Agencies of the Federal Financial Institutions Examination Council have weighed in on the “extend and pretend” debate, and it appears they are willing to extend―given the right circumstances. The term refers to the practice of a lender extending the term of a maturing loan for a short period of time rather than forcing the borrower to pay it off or to right size it, given the pressure on commercial real estate valuations. Essentially, “extend and pretend” pushes the valuation issue off to a future date.
In October, the Council issued a policy statement on Prudent Commercial Real Estate Loan Workouts. The statement presented guidelines to lenders on how to address troubled commercial real estate loans and encouraged them to work with strong borrowers. The guidelines indicated:
While commercial real estate borrowers may experience deterioration in their financial condition, many continue to be creditworthy customers who have the willingness and capacity to repay their debts. In such cases, financial institutions and borrowers may find it mutually beneficial to work constructively together. In addition, renewed or restructured loans to borrowers who have the ability to repay their debts according to reasonable modified terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the loan balance.
So what does this mean to self-storage owners facing maturing loans? Assuming you have sufficient cash flow to service the loan’s debt, the guidelines are good news. Regulators made it clear that modified loans can continue to be classified as “performing” even if the property is worth less than the loan amount. Regulators are encouraging lenders to go beyond the property’s current value and cash flow to consider a borrower’s entire financial picture when determining whether to extend a loan.
These new guidelines also provide examples of loan modifications considered prudent by regulators. Lenders can bridge the difference between a property’s loan amount and current market value by demonstrating there’s enough cash flow being generated from the property and the sponsor’s other assets (global cash flow) to service the modified loan. The guidelines also indicate the modified loan’s interest rate must be at a prevailing market level to compensate the lender for the additional risk. If not, the lender will have to classify the loan as “non-accrual” or “non-performing.”
Given these guidelines and the overall market environment, lenders will consider several criteria when determining which loans to extend. One of the terms cited frequently in the new guidelines is “borrower’s repayment capacity.” This refers to the borrower’s character, overall financial strength, and historical payment record on this and other loans. Lenders are also closely examining the historical basis and market conditions affecting the property’s cash flow and value, the borrower’s other contingent liabilities, and the ability to support repayment through personal guarantees.