CRE Loan Modifications Make Sense; Residential Loan Mods Don't

Includes: KBE, XLF
by: Tom Brown

In the course of agreeing with not a syllable of my post earlier this week regarding Nouriel Roubini’s inability to kick his doomsaying habits, commenter “No Banker Left Behind” hurls the following charge of hypocrisy:

Interestingly, while you rail against the idea of residential mortgage modifications (write downs), I don't sense the same indignation at modifications made in banks CRE portfolio's [sic].

NBLB raises an interesting point! There’s an important reason why modifications of CRE loans often make sense for lenders, while residential loans mods tend to be exercises in futility. It’s this: even stressed CRE properties tend generate some cash, while stressed residential properties don’t. In the near-term during a downturn, therefore, a prudent lender might restructure a loan in order to capture as much of those dwindling cash flows as it can, as an alternative to foreclosure, in anticipation of an economic recovery and a loan re-restructruring to something closer to its original terms later on. It really isn’t hard to make some macro assumptions, run an NPV, and come up with a number that’s much preferable than what would be left after foreclosure and disposal.

Delinquent residential properties, by contrast, generate squat. Very often, the borrower has no income whatsoever, and is working through his savings. There’s no number a lender can restructure the loan down to that would make any economic sense. Usually the best alternative for the lender is to foreclose and move on.

That’s why I always laugh at banking critics who pooh-pooh commercial loan modifications as “extend and pretend.” They’re anything but that. Lenders who modify CRE loans understand that the cycle will turn and that, once it does, the borrower’s cash flows will improve. Loan mods in the interim simply take account of that. It’s the lenders modifying residential loans that are the ones extending and pretending. If you doubt it, look at the numbers. They’ve been so bad for so long, I’m surprised the loan-mod fetish persists.

As to the rest of NBLB’s points, I’ll let them stand, except to point out that he’s the one who notes that the number of delinquent commercial-backed securities has fallen for three months in a row, not me. As for me being a shill for the banking business, with so many stocks trading at just over 1 times tangible book, I’ll shill all day long.