Regulators Issue Final Rule on CRE Loan Modifications

Last September, in anticipation of a potential CRE meltdown in the face of sharply escalating interest rates, the Office of the Comptroller of the Currency; the Treasury; Federal Deposit Insurance Corporation; and National Credit Union Administration published a proposed change to a 2009 policy addressing commercial real estate loan accommodations and workouts.

The final version of the rule is now out. “The updated statement also addresses relevant accounting standard changes on estimating loan losses and provides updated examples of classifying and accounting for loans modified or affected by loan accommodations or loan workout activity,” as it stated. Many may find themselves immediately drawn to the appendices.

Appendix 1 has the examples. The second appendix is “a summary of selected references to relevant supervisory guidance and accounting standards for real estate lending, appraisals, restructured loans, fair value measurement, and regulatory reporting matters.” Appendix 3 keeps information from the original statement about “valuation concepts for income-producing real property.” And the fourth “provides the agencies’ long-standing special mention and classification definitions that are applied to the examples in Appendix 1.”

There are multiple examples in the document. Here’s a review of the first, with the others available at the link at the top of the article.

There is a $15 million office building loan based on a 20-year amortization and a $13.6 million balloon payment at the end of year five. There was a 75% LTV on origination based on a $20 million “as stabilized” market valuation with a debt service coverage ratio of 1.3 times. They borrower hadn’t been delinquent.

“Due to technological advancements and a workplace culture change since the inception of the loan, many businesses switched to hybrid work-from-home arrangements to reduce longer-term costs and improve employee retention. As a result, the property’s cash flow declined as the borrower has had to grant rental concessions to either retain its existing tenants or attract new tenants, since the demand for office space has decreased.”

There were three scenarios. In the first, a one-year renewal of the $13.6 million balloon payment with cash flow for a DSCR of 1.12. Under this, the lender graded the loan a pass with the examiner agreeing. The lender maintained the loan in accrual status as cash flow seemed sufficient to remain current with obligations.

In the second scenario, most of the conditions remain the same except some leases are coming due and the property owner may need to provide additional concessions to retain tenants or attract new ones. The stabilized market value is now $14.5 million meaning a 95% LTV but no current valuation has been ordered and the lender hasn’t asked for updated financials. The lender rated the property as a pass but the examiner, disagreeing, listed it as special mention. There’s a declining trend in the revenue stream and likely reduced collateral margin. The lender ultimately maintained the loan in accrual status because cash flow is sufficient for payments and full repayment is expected.

The third scenario has the lender having restructured the $13.2 million on a 12-month interest-only below-market interest rate basis. The borrower has been sporadically delinquent on payments and projects a DSCR of 1.10 for the restructured terms. But the majority of tenants have short-term leases and three lapsing within three months. There is no update as to whether those leases will renew at maturity. Again, a recent appraisal for the “as stabilized” market value was for $14.5 million, resulting in a 94% LTV.

The lender graded the loan pass and is monitoring credit. The examiner graded it substandard. The lender maintained the loan in accrual status while the examiner disagreed. After a discussion, the lender placed the loan on nonaccrual.

The other examples are retail; hotel; residential acquisition, development, and construction; SFR construction loan; land acquisition, condominium construction, and conversion construction loan; commercial operating line of credit in connection with owner-occupied real estate; land loan; and multifamily property. Each has multiple scenarios.

Although intended as guidance to lenders, they can help inform borrowers as to potential outcomes.