Relief for borrowers or ‘extend and pretend’?

As banks struggle to assist their struggling customers, some are raising concerns that the restructured loans are merely a method to push the pain off just a little bit longer and trade write-downs now for losses later.

Loan restructuring has soared nationally in recent quarters, and is sometimes dubbed “extend-and-pretend,” a term that implies that restructuring only delays the inevitable collapse of failing loans. At the end of the first quarter, almost $65 billion in troubled debt had been restructured at U.S. institutions, up 94 percent compared to the first quarter in 2009. During that same period, noncurrent loans increased only 40.2 percent.

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Restructurings are up at Northern Colorado banks, too. However, local bankers feel that most restructurings are being done to increase the likelihood of repayment rather than as a method to delay the pain.

For the 15 banks based in Larimer and Weld counties, troubled loan restructurings totaled $50.3 million at the end of the first quarter, up 119 percent from the first quarter in 2009. Noncurrent loans increased 26 percent during the same period.

Local bankers seem to agree that there is no easy answer to a restructuring – each is decided on a case-by-case basis. However, the common factor among all is that the borrower must be ready and willing to do something different. The “extend and pretend” model won’t work – especially with no real economic recovery in sight.

“If that’s all you’re doing as a bank, it’s not a good policy,´ said Bank of Choice President Darrell McAllister.

Bank of Choice’ restructured loans have increased for several quarters. At the end of the first quarter, the bank reported $21.6 million in restructured loans, up from $3.8 million last year.

McAllister said that the bank sits down with customers to determine whether an extension will help them get healthy. For example, a commercial real estate landlord might be facing some recent vacancies. Allowing that property owner to pay interest only on his or her loan for up to a year to replace economically crunched tenants preserves the borrower’s ability to pay on the debt. McAllister said Bank of Choice has been allowing more time for payment but requiring that there be some payment in the interim under new negotiated terms.

“There’s not one formula that fits all,” he said.

Ability to pay key

Of all the variables – the borrower, other debts, collateral – the constant in restructuring is ability to pay.

“We can (work with a borrower) if there’s light at the end of the tunnel,´ said Leroy Leavitt, president of New West Bank.

New West Bank has historically had a low number of noncurrent loans, though they have crept up during the past year. Leavitt said the bank proactively reaches out to clients at the first signs of delinquency. In nine out of 10 cases, the payments will be caught up without a need to look at restructuring.

“It’s about doing what’s best for the customer and best for the bank,” he said. “We want them to make it, as well. Sometimes they are too delinquent to be saved.”

For that reason, Home State Bank has a team of bankers dedicated to reaching out to customers on the brink of delinquency. That team works with business borrowers to decide the best way the bank can assist them – interest rate or maturity concessions, for example – while still servicing the debt.

“Obviously, it has to be mutually beneficial,´ said Home State CFO Mark Bower.

Not all restructurings are successful, and even a single failure is hard to take.

“It’s never enough. Most of that is due to forces outside of our control or the borrower’s control, i.e., the economy,” Bower said. “But there are some successes, and those make it all worthwhile.”

Bower feels that most banks’ efforts to restructure are done with the expectation of repayment, not to delay the inevitable. A bank that was covering up loans that had no hope of being repaid would soon be found out under intense regulatory scrutiny.

“To kick the can down the road without addressing the real issues doesn’t solve anything,” agrees Bank of Colorado President Tom Goding. With the uncertainty in the economy, it isn’t likely that a can could be kicked far enough.

“If a customer comes to us and does everything they can, we’ll try to do everything we can,” he said. “Part of it is for the customer to recognize that they have a problem and be willing to work on it.”

Restructurings at Bank of Colorado are for customers that truly need it. Goding said that the bank holds customers to their contracts if they have the ability to pay. In cases where the borrower absolutely can’t pay, the bank will try to identify options. Ultimately, it’s up to the borrower to choose the option or not.

Federally approved option

Whether “extend and pretend” is an actual phenomenon or unfortunate reality of the extended downturn, banks might soon have a federally approved option for extending losses. Colorado Congressman Ed Perlmutter helped to steer an amendment into the Small Business Jobs and Credit Act that would allow community banks to push off commercial real estate losses in order to free up capital to lend to small businesses.

“Businesses are telling us that they need loans, and bankers are telling us that they can’t make loans,” explained Leslie Oliver, spokeswoman for Perlmutter.

The amendment would allow banks of less than $10 billion in assets to amortize real estate loan losses for a six to 10 years. The length of time allowed will depend on how much the institution increases its lending to small businesses. A similar provision was used in the 1980s during the farm credit crisis.

The House version passed the bill, amendment and all, in June. It is currently passing through Senate committees, where the amortization amendment has been under scrutiny.

Supporters of the proposed legislation feel the amortization will give the real estate market time to normalize instead of immediately draining capital.

“We’ll have to see what comes out of the Senate,” Oliver said, adding that the item will run as a standalone bill in the House as well.

Most banks and banking organizations are fully behind the measure, saying it would provide some relief without tapping taxpayer dollars as the “big bank” bailout did.

“It would be huge in helping the local community banks,” McAllister said.

McAllister explained that mark-to-market accounting rules mean that banks are eating into capital with every new property appraisal. When a property’s value declines, so can the value of the loan requiring a writeoff against capital.

“All we’re asking for is a little forbearance,” he said.

If the measure is adopted, not all banks will be quick to jump on board.

“For New West Bank, I don’t like the thought of amortizing losses, because we don’t have that many,” Leavitt said. “I certainly wouldn’t likely do it, given the option.”

Leavitt feels that if other banks are given the option and choose to exercise it, New West Bank will be in a better competitive position. Even as the economy improves, banks that opted to amortize losses will continue to “pay for sins of the past.”

“There’s no question it has merit,” Leavitt said. “It just depends on where you are in the cycle.”

If the economy doesn’t pick back up, amortization will only add up. If the economy improves or even if it only maintains, the amortization could work to provide some relief.