Some business owners are getting a shock when it is time to renew their commercial loans and find that the reduced value of their property may require them to come up with more cash or a restructuring of the loan.
Lon Rupnow, vice president for business banking at American National Bank in Appleton, says the bank requires a valuation on a property before it renews a loan.
Bankers agree that new valuations are largely a waste of time, although some regulators require them before a loan is renewed. Property prices are down from five years ago, and that isn’t a surprise, but lenders focus on cash flow and the business owner.
“When we did a loan five years ago and got an appraisal, the way we underwrote it was fine with good cash flow, adequate collateral, the loan is still performing and payments have never been missed,” says Rupnow. Now the loan has matured and it makes little sense to get another price evaluation, he adds. “We know the value will be lower because commercial real estate values have dropped, but that is our secondary source of repayment when we underwrite. The primary concern is the character of the borrower and cash flow. Collateral is only important when everything fails and we have to sell it.”
If residential property is included in the collateral, the bank gets an evaluation on that as well. Sometimes the bank may require additional collateral.
The bank can restructure the loan to help a business over a short-term setback. On a loan with a 20-year amortization and a five-year term, if the owner has problems making payments in the third year, the bank could make some of the loan interest-only for a period.
A business with a $1 million, 20-year loan which had been paying $5,000 a month may have lost a tenant or seen a slowdown in business and can pay only $2,000, Rupnow explains by way of example. The bank might restructure the loan to a $500,000 loan and charge off the remaining $500,000 by putting it on a B note. Now instead of listing a $1 million troubled loan, the bank is reporting a $500,000 troubled loan, although the owner is still liable for the full amount.
“Rather than tell them they have to come up with another $300,000 – who can do that? – we are being proactive with this A/B note split and saying the economy will improve, real estate will come back and we can bring that B note back into the fold again and recover it,” Rupnow explains. Otherwise, he says, the bank would almost be forced to push them out of the bank and foreclose.
American National has had a few commercial foreclosures, he adds.
Banks try to avoid taking over properties because then they are stuck managing a building, paying taxes and insurance, sometimes investing in repairs to make it salable.
New regulations from the U.S. Treasury Department’s Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (FDIC) have placed burdens, often conflicting, on banks.
Christine Barry, research director at the financial analyst firm Aité Group, based in New York, says banks across the country face problems of regulatory overlap.
“It almost doesn’t matter what product set an institution is selling, they are governed by a number of different agencies without any single overarching regulator to make sure the rules are in synch. One agency goes into a bank and says X, and the next day another agency comes in and says Y. It is extremely frustrating for the institutions to respond and manage.”
In some cases the regulation has gotten so onerous it will force banks to drop certain types of business, she adds.
BayLake Bank, headquartered in Sturgeon Bay, doesn’t require new property evaluations when a commercial loan comes up for renewal, according to Jeff Miller, vice president of business banking.
“Cash flow is the primary source of repayment, so if the company continues to do well, making payments and showing a profit, there is no reason for a bank to be upset. We would renew the note for another three years, because cash flow, rather than collateral, is driving the decision.”
From 2008 to 2010, a lot of local businesses were struggling with cash flows and banks took back a lot of properties because of a lack of payments, rather than lack of collateral, he adds.
“Now that the market has started to turn, property values have gone up and it is far less of an issue.”
The biggest issue that loan officers are dealing with now is the term of a loan and the price. Interest rates will probably increase in the next three or five years, so refinancing requires some decisions about how long a loan to take out, and at fixed or variable rate. An owner might pay more for a five-year fixed but she can sleep better knowing that the rate won’t suddenly jump 2 or 3 percentage points, he says.
“It’s the customer’s decision; we try to talk through what is best, and that may be paying a little higher rate to get locked in.”