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U.S. Banks: Stop “Pretending” Start “Amending”

February 1, 2013

By Buddy Norman, President, Keller Williams Commercial

The commercial real estate downturn skirted the sidelines for the first three years that residential markets were declining in 2006-2008, but once it hit, it hit hard. This CPI chart indicates commercial property values were on a steady uphill climb throughout most of the past decade – peaking in February of 2008, and then dropping precipitously through 2010.

Today we face trillions of dollars in underwater commercial mortgages, threats that foreclosures will flood the market and further depress values, and questionable accounting practices that mask reality while delaying the commercial market’s recovery.

Commercial mortgages tend to be refinanced every three to seven year years. Studies by Deutsche Bank indicate over half of these loans made during the commercial run up in values are either non-compliant or non-conforming and will face extreme difficulties in qualifying to be refinanced. The stop-gap strategy adopted by most commercial lenders today however has tended to be “Extend and Pretend” that the loan is compliant and no loss in principal value has taken place.

U.S. banks, fearful of the balance sheet impact of these non-compliant loans, have exerted enormous pressure on The Financial Accounting Standards Board (FASB), and have forced an amendment to accounting principles for the banking industry that allows banks to use “cost” accounting for their troubled loans vs. “mark-to-market” accounting. This flawed policy will allow banks to keep loans on the books at the loan amount, irrespective of any loss in valuation due to the market decline.

This policy continues “Extend and Pretend” vs. “Extend and Amend” and accounts for the principal losses of their commercial loan portfolios. A compromise solution would be to require banks to phase in “mark-to-market” accounting for 20-25% of loan portfolios each year thus working out the problem loans over a 4-5 year period. Such a compromise could avert the Japanese scenario of the 1980s when they implemented “Extend and Pretend” leading to an economic malaise that has been termed their “Lost Decade.”

Despite the adversity of the current commercial market, adversity presents opportunities and a commercial client base that is begging for strong leadership. More than ever before, clients look for commercial brokers who have the knowledge, expertise and skill set to help them effectively navigate the commercial real estate landscape. A sensible return to accountability and trust in our banking system would be a good first start.

Learn more at: http://kwcommercial.com/commercial/index.html

Buddy Norman, president of KW Commercial, has taken the lead in creating a market-leading new division within Keller Williams Realty