Bank Regulators Just Might Make Loan Workouts A Little Easier

Federally regulated lenders, such as banks, still play a major role in commercial real estate financing. As commercial real estate encounters headwinds, borrowers will often need relief from those lenders, but regulated lenders typically cower in fear about doing anything that might cause regulators to raise their eyebrows or ask difficult questions. This mentality often leads regulated lenders to behave with a level of flexibility, creativity, cooperation, and speed reminiscent of the Internal Revenue Service. Result: workout negotiations can become difficult or impossible. Sometimes a loan that might have been “saved” if given more time and TLC instead goes into default and foreclosure.

The federal bank regulators may have tried a bit to change that dynamic when they recently issued a joint policy statement on commercial real estate loan accommodations and workouts. Whether anything has actually changed will, of course, remain to be seen.

The policy statement opens by recognizing “the importance of financial institutions working constructively with CRE borrowers who are experiencing financial difficulty.” It refers to a policy statement issued in 2009, another time when commercial real estate also faced problems. Today’s policy statement doesn’t purport to revolutionize bank regulation, but it does reaffirm that lenders should exercise some flexibility and judgment in dealing with borrowers in trouble. It restates two general principles from the 2009 guidance:

1. Financial institutions that implement prudent CRE loan accommodation and workout arrangements after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for engaging in these efforts, even if these arrangements result in modified loans with weaknesses that result in adverse classification.
   
   
2. Modified loans to borrowers who have the ability to repay their debts according to reasonable terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the outstanding loan balance.

Those general principles sound pretty good, if regulated lenders dare to apply them. The regulators’ guidance also encourages use of short-term measures to help borrowers through rough patches, rather than declaring those borrowers in default. Short-term or temporary accommodations “can mitigate long-term adverse effects on borrowers by allowing them to address the issues affecting repayment ability and are often in the best interest of financial institutions and their borrowers,” according to the regulators.