Four Considerations with CRE Changes

9/16/2010

By Daniel R. McDonald

Bankers often ask, ”When a development loan, speculative real estate loan or other commercial real estate loan stalls or is not meeting projections, what items need to be considered when renewing, modifying or restructuring such credits?” We believe that there are four items that need to be considered: Principal curtailments, Amortization, Income and Liquidity.

• Principal Curtailments - the rule of thumb for a principal curtailment, when “touching” these credits, is a 10% principal pay-down
• Amortization – the credits should be amortized over a reasonable period of time, considering the type of loan, cash flow potential and reasonableness of the credit request
• Income – all sources of income need to be considered, from borrower to co-maker to guarantor (and subsequent other entities) to determine what level of global income (and therefore cash flow) is available to service global debt obligations
• Liquidity - what available liquidity sources, globally, are available to support the debt service of the credit request, should available cash flow not fully support repayment? Checking accounts, savings accounts, money-market demand accounts, time certificates of deposit and brokerage accounts are all sources to considered. However, it is just as important to make sure all of the available sources have been verified with appropriate account statements to validate such levels.

While it would be nice to have all of the above happen, it is not realistic to believe all will occur. A combination of these may help the bank reduce the overall risk of loss to the individual credits, which is one of the primary goals for banks. Making one, all or a combination of these four considerations may not keep a loan from being downgraded by bank regulators or external loan review companies, but it will show strong loan administration and hopefully reduce or eliminate loan losses within these problematic loan categories.