I just got off the phone with the commercial lending VP at a small local bank. This bank just survived its first Office of Thrift Supervision audit since the financial meltdown. This audit took the better part of two months — all for a bank with less then $200 million in assets.
As I mentioned, they survived. That means that the auditors accepted their loan products, their underwriting processes, loss mitigation methodologies, and their loan delinquency rates. All-in-all… not a bad day at the office.
Except that the auditors were very concerned that this lender is one of a few in their market that is still catering to real estate investors and as such, were exposing themselves to ever increasing risk as fewer and fewer lenders were available. Coupled with this is the pessimistic economic outlook promoted by the auditors over the next 3 – 5 years. It ain’t pretty, and the regulators are requiring lenders to protect themselves now just in case things don’t improve – which based on my conversation, isn’t likely to happen too soon.
Here is the situation this lender and almost any lender is confronted with.
All lenders can only have a certain dollar value, as measured against its total asset base, of loans in any single asset class. Real estate is an asset class. Normally this is not a big deal, as many loans are retired either through the sale of the property or because many small lenders can bundle their loans and resell them to larger banks, thereby recapitalizing their loan coffers. The challenges are two fold: first the level of certainty that a property will sell is quickly diminishing with the expiration of the Homebuyers Tax Credit and secondly, no one wants to buy real estate loans.
This forces small lenders to have to keep the loans on their books and in time, as they continue to underwrite more loans, they soon reach the limits for the real estate asset class. There are just a few things a lender can do at this point — sell stock or increase profits. In today’s economy, you can readily see the challenge in this scenario.
So… what to do?
Here is what this lender is planning to do
They are going to continue with their purchase and renovation loan product. They are going to be extremely selective about who they make these loans to, in terms of experience and overall knowledge. Their criteria are going to be more stringent, with special attention being paid to available reserves and the quality of the deal. They are going to reduce their LTV to further protect their position.
In essence, they are doing exactly what every investor in today’s market should be doing, buying low to lock in their profits while mitigating future downside risk.
They are less optimistic regarding longer term loans. Loans that would normally be made for rental properties. Their reasoning is simple. What if the property values continue to fall and end up below the loan level, and what if the borrower can’t get the loan refinanced at the maturity date?
And with that in mind… here is the other point that was made that only helped to confirm our topsy-turvy world. For many banks having difficulties today, who have a large number of real estate loans, good or bad on the books coming due within 12 months of their maturity date, the banks are being told to have the borrowers get a new loan or the bank will be forced to place the loan into default and foreclose on the property. And, since borrowers are having the dickens of a time finding new financing, they are being forclosed on. Did you get that? Even if the loan is performing the banks are being told that they can’t issue a new loan — they have to foreclose.
This is absolutely nuts, and only serves to reinforce the idiocy of what is going on within our Government.
Now, what do we to protect ourselves, our portfolios and our businesses?
I don’t think the answer lies with better relationships, or more knowledge, or greater amounts of capital. No, I think the answer to this situation is that we are going to have to ensure our elected representatives understand just how important real estate investors are to this struggling recovery. They have to be shown that through policy or regulatory decisions, often times arbitrary at best, they are strangling the only sector of the real estate market that is thriving… real estate investments!
How do we do this? I’m not sure, but I am open to your suggestions.