01 September 2010

The art of the delayed write-off

This information from a bank insider does a great job illustrating how much flexibility banks have in avoiding write-downs on their books with non-performing loans. It goes a long way to explaining why many lenders have been so incredibly tardy in foreclosing, and taking possession, of properties with delinquent loans.
Many people don't understand the magnitude within the banking industry to "Kick the Can" or "Extend and Pretend". We see a lot of this within the industry.

Banks with existing balance sheet issues (nonperforming loans) really don't want to recognize more loan issues because it could force the FDIC to close them down.

In that light, a bank can take a commercial real estate loan or a business line of credit having issues and do a 3 month extension at loan maturity or change loan payments to interest in an attempt to give the borrower with more time to work things out or bring more capital to the table.

It's not uncommon for a bank to do multiple extensions in the mode of working out a loan with principal reductions over time. I've been in the situation where extensions have lasted 1-2 years. In normal recessions, extensions have worked quite well because borrowers could take equity out of their house or sell stock market assets to cure the loan.

In my estimation, if every bank had the collateral of all loans accurately appraised and each loan’s loan grading was finely tuned for an expected loss based on financial performance and collateral values, the number of essentially bankrupt banks in this county would increase by a factor of 4-5 from the current level.

In other words, there is a potential pool of 2000-3000 banks that would be on the FDIC radar's for getting closed.

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