By Richard Neiman
But a disaster in the diverse CRE sector is not inevitable. Unlike the meltdown in residential subprime mortgages, we have a much fuller picture of the scope of the impending CRE problem. That insight provides a narrow but critical window in which to make course corrections. This issue is of particular interest to New York, given our large market for commercial and multifamily properties, including affordable housing stock.
The Policy Statement on Prudent Commercial Real Estate Loan Workouts issued by the federal banking agencies in October is an important tool for promoting sustainable outcomes for banks, borrowers, and our communities. The statement includes multifamily properties in the definition of CRE, and makes clear that prudent CRE loan workouts are often in the best interests of all stakeholders. It also affirms that examiners will be taking a balanced approach in assessing an institution’s risk management in restructurings of CRE loans.
We will be reinforcing these federal principles in the department’s examination of New York state-chartered banks as well. Stabilizing the CRE sector will require a multi-pronged approach, as the loans at risk are diverse and complex. But this policy statement can make a positive contribution toward the comprehensive solutions that are needed.
The policy statement provides clarity on the regulatory treatment of renewed and restructured CRE loans. It is particularly effective in its standards for CRE loans that are underwater, with collateral that is now worth less than the loan amount. Performing loans, including loans renewed or restructured on prudent terms, will not be subject to adverse classification solely because the collateral value is below the loan amount. And if a bank engages in a prudent workout but the loan nevertheless fails to perform and becomes adversely classified, the bank will not receive regulatory criticism for having tried to do the right thing. These reassurances on the treatment of CRE loans clarifies that banks should do what is in their best interest, to modify CRE loans, by reducing uncertainty in terms of regulatory compliance risk.
This clarity on regulatory standards should not be misinterpreted as laxity, however; the policy statement is not an excuse for banks to attempt an “extend and pretend” approach to troubled loans. Because at the same time that it provides clarity, the issuing of a policy statement also raises the profile of an issue and anticipates closer regulatory scrutiny. Furthermore, fair value can apply to loans held to maturity, not just to loans held for sale or in the trading book. Every impaired held-to-maturity loan that is collateral dependent must be recorded at the fair value of the collateral less estimated selling costs if that amount is less than the loan balance. I would expect banks to be proactively analyzing their own portfolios in light of this statement, promptly recognizing losses and determining whether they have loans that could be prudently restructured.
Perhaps most important of all, a policy statement provides an opportunity for dialogue on an issue with all stakeholders. CRE workouts could be structured with community development goals in mind. Part of the reality check on CRE involves recognition that a property’s best economic use and its best use in terms of community impact may be one and the same. For example, luxury apartment developments constructed during the boom years sit unoccupied, and may have the greatest value today if converted to affordable housing. Foreclosure prevention for multifamily housing can prevent displacement and further neighborhood destabilization, as one in five foreclosures nationwide appear to be affecting renter-occupied units. And in terms of job creation, mortgages that help businesses remain open are critical to economic recovery.
I also serve as a member of the Congressional Oversight Panel for the Troubled Asset Relief Program (TARP), and organized the panel’s hearing on CRE here in New York earlier this year. It is time to revisit this issue, to make the most of the opportunity we have to get ahead of the problem. I look forward to banks’ responsiveness on these issues that are vital to the health of our communities, and to hearing your innovative ideas on stabilizing CRE and multifamily loans.
Richard H. Neiman, superintendent of the New York State Banking Department, writes on regulatory issues for Banking New York.