Modifying a Land Loan

9 Feb

Timothy McCandless Esq. and Associates
Offices Statewide

(909)890-9192
(925)957-9797
FAX (909) 382-9956
tim@Prodefenders.com

http://www.timothymccandless.com

(Adapted from the October 30, 2009 Policy Statement on Prudent Commercial Real Estate Loan Workouts)

Introduction

In response to the residential mortgage crisis, and in anticipation of the looming commercial mortgage crisis of much greater potential magnitude, the federal banking regulators got together and issued a policy statement to encourage lenders to modify commercial mortgages and other loans secured by commercial real estate. Attachment 1 to the Policy Statement featured six example scenarios to help lenders to understand that the question isn’t whether you modify a loan, but rather how you modify a loan, that may result in regulatory penalization.

From the statement: “[t]he regulators have found that prudent CRE loan workouts are often in the best interest of the financial institution and the borrower. Examiners are expected to take a balanced approach in assessing the adequacy of an institution’s risk management practices for loan workout activity. Financial institutions that implement prudent CRE loan workout arrangements after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for engaging in these efforts even if the restructured loans have weaknesses that result in adverse credit classification. In addition, renewed or restructured loans to borrowers who have the ability to repay their debts according to 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. ”

What follows is the regulator’s example of modifying a Land Loan.

Note:

* The financial regulators consist of the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA), the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS), and the Federal Financial Institutions Examination Council (FFIEC) State Liaison Committee (collectively, the regulators).

BASE CASE: Three years ago, the lender originated a $3.25 million loan to a borrower for the purchase of raw land that the borrower was seeking to have zoned for residential use. The loan had a three-year term and required monthly interest-only payments at a market rate that the borrower has paid from existing financial resources. An appraisal obtained at origination reflected an “as is” market value of $5 million, which resulted in a 65 percent LTV. The borrower was successful in obtaining the zoning change and has been seeking construction financing for a townhouse development and to repay the land loan. At maturity, the borrower requested an extension to provide additional time to secure construction financing that would include repayment of the land loan.

SCENARIO 1: The borrower provided the lender with current financial information, demonstrating the ability to make principal and interest payments. Further, the borrower made a principal payment of $250,000 in exchange for an extension of the maturity date of the loan. The borrower also pledged additional unencumbered collateral, granting the lender a first lien on an office building with an “as stabilized” market value of $1 million. The financial information also demonstrates that cash flow from the borrower’s personal assets and the office building generate sufficient stable cash flow to amortize the land loan over a reasonable period of time. A recent appraisal of the raw land reflects an “as is” market value of $3 million, which results in a 75 percent LTV when combined with the additional collateral and the principal reduction. The lender restructured a $3 million loan with monthly principal and interest payments for another year at a market rate that provides for the incremental credit risk.

*
Classification: The lender internally graded the loan as pass due to the adequate cash flow to pay principal and interest from the borrower’s personal assets and the office building. Also the borrower provided a curtailment and additional collateral to maintain a reasonable LTV. The examiner agreed with the lender’s internal grade.
*
Nonaccrual Treatment: The lender maintained the loan on accrual status, as the borrower has sufficient funds to cover the debt service requirements for the next year. Full repayment of principal and interest is reasonably assured from the collateral and the borrower’s financial resources. The examiner concurred with the lender’s accrual treatment.
*
TDR Treatment: The lender concluded that while the borrower has been affected by declining economic conditions, the level of deterioration does not warrant TDR treatment. The borrower was not experiencing financial difficulties because the borrower has the ability to service the renewed loan, which was prudently underwritten and has a market rate of interest. The examiner concurred with the lender’s rationale and TDR treatment.

SCENARIO 2: The borrower provided the lender with current financial information that indicated the borrower is unable to continue to make interest-only payments. The borrower has been sporadically delinquent up to 60 days on payments. The borrower is still seeking a loan to finance construction of the townhouse development, but has not been able to obtain a takeout commitment. A recent appraisal of the property reflects an “as is” market value of $3 million, which results in a 108 percent LTV. The lender extended a $3.25 million loan at a market rate of interest for one year with principal and interest due at maturity.

*
Classification: The lender internally graded the loan as pass because the loan is currently not past due and at a market rate of interest. Also, the borrower is trying to obtain takeout construction financing. The examiner disagreed with the internal grade and adversely classified the loan. The examiner concluded that the loan was not restructured on reasonable repayment terms because the borrower does not have the capacity to service the debt and full repayment of principal and interest is not assured. The examiner classified $550,000 loss ($3.25 million loan balance less $2.7 million, based on the current appraisal of $3 million less estimated cost to sell of 10 percent or $300,000). The examiner classified the remaining $2.7 million balance substandard. This classification treatment recognizes the credit risk in the collateral dependent loan based on the property’s market value less costs to sell.
*
Nonaccrual Treatment: The lender maintained the loan on accrual status. The examiner did not concur with this treatment and advised the lender to place the loan on nonaccrual because the loan was not restructured on reasonable repayment terms, the borrower does not have the capacity to service the debt, and full repayment of principal and interest is not assured.
* TDR Treatment: The lender reported the restructured loan as a TDR. The borrower is experiencing financial difficulties as indicated by the inability to refinance this debt and the inability to repay the loan at maturity in a manner consistent with the original exit strategy. A concession was provided by renewing the loan with a deferral of principal and interest payments for an additional year when the borrower was unable to obtain takeout financing. The examiner concurred with the lender’s TDR treatment.

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