Yesterday, we began our discussion on the new Policy Statement on Prudent Commercial Real Estate (CRE) Loan Workouts just released by the regulatory agencies. While it is a robust set of guidance, it does appear to provide a cautious yellow light generally supportive of using CRE loan workouts to solve issues related to otherwise creditworthy borrowers. This is not a bright green light to restructure every CRE loan in the book, but neither is it a red light. Proceeding cautiously at this point will help both borrowers and lenders. One of the things the new guidance accomplishes is to allow a road to restructure certain qualifying higher LTV loans with a limited impact to capital.
Some specific things community bankers should do to avoid being criticized when it comes to restructured loans include having a strong workout policy that not only spells out loan terms and amortization schedules, but also allows the bank to modify the workout plan if sustained repayment performance is not demonstrated (or if collateral values do not stabilize). Banks should have a reasonable plan for each credit that analyzes current borrower financials and the ultimate collection of P&I.
Other key elements of a workout plan include obtaining: updated and comprehensive financial information on the borrower, the project and any guarantors; current valuations of the collateral; analysis and determination of appropriate loan structure, curtailment, covenants or re-margining requirements; appropriate legal documentation for any changes to loan terms; analysis of the borrower's global debt service (the aggregate of a borrower's or guarantor's financial obligations, including contingent obligations) that reflects a realistic projection of expenses; having systems to monitor performance of the borrower and guarantor under the terms of the workout; a grading system that accurately and consistently reflects the risk in the workout arrangement. The ALLL should also cover estimated credit losses in any restructured loan and recognize losses in a timely manner (through provisions and charge-offs).
Per the guidance, regulators will be placing a greater weight on cashflow, assessing the borrower's ability to repay the loan based on reasonable terms and cashflow potential of the underlying collateral or business. Factors examiners will analyze: borrower character, overall financial condition, resources and payment record; protection provided by the cash flow from business operations or the collateral on a global basis; market conditions that could impact repayment prospects; potential of the business operations or collateral; prospects for repayment support from any financially responsible guarantors. Those are all good to hear for many community bankers that have been prudently lending for years and already collect such information.
When it comes to guarantors, the guidance spells out specific things regulators will be looking for. These include: how financially responsible the guarantor has historically been; whether the guarantor has both the financial capacity and willingness to provide support for the credit through ongoing payments, curtailments or re-margining; whether the guarantee is adequate to provide support for repayment of the indebtedness, in whole or in part, during the remaining loan term and ensuring the guarantee is written and legally enforceable. To make sure regulators are comfortable, bankers should have enough information on the guarantor's global financial condition, income, liquidity, cash flow, contingent liabilities and other relevant factors
(Including credit ratings) to demonstrate capacity.
We have much more to cover related to the policy statement, but overall, it appears to be a positive step by the regulatory agencies from a community banker's standpoint. The problem at this point unfortunately, is one of timing. Already, so many community bankers we know are road weary from recent examinations; few are willing to take any chances. As such, we project it will take an exam cycle before banks once again feel comfortable enough to proactively restructure CRE loans on any large scale basis. The good news is that the light appears to once again be yellow for regulators. For community bankers, time and first-hand exam experience are needed to change the light from red to yellow.