Earlier this year, federal regulators relaxed the "mark-to-market" accounting rules that forced banks to tell the truth about what their assets were worth.
This allowed banks to pretend that assets were worth, say, 90 cents on the dollar when their market value was closer to 50 cents. This makes the banking system seem much healthier than it is (look, ma, no writeoffs!). But because the market value of the assets is 50 cents for a reason, the change has likely just prolonged the agony. Instead of banks that would have been fixed rapidly, if painfully, by marking to market, we've got zombie banks.
And, now, regulators have essentially done the same thing for commercial real estate loans.
The commercial real-estate crisis is taking a while to play out, and the new rules will ensure that it takes even longer. Instead of having to foreclose and take writeoffs, the new rules encourage banks to modify existing commercial real-estate loans, even when the value of the asset has fallen below the value of the loan.
Because interest rates are so low, many commercial real-estate owners, especially those with long-term leases, are not having trouble making payments, even when the value of their buildings is well below the amount they owe. These property owners would not be able to refinance the loans because of the loan-to-value problem, so when the loans come due, they might be screwed.
There's nothing wrong with encouraging modification: If modification allows these companies to hold onto their properties until values recover, then the tactic will work. If, however, values don't recover in time, the modifcations will just kick the can down the road.
Why?
Because, as the value of the buildings have fallen, rents have, too. As current leases roll off, therefore, rents will drop, which will make payments harder to make. If interest rates ever rise, moreover, the payments will become even more of a burden.
So it's easy to imagine a scenario a few years down the road in which rates are moving higher and building values and rents are still in the tank. This could prompt the wave of defaults that we're just postponing now.
In the meantime, moreover, we will be prolonging the illusion that the banks are healthy. The modified loans will still be classified as "performing" and carried at par--even though the actual asset value is far lower.
Lingling Wei, WSJ: Federal bank regulators issued guidelines allowing banks to keep loans on their books as "performing" even if the value of the underlying properties have fallen below the loan amount.
The volume of troubled commercial real-estate loans is skyrocketing. Regulators said that the rules were designed to encourage banks to restructure problem commercial mortgages with borrowers rather than foreclose on them. But the move has prompted criticism that regulators are simply prolonging the financial crisis by not forcing borrowers and lenders to confront, rather than delay, inevitable problems.
The guidelines, released on Friday by agencies including the Federal Deposit Insurance Corp., the Federal Reserve and the Office of the Comptroller of the Currency, provide guidance for bank examiners and financial institutions working with commercial property owners who are "experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or renting commercial properties." Restructurings are often in the best interest of both lenders and borrowers, the guidelines point out.
Read the whole thing >
Here are the new guidelines: bcreg
Paul Stillwaggon,
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