Lesson in high-profile foreclosure: Resist temptation to relax terms
By John Reosti
Published May 04 2018, 2∶24pm EDT
A high-profile foreclosure in New York is highlighting the importance of disciplined underwriting.
Preferred Bank in Los Angeles disclosed recently that it has begun foreclosure proceedings on a pair of luxury apartment buildings in Manhattan, a move that will dramatically increase the level of nonperforming assets on its balance sheet. The loans have an outstanding balance of $41.7 million.
If there’s a silver lining, it’s that the $3.8 billion-asset bank expects the financial hit to be minimal because the loan-to-value ratio — the balance divided by the appraised value at
origination — for each of the loans is below 70%.
Preferred’s experience serves a reminder of how important terms will be as loan demand increases, interest rates rise and lenders try to gain a competitive edge. Those who get too
aggressive could be burned when the economic cycle takes the inevitable turn for the worse, bankers and industry observers said.
“If you’re going to compete on commodities — that’s where the cycle starts to turn,” said Joseph Campanelli, CEO at the $2.1 billion-asset Needham Bank in Massachusetts, adding
that it can be tempting to follow the pack in areas such as rate and terms.
“Well, so-and-so is doing this rate, so let’s match it,” Campanelli said. “Or so-and-so is doing it without recourse, or doing a higher loan-to-value, let’s match it. That’s the slippery slope.”
The average loan-to-value ratio for commercial real estate deals increased to about 80% in the fourth quarter from 73% a year earlier, according to PrecisionLender, a technology firm
that helps lenders fine-tune pricing and terms. The firm evaluated more than $2 billion in quarterly volume by its clients.
To be sure, many banks are sticking to their guns when it comes to LTV.
Campanelli and Edward Czajka, Preferred’s chief financial officer, said they are seeing very few signs that lenders are throwing caution to the wind.
“I don’t see any trends pushing standards in the opposite direction,” Czajka said, adding that the average loan-to-value ratio in Preferred’s $1.3 billion-asset commercial real estate portfolio
“One of the things we’re seeing this go-around is a lot more liquidity going into deals,” Campanelli said. “It’s not uncommon to do a deal at 65% loan-to-value.”
Needham, like Preferred, is a significant commercial real estate lender with more than $400 million of CRE-related loans on its books.
While Preferred did not disclose the reason for the foreclosures, other media outlets have noted that Michael Paul D’Alessio, a developer and one of the properties’ owners, is facing lawsuits alleging that funds intended for a number of projects were improperly diverted for other uses.
D’Alessio is also being sued by three New York banks — Greater Hudson Bank, Westchester Bank and BNB Bank — that are trying to recoup $6.4 million through an involuntary
bankruptcy petition filed last month in the U.S. Bankruptcy Court for the Southern District of New York.
D’Alessio did not respond to a request for comment.
The situation at Preferred shows how important it is to fully vet a borrower and not just an isolated deal, industry experts said.
“Problems can cascade,” said Jon Winick, CEO of the Chicago advisory firm Clark Street Capital. “Trouble with one project drags down another one. … A borrower can be highly coveted and, all of the sudden, no one wants to touch them.”
“What else does that developer or real estate group have going on?” Campanelli said. “If they’re overleveraged in other areas, you would have to conclude that, on a global basis, the
cash flows aren’t strong enough, even though the individual project looks OK.”
Preferred still considers itself a conservative lender, Czajka said, noting that the bank’s credit quality had been uniformly excellent for years. While the bank is pursuing foreclosure now, it is
is keeping all its options — including selling the loans — on the table.
In its first-quarter call report, Preferred reported $3.3 million of nonaccrual loans, or 0.11% of total loans.
Winick said he expects loan-to-value ratios to be lower on large CRE loans, which seems to be the case with Preferred’s deals. As a result, the bank’s minimal-loss forecast “seems
reasonable,” but there are no guarantees.
“It does take time to sell buildings,” Winick said. “They’re probably fine, but it’s hard to tell.”
Clark Street Capital Featured in American Banker-5/4/18
Small banks count on new appraisal rule to boost CRE lending
By Andy Peters
Published May 04 2018, 2∶27pm EDT
Community bankers are counting on a new federal rule that relaxes requirements on real estate appraisals to help them better compete with nonbank lenders on smaller commercial real estate loans, but appraisers themselves say that the change will only encourage banks to take more risks.
The three federal bank regulatory agencies last month increased the threshold for loans that require an outside appraisal on the property used as collateral from $250,000 to $500,000. The rule was last updated in 1994 and lenders say regulators changed it because it did not accurately reflect current property values.
The rule change will remove the costly appraisal requirement on tens of thousands of commercial properties, which could allow banks to make more loans in this size range, said Justin Bakst, the director of capital markets at CoStar. As of April 20, roughly 154,000 properties nationwide were each valued at between $250,000 and $500,000, according to CoStar. Those properties are valued at about $68 billion.
Though these loans should be right in community banks’ wheelhouse, many small banks have actually shied away from them because they became too costly to make once appraisal fees were factored in, said Jon Winick, CEO at Clark Street Capital, a Chicago firm that advises banks on loan sales.
“To spend $3,500 for an appraisal on a $250,000 loan, that wasn’t worth it,” Winick said.
Community bankers said that the rule change should help them better compete with insurance companies, individual investors and other nonbank lenders that were not subject to the same appraisal requirements.
Eliminating in-person appraisals for loans of less than $500,000 will both reduce costs for small banks — allowing them to offer better rates and terms — and speed up decision-making, they said.
Banks had not officially asked for an increase in the threshold since it was last updated in 1994, said Chris Capurso, an attorney at Hudson Cook in Richmond, Va., who advises banks on lending laws. But a federal law that requires federal agencies to review their regulations every decade opened the door for the current push, Capurso said.
Additionally, the price of commercial real estate has significantly increased since the financial crisis, which made it more palatable for regulators to boost the threshold, said Curt Everson, president of the South Dakota Bankers Association.
Banks will still need to value their collateral, but instead of hiring a certified independent appraiser, they now can commission an evaluation of properties in this value range using publicly available real estate data.
“Evaluations cost less than appraisals, take less time than appraisals and do not require the bank to go out and find a certified appraiser,” Capurso said. “All of this adds up to banks, especially banks with fewer resources, being able to make more CRE loans.”
However, appraisers have questioned why regulators are making it easier for banks to make CRE loans at a time when they’ve been concerned about overexposure to the sector. The rule change is “yet another relaxation of sound collateral risk policies that provide minimal benefit to financial institutions while creating significant potential risk to the financial markets as well as
consumers,” the Collateral Risk Network, which represents appraisers and risk managers, wrote in a September letter to regulators.
The Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Federal Reserve Board dismissed concerns about the change posing increased risk to the financial system. “The agencies … determined that the increased threshold will not pose a threat to the safety and soundness of financial institutions,” they said in a joint press release on April 2.
Bankers in rural areas have also supported the rule change, as they believe it will help address the problem of a dearth of commercial real estate appraisers in certain sections of the country.
“The supply of licensed and certified appraisers, especially those willing to work in rural areas, has diminished,” Everson wrote in a September letter to regulators. “In too many instances … owners of small businesses on main street, farmers and ranchers seeking to restructure current year operating loans into longer term notes incur higher costs … because of appraisal threshold
requirements that have not been updated in decades.”
Some bankers had called for regulators to raise the appraisal-requirement threshold to $1 million, saying that the $500,000 cap would still shut them out of too many deals. However, Capurso noted that regulators based the $500,000 figure on the increase in the Federal Reserve’s Commercial Real Estate Price Index over the past 24 years.
“The agencies didn’t come to the limit haphazardly by merely doubling the previous limit,” Capurso said. “There’s a basis to it, and I think it’s a fair one to use.”
Clark Street Capital Featured in American Banker-4/13/18
It may be time to ditch those distressed credits
By Jackie Stewart
For banks still holding on to longtime problem assets, now might be the time to consider selling. In the aftermath of the financial crisis, banks were saddled with scores of soured loans. But
even if institutions were looking to sell these assets, and investors were interested in purchasing them, banks were often constrained by capital level requirements from taking the necessary
write-offs associated with fire sales. Now capital levels are higher so banks would be better able to absorb losses, and investors are still hungry to buy distressed assets for good prices. But banks have mostly been reluctant to complete loans sales.
That could be a mistake if credit quality were to take a turn for the worse, and there are a few indicators that new problems could be on the horizon.
“If you are selling assets today, you are probably being more tactical,” said Jeff Davis, a managing director in Mercer Capital’s financial institutions group. “You are thinking strategically as the economic cycle ages, and you are trying to take some chips off the table.”
Credit quality has improved significantly since the depths of the recession. Problem assets for all banks totaled $193 billion at Dec. 31, according to data from the Federal Deposit Insurance
Corp. That figure included other real estate owned, assets that were 30 to 89 days past due and at least 90 days late, and those in non accrual status.
Still the recent number is roughly 42% higher than the $136 billion recorded in 2006, according to data from the FDIC. “Banks still have a pretty elevated level of classified assets because many of them didn’t fully pull off the Band-Aid half a decade ago,” said Jon Winick, CEO Clark Street Capital. “You are starting with a decent sized workout universe to begin with. Now there are new credits coming in.”
There are signs that credit quality could weaken, though certainly no one is predicting an imminent financial collapse. For instance, the Federal Reserve Bank of New York said in a
report on household debt earlier this year that credit card delinquencies increased “notably.” The percent of credit card balances that were at least 90 days late rose to 7.55% in the fourth quarter from 7.14% a year earlier, according to the report. Winick said an uptick in credit card delinquencies can be an early indicator of wider problems to come. Generally, business customers have more resources to keep their loans current when trouble starts to brew.
Interest rate hikes may also put pressure on certain commercial customers, especially in the commercial real estate portfolio. For instance, multifamily housing has been overbuilt in some
cities, meaning that supply has out stripped demand. Owners of these buildings could have problems increasing rents as a result. That may become a problem as their loans come due and they get new financing at higher interest rates, Winick said. Owners of retail properties in some areas may also struggle to raise rents on tenants either because of long-term leases or because the market won’t support such hikes, Winick said.
Retail is also facing pressure from broader changes in consumer behavior as more people shop online. “The 900-pound gorilla is Amazon,” said Lynn David, CEO of Community Bank Consulting Services. “What it is doing to retail is phenomenal. It has to be a concern to everyone. I don’t care if it is paper towels. You can now order it online from Amazon and get them shipped for free.”
To be sure, there have been banks in recent months that have looked to sell loans, both performing ones and problem credits. Substandard loans that banks consider selling may still
be performing, but there could be other concerns, such as a covenant being breached. A bank may decide to unload good loans if they are concerned about concentration levels, are
looking to exit a certain business line or decide they could redeploy the funds into a higher yielding asset.
PacWest Bancorp in Beverly Hills, Calif., announced in December that it would sell cash flow loans worth roughly $1.5 billion as it looked to wind down its commercial lending origination
operations related to healthcare, technology and general purposes. PacWest President and CEO Matt Wagner said in the release that the $25 billion-asset company made the decision “for both cyclical and competitive reasons.”
Other banks looked to pare back their exposure in energy after oil prices tumbled. Still, many banks are deciding to hold onto credits, even ones that are in danger of becoming
distressed. This lack of supply could be helping to drive up pricing for the loans that do become available, said Kip Weissman, a partner at Luse Gorman. “We are at the top of a credit cycle and that means there’s less of a supply,” Weissman said.
“More loans are performing, and it is a countercyclical industry.” Michael Britvan, a managing director in loan sale and asset sale group at Mission Capital Advisors, has observed banks are currently less willing to sell loans at a loss, likely due to the potential impact on earnings. This decision seems counter intuitive as the market is awash inliquidity, resulting in the narrowest bid-ask spread in recent history, he said. ”Performing, subperforming or nonperforming debt is in vogue,” he said. “We have been in an extended bull market run, therefore investors are targeting fixed-income investment, targeting assets they view to be slightly less risky and less correlated with the broader market.”
Matthew Howe, vice president of special assets at Lakeside Bank in Chicago, said he has seen better pricing on stressed commercial loans than in recent years. He said the bank is seeing bids between 85% to 90% of a loan’s outstanding balance, compared with offers in the low 80s just a few years ago.
Even though the $1.6 billion-asset Lakeside is not suffering from the credit problems that plagued the industry after the recession, management still tries to be proactive in managing its loan portfolio. That means even in a strong economy sometimes the bank offloads distressed credits. Howe says one reason driving buyers’ interest in distressed assets is that foreclosures are
moving faster through the court system. That can eliminate some of the uncertainty for potential buyers of troubled commercial real estate loans.
“It has been aggressive,” Howe said. “There is an appetite in the marketplace for distressed and for performing loans.”