Inside Financial Services

Extending, But Not Pretending

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In the course of agreeing with not a syllable of my post earlier this week regarding Nouriel Roubini’s inability to kick his doomsaying habits, commenter “No Banker Left Behind” hurls the following charge of hypocrisy:

Interestingly, while you rail against the idea of residential mortgage modifications (write downs), I don’t sense the same indignation at modifications made in banks CRE portfolio’s [sic].

NBLB raises an interesting point! There’s an important reason why modifications of CRE loans often make sense for lenders, while residential loans mods tend to be exercises in futility. It’s this: even stressed CRE properties tend generate some cash, while stressed residential properties don’t. In the near-term during a downturn, therefore, a prudent lender might restructure a loan in order to capture as much of those dwindling cash flows as it can, as an alternative to foreclosure, in anticipation of an economic recovery and a loan re-restructruring to something closer to its original terms later on. It really isn’t hard to make some macro assumptions, run an NPV, and come up with a number that’s much preferable than what would be left after foreclosure and disposal.

Delinquent residential properties, by contrast, generate squat. Very often, the borrower has no income whatsoever, and is working through his savings. There’s no number a lender can restructure the loan down to that would make any economic sense. Usually the best alternative for the lender is to foreclose and move on.

That’s why I always laugh at banking critics who pooh-pooh commercial loan modifications as “extend and pretend.” They’re anything but that. Lenders who modify CRE loans understand that the cycle will turn and that, once it does, the borrower’s cash flows will improve. Loan mods in the interim simply take account of that. It’s the lenders modifying residential loans that are the ones extending and pretending. If you doubt it, look at the numbers. They’ve been so bad for so long, I’m surprised the loan-mod fetish persists.

As to the rest of NBLB’s points, I’ll let them stand, except to point out that he’s the one who notes that the number of delinquent commercial-backed securities has fallen for three months in a row, not me. As for me being a shill for the banking business, with so many stocks trading at just over 1 times tangible book, I’ll shill all day long.

What do you think? Let me know!

10 Responses to “Extending, But Not Pretending”

  1. No Banker Left Behind

    TB: Thanks for responding to my comments. I have to say I was quite surprised to see that they generated a column and not just a blurb from you down in the comments section where I and other folks with too much time on their hands inhabit. I have aired a number of missives in this comment section over the last couple of years; admittedly, most of them were laced with sarcasm and, at times, somewhat snarky, as I’ve been hard pressed to agree with your views. Today I’ll try and engage in a more thoughtful dialogue sans the attitude. Here’s the sand in my eyes: during this financial crisis I believe you’ve been too tied to financial and credit models that now appear far less robust than once believed (see Alan Greenspan in his testimony to Congress). From my vantage point, the worse things became, the more stubborn you were in adhering to those views. With apologies to you and readers for its length, let me quote you from mid-2008 column:

    Have I hedged myself sufficiently? Good. For, as it happens, I believe July 15, 2008 will turn out to be as good a date as any to mark the end of the long, painful bear market financial stocks have endured for the past 18 months. And more to the point, it marks the beginning of the greatest financial stock bull market in our lifetime, one that will be much broader than the bull market that began in 1990.

    Caution! The observation above is offered to investors only. If you can’t stand the idea of seeing another, say, 20% on the downside, please stop reading at once and head back to If you measure your investment horizon in weeks or months, please, for your own good and sanity, leave this site pronto.

    But if you understand what drives stock prices, and have an investment time horizon of at least one year, feel free to keep reading. And if you are a patient value investor, get out your highlighter and get ready to buy stocks.

    I believe the current valuations of scores–even hundreds–of financial companies are wildly

  2. No Banker Left Behind

    (CONT) models. I don’t know what’s on the balance sheet and what’s off, so do it’s hard for me to have great confidence in their reported “tangible book” value. As you rightly point out, the number of delinquent CBS’s has come down each of the last three months, yet the overall percentage stands at an historical high and is continuing to climb. Perhaps the trend will be your friend, things in the commercial space will improve, and your view will be borne out. That said, having seen many things over the last three years that “couldn’t happen” happen, I’m far less sanguine than you. Are they modifying loans or just kicking the can down the road?

    Finally, did you see the news on Elizabeth Warren? It seems she isn’t as far afield as you may have suggested (See column “Boy, is this going to hurt….). Today, it was announced she’d appointed two Wall Street bankers and a former Freddie Mac official to top positions in the “dreaded” CFPB. Even Financial Services Roundtable applauded.

    Well TB, even I have more interesting things to do on a Friday night so let’s call it a day (for those who disagree with me, insert nasty comments here). I will continue to read and comment from time to time, though I’ll try and find my more “civil inner commentator”. All I ask is a column on something other than NR, MW, and those dirty, rotten regulators (see, change is hard……..)

  3. JRG

    The decision to make a modification on a CRE loan depends on a number of factors and is not as simple as you portray it. It may make sense if the borrower needs more time to lease up a property and there is a reasonable probability that the rental/sale market is viable and will offer a decent chance for success. Also you may have a strong liquid guarantor who can support the project. The appraisal has a lot to do with this also. If the stabilized value of the property is less than the loan balance an extension or interest only period will not work. The loan needs to be rebalanced back to an acceptable LTV. What is not acceptable is to offer an extension or interest only when there is little hope that the project can stabilize and repay the loan either through a sale, take out or normal amortization. Offering modifications on a problem loan to avoid a down grade or loss is what “pretend and extend” is about. The relality is that there are a lot of bad CRE loans out there where no amount time will save them. The “cycle” wont save these loans because they were underwriten at the peak of the market. How long will it take problem large retail projects underwritten in 2007 to recover, most of them won’t. This is a big issue with regulators and if you don’t think its a problem spend some time reading a few C&D orders. There are plenty to look at.

  4. Bob

    Another important point on loan mods. In the last cycle, regionals lagged coming out of the cycle but caught up as recoveries increased 1992-95. The regionals worked with their customers in restructures and loan mods ect and came out of the cycle with loyal customers. When the cycle improved, those regionals also saw revenue growth from that loyal (cemented) customer base.
    To use Tom Hanley’s quote…the next 5 years were bank heaven as M&A accelerated with the big banks buying the regionals in the never ending quest for revenue growth. Fact is, the big banks had alientated many with hard line work out tactics. The cycle will turn and in the end, we will once again see that the punitive, arm chair quarterbacking pendulum swung too far once again.

  5. Thor

    JRG – You can’t tell anything from a C&D/Consent order…they are boilerplace. Most banks these days are moving towards Loan A/Loan B structures and partial charge offs as part of the modifications.

  6. ex banker in California

    Not exactly a valid comparison. You should compare modifications or take backs of CRE loans to short sales of residential mortgages. And also the number and amount of defaulted residential mortgages should be adjusted by netting out those defaults where the borrower could not get their bank to accept a short sale. Out here in California everyone can relate multiple horror stories of banks refusing to accept a valid short sale on a residential property . Bottom line to consumers — if you cannot reach agreement with your mortgage holder to accept a short sale and you project that your property value will not equal the principal amount on your mortgage for at least seven – eight years then JUST WALK AWAY. This scenario no different than Morgan Stanley walking away from five office buildings and their mortgages in San Francisco in December 2009.

  7. Yes, CB

    I remember hearing this same case made from a lender around during the last round of 1980′s stagflation. A lot of goodwill created in those modifications, but competition was different then with funding a lot less fungible. Time loves a hero and only time will tell what this landscape looks like when the Fed decides to do something with the $3T in balance sheet reserves. Extending the lending might prove very smart in the next round. But hard to imagine that happening as the views of spineless regulators shift with the prevailing winds. The Phillips curve is dead, and it’s going to be a bumpy ride for banks that are long CRE duration. Thank goodness for competition.

  8. JRG,

    Thor, although anecdotal, my experience along with numerous discussions with regulators is that some (most?)troubled banks have been using extensions to avoid downgrades, non accrual and charge offs. When you read comments in consent orders about improving credit mangement practices its normaly about grading, problem loan recognition and problem loan mangement. A&B note structures have been around a long time and is a form of a TDR and only makes sense if the project is generating adequate cash flow to structure a conforming A note. I’m not hearing the regulators allowing these structures for problem ” for sale” projects like stalled residential lot loans and condos If you meet the accounting rules you can take interest into income as received and eventually put the loan back on accrual which is the attractive to the bank.( on the A note only) Again its a modification tactic that recognizes the inherent loss in the loan but will only work if there is demonstrated cash flow coming of the project. Tom’s point about modifying a loan while waiting for the market to turn is a bad lending prarctice and the regulators won’t let you do it anyway.

  9. S stark

    I hope you are finished pumping Synovus stock for the imaginary upturn. Your perspectives on other issues suffer from a serious credibility gap after riding that dead horse for so long.

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