FDIC Adopts Guidance on Prudent Commercial Real Estate Loan Workouts

FDIC Adopts Guidance on Prudent Commercial Real Estate Loan Workouts

FOR IMMEDIATE RELEASE
October 30, 2009

The Federal Deposit Insurance Corporation (FDIC), in coordination with the other member Agencies of the Federal Financial Institutions Examination Council (FFIEC), adopted a policy statement today supporting prudent commercial real estate (CRE) loan workouts. This policy statement stresses that performing loans, including those that have been renewed or restructured on reasonable modified terms, made to creditworthy borrowers will not be subject to adverse classification solely because the value of the underlying collateral declined.

This policy statement provides guidance to examiners, and financial institutions that are working with CRE borrowers who are experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or renting commercial properties. It also recognizes that during these difficult economic circumstances, continued credit availability to businesses, especially small businesses, is challenging, even where borrower performance has been acceptable. This policy statement reflects the appropriate balance of prudent credit practices and meeting legitimate credit needs.

The FFIEC Agencies recognize that prudent loan workouts are often in the best interest of both financial institutions and borrowers, particularly during difficult economic conditions. This policy statement details risk-management practices for loan workouts that support prudent and pragmatic credit and business decision making within the framework of financial accuracy, transparency, and timely loss recognition. Financial institutions that implement prudent loan workout arrangements after performing comprehensive reviews of borrowers' financial conditions will not be subject to criticism for engaging in these efforts, even if the restructured loans have weaknesses that result in adverse credit classifications.

The policy statement includes examples of CRE loan workouts. The examples, provided for illustrative purposes only, reflect examiners' analytical processes for credit classifications and assessments of institutions' accounting and reporting treatments for restructured loans. The policy statement reiterates existing guidance that examiners are expected to take a balanced approach in assessing institutions' risk-management practices for loan workout activities.

The member Agencies of the FFIEC include the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the FFIEC State Liaison Committee. The FDIC currently chairs the FFIEC.

http://www.fdic.gov/news/news/financial/2009/fil09061a1.pdf

CLARIFICATIONS AND CHANGES TO THE REMIC RULES

The Commercial Mortgage Securities Association has issued the following talking points in regard to modification of commercial mortgages within Real Estate Mortgage Investment Trusts (REMIC's)

CLARIFICATIONS AND CHANGES TO THE REMIC RULES




The changes to the REMIC Rules addressing CMBS loan modifications issued by the IRS have garnered significant attention and commentary from CMBS industry participants and spectators, sparking a conversation among borrowers, lenders, servicers, investors, and industry groups about the practical effect these changes will have on their business. While the Revenue Procedure and Regulations relax certain constraints on modifying mortgage loans held in REMICs, it is not clear how significant an impact these changes will have in practice.

1. The flexibility incorporated into the changes in the REMIC Rules may allow modifications to be made earlier without incurring adverse tax consequences if the servicer reasonably believes that there is a significant risk of default. These changes do not, however, accelerate the timing of transfers to the special servicer, allow for modifications not in the best interest of the certificate holders, negate the need for special servicer or controlling class holder approvals, or amend any terms of the servicing agreements governing servicing of the loan. Therefore, the impact of the new REMIC guidelines in existing transactions will not be significant.

2. As has always been the case, borrowers should work with their servicers when they have questions or concerns.

(a) The primary servicer remains the initial point of contact for the borrower. The borrower most likely sends loan payments and financial statements to the primary servicer and the primary servicer is the day to day contact for the borrower. The most effective means of communication with the servicer is by providing a specific written request with supporting documentation regarding the status of the loan, collateral property and market. The changes to the REMIC Rules do not change this.

(b) Under the Pooling and Servicing Agreement (“PSA”), it is the primary and master servicers who are responsible for the loan while it is performing, and the special servicer will, in most cases, take over responsibility should the loan go into default or be at risk of imminent default. The changes to the REMIC Rules do not change this.


(c) The provisions of the PSA determine whether the special or master servicer will work with the borrower on a proposed amendment or extension. In virtually all cases, the special servicer is responsible for these matters. In general, it is the master servicer, governed by the terms of the PSA, which determines if and when a loan should be transferred to the special servicer. The changes to the REMIC Rules do not change this.

(d) A borrower’s and lender’s rights and obligations with respect to the loan are set forth in the loan documents. Any change or modification to the loan documents must be agreed to by the lender and borrower. Once a loan is securitized, the servicer represents the collective interests of the Trust. The changes to the REMIC Rules do not mean that a lender/servicer is required to agree to any modification, amendment or waiver of the terms and conditions of the loan documents.




(e) All servicers must adhere to the servicing standard (the “Servicing Standard”) which places a responsibility on the servicer to act in the best interests of the investors under the trust and other interest holders in the loan. If the loan becomes troubled, and the servicer concludes a modification is the route to the highest recovery on a net present value basis for the collective interest of the bond holders and other interest holders, it will be pursued. If a foreclosure is the best route, it will be pursued. The changes to the REMIC Rules do not change this.

3. While the REMIC Rules play an important part in the overall structure of the commercial mortgage‐backed securities market, the REMIC Rules and the recent clarifications and changes to the REMIC do not change:

(a) The terms of:
(i) the mortgage loan documents governing the loan;
(ii) the PSA that specifies the responsibilities and duties of the loan servicers, the rights and priorities of investors and the timing of transfers to the special
servicer. Generally transfers can only occur in the case of a default or imminent
default which will not be cured within a specified period of time. This is not the
same as a “reasonably foreseeable default” as described in the Revenue
Procedure.

(b) The Servicing Standard is the criteria servicers must use when evaluating potential extensions or other loan modifications. It remains the same and servicers still cannot change the terms of a loan unless the changes, taken as a whole, benefit the investors and other interest holders of the Loan.

4. The REMIC Rule changes loosen some tax restrictions and enhance opportunities for discussion of loan extensions or other modifications without concern that such actions would threaten the REMIC status of the trust. Now, if, based on all the facts and circumstances, the servicer reasonably believes that there is a significant risk of default upon maturity of the loan or at an earlier date, then the IRS will not challenge the REMIC status of the trust if the loan is modified, provided the balance of the requirements set forth in the REMIC Rules are met. This, however, does not mean that under any PSA a loan can be modified simply because the tax rules permit modification.

5. If a borrower believes a significant risk of default exists and wants to request a loan modification or extension, the borrower generally should:

(a) Conduct a review of the loan documents to determine their contractual rights and obligations.

(b) Carefully analyze their property condition, performance and outlook to determine what factors indicate a significant risk of default, and make an assessment of the best plan to enable the borrower to perform its obligations under the loan.

(c) Prepare a written request outlining the results of the assessment, together with a proposal for the lender to consider. Factors generally considered by servicers in reviewing such a request include the original use of the mortgage proceeds, the current condition of the property and its income stream, projections regarding how that income stream will change over the course of the remaining loan term, significant lease non‐renewals or terminations, the number and timing of refinance applications and rejections, equity infusions or contributions the borrower is prepared to make, and other factors affecting the requested loan modification or extension, including guarantees or additional collateral. It is important to provide evidentiary back up to support forecasts, conditions and assumptions.

(d) Communicate in writing with the servicer to which the borrower submits its monthly debt service and financials reasonably in advance of the perceived events creating risk of default.

Peter Schiff on Real Estate Investing

In this video, Peter Schiff who is running for Senate in CT offers his perspective on real estate investing. Schiff, who correctly predicted the housing bubble and collapse is still bearish on real state in the US and recommends investments outside the United States.

Interagency Bank Regulators Prepare Commercial Modification Guidance

Washington bank regulators are putting the final touches on administrative guidance to banks on commercial loan work outs. The guidance will be designed to allow banks to modify the terms of loans that are maturing or going into default within the framework of the regulatory agencies.

In testimony last week Federal Reserve Gov. Tarullo said the following in a prepared statement.

We are currently in the final stages of developing interagency guidance on CRE loan restructurings and workouts. This guidance supports balanced and prudent decision making with respect to loan restructuring, accurate and timely recognition of losses and appropriate loan classification. The guidance will reiterate that classification of a loan should not be based solely on a decline in collateral value, in the absence of other adverse factors, and that loan restructurings are often in the best interest of both the financial institution and the borrower. The expectation is that banks should restructure CRE loans in a prudent manner, recognizing the associated credit risk, and not simply renew a loan in an effort to delay loss recognition.

Chairman Bair from the FDIC added the following.

In addition, the federal banking agencies will soon issue guidance on CRE loan workouts. The agencies recognize that lenders and borrowers face challenging credit conditions due to the economic downturn, and are frequently dealing with diminished cash flows and depreciating collateral values. Prudent loan workouts are often in the best interest of financial institutions and borrowers, particularly during difficult economic circumstances and constrained credit availability. This guidance reflects that reality, and supports prudent and pragmatic credit and business decision-making within the framework of financial accuracy, transparency, and timely loss recognition.

This guidance is expected soon and it will be posted on this blog as soon as it is available to the public.
Register at www.commercialmodification.com if you are a commercial property owner and would like to have a consultation with an experienced commercial mortgage negotiator.

Regulators Discuss Commercial Loan Modification

Last week, the nations top banking regulators met on Capitol Hill to report to the Senate Banking Subcommittee on the financial health of the nations banks and financial industry. The panel included Sheila Bair, Charmain of the FDIC, and other regulators from the Fed and OCC.

The officials told the committee that losses on CRE loans posed the biggest risk to the banking system and in particular smaller banks whose exposure is greater to commercial real estate loan losses. Regulators said the government would issue guidelines to help the banks modify commercial mortgages.

Ms. Bair said that they are in the final steps of releasing administrative guidance to banks with examples as to what would be a prudent loan work out for commercial borrowers.

FHA the new subprime hazard

Please consider this discussion of the FHA with Larry Kudlow which I wrote about last month.  My original blog post appears below.

 

FHA - The new subprime hazard

Wednesday, September 2, 2009

With the FHA replacing the subprime mortgage market with ridiculous underwriting guidelines we are setting ourselves up for the next bailout. Why does the government allow this foolishness? Lending with just 3% down is utter folly and the epitome of stupidity. Add the tax credit for people have not owned a home in 3 years (so-called first time home buyers) and that makes it 100% financing. If the market drops another 10, 20 or 30% do you think these borrowers are going to make the payments? Many won't. Too many to sustain the FHA causing it's ultimate failure.

Interest in commercial loan modification business intensifies.

Interest in the commercial mortgage modification consulting business has intensified as the residential loan modification industry in California is squashed in its infancy by SB 94. 

The law prohibits advance fees for loan modifications on residential properties of 4 units or less.  The new statute was enacted to protect the public from a group of attorneys (16 in total are being investigated) who allegedly took advantage of vulnerable homeowners by collecting advance fees without obtaining results for the clients. In a few cases homeowners actually lost their homes when they believed the attorneys in question were processing modifications on their behalf.

In one fell swoop thousands of for-profit housing counselors, intake clerks, receptionists and loan modification processors got pink slips this week.  While there are some companies that will remain in the business, they can no longer collect any fees until specific work and milestones have been completed. 

Essentially an attorney or loan modification company would have to provide unsecured financing for people who have already demonstrated their inability to pay.  Recent data show that over 50% of modified mortgages re-default within six months. This demonstrates the fact that the credit risk is too great for service organizations that rely on income produced by service fees to finance continuing operations. 

Those who have built their livelihood on helping homeowners get modifications in California have to find a new line of work. Homeowners will have a hard time finding  someone that will take their case under the new statutory terms.

Mortgage brokers and attorneys who were doing residential loan modifications are now looking at the commercial mortgage modification business as an alternative.  Advance fees and retainers are not prohibited for commercial property under SB 94.

There are many misconceptions about the commercial mortgage modification business especially in how it relates, in scope to the residential business.  Let's have a look at the numbers. 

There are about 125,000,000 single family homes in the United States.  Extrapolating the data released from RealtyTrac today who said that foreclosure reached one in every 136 homes, gives us a little over 900,000 homeowners in imminent danger of losing their home.  Several hundred thousand more loans will default in the coming quarters as Alt-A and the toxic pick-a-payment loans reset in 2010, peaking in 2011.

The commercial property marketplace is much smaller in terms of the number of property owners.  There are about 5 million commercial properties in the US. With the default rate on commercial loans running just under 3% this represents about 150,000 properties in which the owner is in need of modification consulting.  There are more potential clients that are not in default but this number represents a nominal market place population of under 50,000 individuals since many commercial property owners have more than one property.

With the termination of an entire industry in California, somewhere around 10,000 and  25,000 entrepreneurs and their employees in California are looking for a new business model.  Many are exploring commercial modification as a new line of work.

The misconceptions about the commercial modification business starts with the numbers and continues with the scope of work required to complete a successful modification.  In residential modifications, 70% of the deals were cookie cutter deals that fit nicely within the Obama modifications plans like HAMP and Making Home Affordable and other programs put forth by the FDIC and Federal Reserve.  There are rarely any negotiations.  The loan mod company simply submits a package that has been underwritten according to the guidelines published by the FHA, FNMA and Freddie Mac and approved by the loan mod company before being sent to the loan servicer.  This is why many companies claimed a 90% or more success rate. They were easy to do if you knew how to get it done.

The commercial modification business involves real negotiations, in-depth market research, financial analysis and hours of tedious data collection, discovery, verification and reporting.  Most of this is foreign to the residential mortgage broker turned loan modification consultant.

I am getting several calls and inquires everyday from loan mod companies who are in this position.  On one call I got, the owner of the company who has been processing hundreds of deals per week for residential modifications asked me how much for commercial leads and could he get a volume discount.  I asked what he needed and he replied that he needs 500-1000 leads per week.  I chuckled. 

The nitty gritty on SB 94

I found a very good, factual article on SB 94 courtesy of 360 Realty in Los Angeles.

The new law prohibits any person (including real estate licensees) who negotiates, attempts to negotiate, arranges, attempts to arrange, or otherwise offers to perform residential mortgage loan modifications or other forms of mortgage loan forbearance, for a fee or other compensation, from: claiming, demanding, charging, collecting or receiving any compensation until after the licensee has performed each and every service the licensee contracted to perform or represented that they would perform. In addition, licensees cannot take any wage assignment, any lien secured by real or personal property, or any other kind of security to secure payment of compensation in association with their acts. Moreover, no licensee can take any Power of Attorney from any borrower, for any purpose. This part of the law applies to 1-4 residential units only. Violation of this provision would constitute a misdemeanor, with a fine of up to $10,000, plus up to one year in jail. If the violator is a corporation, the maximum fine increases to $50,000. These remedies are in addition to any others imposed elsewhere in the law. The bill specifically exempts parties who own or are servicing the loan in question before the terms of the loan are modified.

Further, the new bill requires any person, including licensees, to provide the following written disclosure in at least 14 point bold type regarding loan modification fees prior to entering into any fee agreement with a borrower:
It is not necessary to pay a third party to arrange for a loan modification or other form of forbearance from your mortgage lender or servicer. You may call your lender directly to ask for a change in your loan terms. Nonprofit housing counseling agencies also offer these and other forms of borrower assistance free of charge. A list of nonprofit housing counseling agencies approved by the United States Department of Housing and Urban Development (HUD) is available from your local HUD office or by visiting www.hud.gov.

If loan modification or other loan forbearance services are negotiated or offered in Spanish, Chinese, Tagalog, Vietnamese, or Korean, a translated copy of the statement above must be given to the borrower in that foreign language. A real estate licensee who violates this new law would be subject to discipline by the Department of Real Estate, and violation of this provision would also constitute a misdemeanor, with a maximum fine of $10,000, and up to one year in jail. If the violator is a corporation, the fine increases to $50,000. These remedies are in addition to any other imposed elsewhere in the law. The bill specifically exempts parties who own the loan or are servicing it before the terms of that loan are modified.

The definition of the term, "Advance Fee" has been significantly changed. Now, an Advance Fee includes any fee, regardless of the form, that is claimed, demanded, charged, received, or collected by a licensee from a principal before fully completing each and every service the licensee contracted to perform, or represented would be performed. Advance Fees now include: a fee for a listing, an advertisement or an offer to sell or lease property (other than in a newspaper of general circulation), issued primarily to promote the sale or lease of a business opportunity or real estate, or for a referral to real estate brokers or salesmen, or for soliciting borrowers or lenders for, or to negotiate loans on, business opportunities or real estate. Thus, licensees must be much more careful about how they charge for services they render. The law now requires real estate licensees to submit all Advance Fee materials to the Real Estate Commissioner before they are used (including contract forms, letters, cards used to solicit prospective sellers, and radio and TV ads), if they are intended to be used to solicit prospective owners and sellers to enter into an Advance Fee Agreement. All materials must be submitted to the Real Estate Commissioner for approval at least 10 calendar days before the materials are used. If the Commissioner finds that the materials are deceptive, the licensee may be Ordered not to use them. The fine for violations of the Advance Fee law has been increased from $1,000 to $2,500, plus violators may spend up to six months in jail. In addition, a violation could result in discimplinary procedures with the Department of Real Estate.

Existing law defines a "Foreclosure Consultant" as any person who (after the recording of a Notice of Default) solicits, represents or offers to perform for compensation or who performs any service for compensation which the person in any manner represents will in any manner do any of the following: (1) Stop or postpone a foreclosure sale; (2) Obtain any forbearance from any beneficiary or mortgagee; (3) Assist the owner to exercise their right to reinstate the existing loan; (4) Obtain any extension of the period within which the owner may reinstate his or her obligation; (5) Obtain any waiver of an acceleration clause contained in any promissory note or contract secured by a deed of trust or mortgage on a residence in foreclosure or contained that deed of trust or mortgage; (6) Assist the owner to obtain a loan or advance of funds; (7) Avoid or improve the owner's credit resulting from the recording of a notice of default or the conduct of a foreclosure sale; (8) Save the owner's residence from foreclosure; (9) Assist the owner in obtaining from the beneficiary, mortgagee, trustee under a power of sale, or counsel for the beneficiary, mortgagee, or trustee, the remaining proceeds from the foreclosure sale of the owner's residence. This bill excludes real estate licensees and California Finance Lenders (CFL) licensees from the definition of a Foreclosure Consultant, when they are acting under the authority of that license. Under the new law, CFL licensees are now prohibited from making materially false or misleading statements or representations to borrowers about the terms or conditions of that borrower's loan when making or brokering a loan. Senate Bill 94 remains effective until January 1, 2013, and it will expire at that time unless further action is taken by the California Legislature.

SB 94 Signed into Law

SB 94 has been signed by Governor Schwarzenegger. In a statement regarding the veto of the more restrictive AB 764 he said..

"Although I support the prohibition of individuals charging advance fees for mortgage loan modifications, I do not agree with the provision of this bill that will only allow fees to be collected if a modification is successful. This could adversely affect legitimate businesses that provide loan modification services. As such, I am signing SB 94 that accomplishes this prohibition against advance fees without unnecessarily harming legitimate companies."

The law applies to mortgages on primary residences and does not restrict the ability of  attorneys and consultants to collect advance fees for modification of commercial mortgages.

CA SB 94 Leaves Homeowners in Unfair Fight

Going to a gun fight with with a knife isn't likely to end very well. With the passage of SB 94 this is exactly what the California legislature and the Governor are asking California homeowners do.  The sweeping law, that will be signed next week by Governor Schwartzenegger will make it a crime for anyone, including attorneys to accept a fee in advance for the purpose of loan modification.

The bill authored by Rep. Calderon was heavily backed by banking interests and lobbyist for the banking industry. The law carries an urgency provision which makes it take effect immediately upon the Governors signature.

Oddly enough, the bill does not make any provision for banning advance fees earned by attorneys and others who work on behalf of banks and loan servicing companies prior to a successful loan modification.  These lawyers are still able to collect large fees from banks to ensure that the collection and foreclosure process works to the banks benefit.

Commercial Real Estate Decline

Please consider these comments from Steve Sakwa of the International Strategy & Investment Group



Mr Sakwa expects CRE markets to bottom out in the next 3-4 quarters.

The Danger Point

Danger does exist of the means taken proceeding to unwholesome inflation.  If the Government does not carry out its intention of reducing its expenditure and so of balancing its budget, and makes up tremendous deficiency by borrowing, with a consequent continual emission of notes, the people would lose confidence in their currency, and there would be a flight from the dollar...

Interesting current events?  No, this is a quote from "The Sydney Morning Herald. - Mar 11, 1933" (http://tr.im/AzVK). In an article describing the government attempts to cause "wholesome" inflation.

At that point in our history, we were emerging from the great depression.  Deflation was countered with inflation of a sound money supply because federal reserve notes (dollars) were exchangeable in gold at the Federal Reserve Bank.

Today, we find ourselves in a  similar situation.  An asset bubble has burst and the government is attempting to reflate it by use of inflation.  The key difference today is that the government can't come out and say they are trying to cause inflation because Federal Reserve Notes are nothing more than paper and can not be exchanged for gold.  All they can do is print more and hope that no one notices that they have no intrinsic value like real money.

Spike in Commercial Modification Requests

We have seen an increase in the number of property owners requesting consultations for commercial modifications at www.commercialmodification.com. The IRS rule change last month is mainly responsible for the 30% increase in lead production.

Our new commercial lead sales portal www.commercialmodificationleads.com allows commercial mortgage consultants, attorneys and mortgage brokers to register to buy the leads on a per lead basis or monthly subscriptions for exclusive or non-exclusive leads.

Qualified users can log in and see the leads before any purchase or any financial commitment.