Fed to Banks With Major Commercial Real Estate Loan Exposure: Bang You Are Dead

The Fed has just released a statement on commercial loan workouts. There can be more than one interpretation to what the Fed is up to here, but the confusion will spook markets even more so than they are now. Here's the full statement:

For immediate release

The Federal Reserve on Friday adopted a policy statement supporting prudent commercial real estate (CRE) loan workouts. This policy statement, adopted by each of the financial regulators,1 provides guidance for examiners, and for 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. The financial regulators 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. In addition, performing loans, including those 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.

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.

Footnotes

1.The financial regulators consist of 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. Return to text

2009 Banking and Consumer Regulatory PolicySo what is going on here?

1. The Fed clearly anticipates serious problems in the Commercial Real Estate market.

2. Problems so big that they are going to be changing policy.

3. They are encouraging banks to workout the loans and there won't be negative feedback from the Fed.

But here's what could be real major spooky to the markets. The Fed is probably also signalling that it is not going to do wholesale bailouts of the commercial real estate loan market, the way it did to parts of the mortgage securitized sector.

This is a total reversal of the attempt to prop up the residential market. The Fed wants the commercial market down and fast.

BOTTOM LINE: This means major, major hits ahead for bank earnings and not all banks will survive.