… roughly half of the $1.4 trillion in commercial mortgages maturing by 2014 are under water.
The new guidelines issued by regulators allow lenders to classify loans as performing even though market values of the underlying real estate have fallen by as much as 40%.
If the borrowers are current on principal and interest, the loan can be classified as performing even though the commercial real estate is worth far less than the loan amount.
Hiding Future Losses
The banking policy has sometimes informally been called ” pretend and extend” but with the accumulation of loans propped up by weak underlying values, a better phrase for the policy might be called ” delay and pray”
” Banks will not resume lending in a meaningful way because they have these loans for which they are hoarding cash to ensure they have enough capital for the inevitable losses”
Kelly believes the guidelines will prop up loans that should not be propped up rather than allow them to fail and clear the market of bad bank loans. Allowing them to fail would free up capital so banks could make fresh loans for projects and developments that stimulate job growth and local markets.
This is important for residential real estate because the policy will cause banks to hoard cash to cover future losses instead of lending out the money. (The bank bailouts didn’t so much cause new lending as give banks money to cover their losses.) Non-governmental mortgage money will likely be tight for years to come and that makes it tough for home values to improve.
On the other hand, the policy will spread out the pain over a number of years instead of triggering a quicker, deeper crisis.
This same type policy was in effect during the savings and loan crisis of the early 1990’s. Many commercial properties the banks held then did not return to their loan value until many years later. A mark-to-market policy back then would have triggered many more banks to fail.
It’s delay and pray again.