Organizing For Problem CRE Loans
When dealing with problem CRE loans, at some point the realization that things need to change in managing these issues will come apparent. Whether that is the shear number of problems, the complexity of the problems, or the dollar volumes involved. The need to organize to deal with them has become painfully evident.
There are three basic steps to determining if and how to re-organize or change methods in dealing with problem CRE Loans. First determine the true scope of the problems, understand and identify the current problems and any potential future problems. Second, determine the expertise needed to deal with and to solve these problems. And finally decide on the implementation of the resources to accomplish the solutions to the problems.
Viewing a realistic picture of the magnitude of the problems. The old saying “plan for the worst and hope for the best” is a great rule to follow.
Start by grouping your entire CRE portfolio by its problem and potential of having a problem. In it’s simplest form we have four basic problem groups:
- Technical Default (such as maturity date has passed or levels of required capital have fallen)
- Delinquent Payment
- Workout / Negotiation phase
- Foreclosure / Legal Action phase
In order to determine the potential of a loan to have a problem, further categorizing each loan as to the type of project (product) and its geographical location. Keep this simple but relative to the total portfolio. Examples might be retail, office, mixed use, industrial, construction, multi-family etc. For example things such as, size, use, or key anchor tenant may be types of categorizes in a portfolio that contains all retail property. The other variable is geographic location. Know the geographic market area of each CRE loan.
The next element in understanding the true scope of the problems is time. Knowing how long each loan has been in its current problem state provides as well as any previous problem state.
Lastly, with all this information, review the portfolio from each of these different angles. Determine the number of loans (and principle balances) within each grouping, category, and location by time and problem. With this information, trends can be identified that will then determine the number of potential problem loans. (Needless to say, but here as a reminder, any loan that is related to a problem loan via the borrower, guarantor, or a related entity should be considered as a potential problem regardless of the “trends”).
The end result in this first step is to get a total real world view of what needs to be resolved; the time frame for resolutions; and in what areas will need the most work. This is the base to determine the type of resources needed.
Determine the types of expertise needed to solve the problems. Regardless of the type of problems, negotiation and market expertise is crucial; and depending on the problem, specialty expertise may also be needed.
Usually the key person that would be working directly with the borrower on a problem loan would need very good negotiation skills. They are a person that can communicate exceptionally well, can look at all sides, be creative to find win-win solutions, and all the while keeping the banks long term best interest first. The traits that are needed for this are:
- Aggressive but diplomatic
- Has composure and understanding
- Knows where they are at and where they want to be
- Ability to close the deal
- Read people’s intentions
- Honest and trustworthy
- Experience with the products
- Inquisitive, to keep searching for the right solution
Because in dealing with any type of CRE problem, market expertise is needed to validate the feasibility of any market assumptions or facts. The need for this expertise is very important, do to the every changing market conditions. The individual with the market expertise is the one that knows the pulse of the industry for a given area.
Depending on the type and number of problems, specialty expertise may be needed. This could be construction, property management, or even homeowner association knowledge. These specialty experts will provide the details needed to evaluate the property, keep the borrower in check, and make sure any assumptions made during negotiations are accurate.
During this step, focus on the type of experts you will need to handle the volume within the required time frame to keep as many loans out of the legal action phase as possible. Often, costs of these experts will come to play, but the costs associated with not aggressively and proactively dealing with the problems are usually far greater. Unfortunately, the tendency in this step is to under estimate the resources needed. Therefore, the reminder here is to keep focused on your needs, not on what you have or think you can afford.
Look at the existing organization to determine what changes need to be made to resolve as many problems as possible. Focus on how to resolve the volume of issues as quickly as possible as well as keeping absolute accountability of the financial responsibility.
Some basic questions would be:
- Can the existing originating/servicing line handle the scope and do they have the needed expertise?
- Should a new group or department be formed to handle this volume?
- Would it be best to subcontract out with an outside service company that deals with these issues?
Being able to internally manage, and resolve all the problems is most likely the preferred scenario. But outside expertise may need to be employed. Let’s look at each basic question to determine the pros and cons.
Having the existing originating/servicing department handle the problems. The primary advantage is that these individuals already have an intimate knowledge of the loan, the project, and the borrower. Therefore, they have a level of understanding and the history, to know about the borrower and what might best work. The problem is that they may not have the specialty knowledge to fully understand the cause of the problem. Also, the volume of problems may be too great to allow them to do their normal SOP duties.
Creating a new group to handle the problems. The primary advantage is the ability to gain more expertise, and thereby achieving better results. Another advantage is that this can ensure that the dealings with troubled borrowers are consistent. Also, if it is designed correctly, is its ability to hire the expertise for a specific period rather than for permanent employment. Thereby, allowing growth and contraction as needed. A good disadvantage is that there is not enough volume to support a separate department. The bad disadvantage is that there is no one with the proper credentials that can start or manage this group.
Subcontract with an outside service company to handle the problems. The primary advantage is that an outside service would (or should) have all the expertise needed to resolve any type of problem. Also, when the problems are resolved their services are terminated. The biggest disadvantage is that they may not always be able to make a decision with the best long-term advantage to the bank, simply because, they won’t know every confidential detail to do so. Another (which should be minor) disadvantage is that an entity outside of the bank’s control has knowledge of all its problems.
Step one – determining the scope in quantity and value by group, category, location and time; step two – determine the needed resources in negotiation, marketing, and specialty expertise; and step three – make the changes needed to fix as many problems as possible in the shortest amount of time.