Going From Mark-To-Market to Mark-To-Make Believe!

By Robert Pliska

Have we gone from "mark-to-market" to "mark-to-make believe"? The FDIC just released its policy statement - Prudent Commercial Real Estate Loan Workouts. The FDIC's purpose is provide transparency and consistency to commercial real estate workout transactions and not curtail the availability of credit to sound borrowers. While the FDIC's intentions are honorable, the policy may provide the opposite effect - lack of transparency and consistency and extending the lack of credit to sound borrowers.

The key point of this policy statement is - loan workouts need to be designed to help ensure that the institution maximizes its recovery potential. Renewed or restructured loans to borrowers who have the ability to pay their debts under reasonable modified terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the loan balance. So if the borrower and/or its guarantors can still make the payment and the financial institution would prefer to extend the loan rather than take a loss, the fact that the property is worth less is not the determining factor.

The loan can be in good standing if the borrower/guarantor can show that they can still make payments. New appraisals need not be ordered if an internal review by the institution appropriately updates the original appraisal assumptions to reflect the current market and provides an estimate of the fair value for impairment analysis. Documentation should demonstrate a full understanding of the property's current "as is" condition. However, if the institution intends to work with the borrower to get a property to "as stabilized" market value, then the institution can consider the "as stabilized value" in its collateral assessment for credit risk rating. This seems to be heading far to the "make believe" area. Just present a "good story" and the institution can buy a lot of time.

This "good story" accounting will provide more of a lack of transparency and consistency. Two people, for example, can tell a "good story" much differently. It will probably make the FDIC's job more difficult. In the 1990's, for example, banks in Japan were allowed to avoid taking losses and write-downs. The result was an entire decade of stagnation. The steps by the FDIC could create a parallel situation. This may extend the time of lack of credit to borrowers. Let's get back to reality rather than "make believe". Hopefully, our commercial real estate problems may be resolved sooner.  For further discuss ion of this topic, feel free to contact the author Robert Pliska, CRE, CPA.