the passive "extend and pretend" philosophy with more proactive loan management is far more likely to stabilize commercial real property values and shorten the down turn in the commercial real property market.
Kenneth Miller is a partner with the law firm of Ervin Cohen & Jessup LLP, in Beverly Hills.