The story is becoming all too common. The bank calls and tells you they are not going to extend your loan. The message comes in many forms: They won’t renew your line of credit. The loan has a balloon payment, but they won’t extend. They are willing to extend, but with draconian terms. They are now enforcing some deep-dark covenant that you’ve never complied with, but now causing a default. Whatever the reason, the effect is the same – they tell you to come up with $X million dollars, which of course you don’t have.
Why are banks doing this?
If you were the borrower who got 95 percent loan-to-value, non-recourse, 3-year balloon on your speculative land purchase, then you know why they’re calling your loan. But, many banks are calling the good loans too. Why? Especially when we hear the political Talking Heads tell us how the Federal Government is encouraging lending, it is difficult to understand why the banks are calling even good performing loans.
The problem boils down to banking regulations. Bank regulations are more heavily risk-weighting loan assets held by Banks. This causes asset/equity ratios to go out of balance. Banks have two options to correct their ratios, either raising capital or convert loans to cash – as cash assets don’t have a risk weighting discount. Of course the banks would like to start with the riskiest loans, but bad loans can’t be collected, so they are forced to call-in good loans. And there you are, minding your own business with a perfectly performing loan. But the bank needs your cash – not your good loan.
What’s a borrower to do?
Real estate loans are the most commonly called. But, the loan collection push isn’t limited to real estate. If your business line of credit is the target, you might be in slightly better shape (assuming your business is still performing well). Many Commercial and Industrial (C&I) borrowers that find themselves in this situation are able to move their lending relationship to a bank with less capital constraints. Refinancing is generally an option.
On the other hand, if your real estate loan is called and your first reaction is to seek a new banking relationship to refinance the loan, you’ll likely find every bank is in the same situation. They’re all calling loans, and trying to reduce their real estate exposure. The local & regional banks, who have always been the leaders in local real estate lending, tend to be the hardest hit by this regulatory correction. But, the national banks don’t necessarily offer a solution, as they are either equally over-weighted in real estate, or they aren’t in the market for local real estate lending.
So, where do you go with your real estate loan? You might choose to do nothing, thus forcing your bank to “call their bluff” and foreclose on your property. If you have come to grips with walking away from any equity you invested, and either your loan is nonrecourse or you can negotiate your personal recourse with the bank, then perhaps handing them the keys is an acceptable solution.
But, they may not want your keys. The fact is that banks are in the business of lending money – not owning real estate. And, in many cases, they have already taken the financial hit to reserve much of your real estate loan balance. So, this might provide for an opportunity to buy-back your loan at a significant discount. This still leaves a big problem – where do you get the money?
Leave it to capitalism to find a solution. The vacuum in the commercial lending world has created a number of changes and opportunities in the capital markets. Specifically, many Private Equity Groups (PEGs), who have recently struggled locating quality traditional investments, are taking advantage of these lending voids. Other non-traditional capital sources are becoming more prevalent as well. (Asset Base Lenders, Sale-Leaseback Funds, Mezzanine Lenders, Real Estate Equity Funds, Hard Money Lenders, etc.). Business and property owners are finding these alternative capital partners to provide the needed capital to re-work or payoff their loans. Clearly the cost of capital from these sources will eclipse that of traditional lenders. But property owners may find partnering with an alternative capital partner is the only way to locate the funds demanded by their lender and still hold-on to some of their equity.
Until the banking system returns to a normal state, we will continue to see loans being called by banks. If you’re the next victim of this new lending epidemic, at least you’ll know others have been there before you. And, hopefully you’ll find a marketplace that is adapting and providing alternatives as well.