Federal regulators have adopted new guidelines that allow lenders more leeway in dealing with troubled commercial real estate loans.
Commercial real estate owners are experiencing diminished property values and cash flows, and sales and rental absorption has not occurred as projected for most new projects. As existing loans mature, property values are sometimes insufficient to support new financing, particularly with the lower loan-to-value ratios that lenders are now requiring. The new guidelines acknowledge these issues, and set out parameters for lenders who are negotiating extensions and modifications of existing loans.
Under the new guidelines, restructured loans will not be classified as "nonperforming" solely because the value of the underlying real property is less than the loan balance. The classification of a loan has a significant impact on the lender's reserve requirement for that loan, and therefore will affect whether the lender is willing to extend the loan, and the terms on which the lender would grant the extension. Under the guidelines, any loan restructuring must be "prudent" and the lender must have a reasonable expectation, based on current project and borrower financials and current valuations of the collateral, that the borrower will be able to repay the loan under the terms of the modification. Both the borrower and any guarantors must have financial capacity and willingness to repay and support the loan. For the current valuation, a lender can rely on the original appraisal, as long as the lender updates the original appraisal assumptions to reflect current project plans and market conditions.
The guidelines caution lenders against structuring the loan modification in a way that might obscure the borrower's inability to repay the restructured loan--for instance, by relying on an interest reserve funded by the borrower from other sources at a time when the project, though complete, is not generating sufficient income to make the restructured debt payments.
Critics of the new guidelines have argued that they encourage borrowers and lenders to "extend and pretend," delaying the inevitable failure of these loans and sale of the real estate that secures these loans, slowing the real estate market's progression toward equilibrium, and keeping banks from using their capital to make new, solid loans. However, for projects that are producing enough income to meet loan payments, but that have experienced a significant drop in value, the new guidelines may provide the help needed to get through the current tough times.
Otten Johnson's Real Estate Finance and Troubled Credits practice groups have substantial experience dealing with issues relating to distressed real estate loans. For more information on this Client Alert or on addressing distressed real estate loan issues, contact any of the attorneys in the Real Estate Finance or Troubled Credits practice groups (for a listing of the former, click here).
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