By Fernando Landa, Partner
On June 29, 2023, several banking regulators – including the Federal Reserve and the Federal Deposit Insurance Corporation –adopted a new Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts. This policy statement provides lenders guidance regarding commercial real estate loans and should be understood by borrowers that may need a loan concession in the rapidly changing commercial real estate credit environment.
This policy statement builds on a similar policy issued on October 30, 2009, as the fallout from the Global Financial Crisis took grip of the commercial real estate industry. The new policy statement emphasizes "the importance of financial institutions working constructively with CRE borrowers who are experiencing financial difficulty…" and provides lenders regulatory leeway if they "implement prudent CRE loan accommodation and workout arrangements."
The statement recommends lenders use "short-term and less-complex loan accommodations" as a tool to grant borrowers relief and "encourages financial institutions to work prudently with borrowers…during periods of financial stress." These short-term accommodations include payment deferment and allowing borrowers to make a partial payment. The statement's emphasis on short-term accommodations reflects the lessons learned during the COVID-19 pandemic when lenders salvaged countless commercial real estate loans with such short-term workouts.
When these "short-term accommodations are not sufficient" to resolve the credit issue, then lenders can proceed with "longer-term or more-complex arrangements with borrowers," including, but limited to extending loan terms and providing additional credit to "improve prospects for overall repayment". Not surprisingly, the statement directs lenders to analyze a borrower's and guarantor's ability to repay the loan and the value of the collateral before agreeing to a longer-term workout. The statement details the best practices to assess these metrics and emphasizes the need for lenders to take existing market conditions into consideration.
The statement also includes three workout examples: one for an income-producing office building loan, one for a hotel acquisition loan and one for a multifamily development and construction loan. These examples serve to "illustrate the application of existing rules, regulatory reporting instructions, and supervisory guidance on credit classifications and the determination of nonaccrual status." Additionally, the statement details recent accounting changes for lenders to estimate loan losses and provides examples of how to classify and account for loans affected by workout activity.
The statement makes clear that borrowers should seek short-term accommodations from their lenders first before seeking a more comprehensive workout strategy. The policy statement underscores the critical balance between responsible lending practices and supporting the stability of the commercial real estate market, providing comprehensive guidelines for financial institutions to navigate evolving economic conditions. Given the statement's strong preference for such short-term accommodations, borrowers are better served proposing a short-term workout in the form of payment deferments or partial payments rather than a more comprehensive workout strategy unless and until such short-term accommodation fails.