I would hope that once the banks have time to review and implement these guidelines, the process for obtaining a commercial loan modification will be more efficient and streamlined. It appears that this was the intent of the FDIC and will be to the benefit of both banks and borrowers.  At the end of the day there will undoubtedly be many loans that are beyond repair and foreclosures on commercial properties will be inevitable, but these guidelines should be able to slow down the bleeding.

Initial reports seem to indicate that so long as the modifications are done in a prudent manner including a thorough examination of the borrower’s creditworthiness, banks will be able to engage in the modifications without any adverse regulatory impact.  Additionally, initial reports have indicated that a bank may modify a loan even if the loan is underwater.  This is a major shift as in recent months many banks have been requiring principal pay downs on loans that are underwater as a prerequisite to a modification.  All of this seems to bode well for borrowers.

Once a CMBS loan goes into default, it is generally moved to what is a called a special servicer.  Often times, this is simply another division of the master servicer.  The special servicer has the authority to make modifications to the original loan in order to maximize the return to the investor.  This gives the special servicer a broad range of duties and powers, but is also very labor intensive.  The influx of defaults and the subsequent strain on its special servicing unit was a critical factor leading to Capmark’s bankruptcy.

This is likely one of the major reasons that the FDIC will soon be announcing a set of guidelines for commercial mortgage modifications.  You hope that the FDIC will be better at implementing these guidelines than they were at implementing the 2006 guidelines.  A comprehensive set of guidelines for the modification of commercial mortgages is likely the only solution for the impending collapse of the real estate markets.  Had the banks not been so highly leveraged and had they not so highly leveraged almost all of their loans, the market may not have reached the breaking point that it is currently at.  But the banks did not follow the rules and the FDIC did not enforce them, so there is blame to be shared by everyone.

The government must act in a manner that allows these banks to rework these loans to reflect the current market.  Another wave of foreclosures is not the answer.  Although many economists may say that foreclosures are needed in order to bring the market back into equilibrium, that theory may be too drastic when our economy is in such turmoil.  A better solution may be to set forth guidelines that will allow these loans to be worked out and give the overall economy time to recover.  A commercial loan modification will also be less costly for banks than going through the foreclosure process while providing them the opportunity to recoup their entire debt.

A set of guidelines by the FDIC is what the market needs in order avert the disaster that befell the residential real estate market.  Encouraging lenders to modify these commercial mortgages will serve to stabilize the market by preventing a flood of foreclosures from coming online over the next three years.  These guidelines could provide for loan extensions at lower interest rates which will serve to address the issue of the influx of loan maturities that are expected.  Since the available funds for refinancing are minimal at best, such programs are necessary to maintain some sense of stability in the market until the economy can turn around.

With commercial mortgage defaults mounting and the lack of a clear plan on the part of the banks and the government as to how to deal with this issue, 2012 may be the point where we get to see just how bad the damage is.  The common theme that I’ve been seeing is that banks are at times hesitant to modify loans because of FDIC regulations that make accounting for these modifications very difficult on the bank’s books.  Although there is some benefit for the bank in foreclosure and ridding themselves of these assets, it seems that a greater benefit for the economy as a whole would be to modify these loans to reflect the current market and stabilize the market using that route.

Chances for a recovery in the commercial market seem slim in the short run as the combination of falling rents, falling property values, an increasing number of maturing loans and a lack of liquidity in the credit markets all work together to drag prices down.  Industrial properties seem to have taken the biggest hit as industrial production is most directly impacted by the recession. 

From what I have been seeing, almost all defaults are a result of missed payments.  This can be a result of owner-users losing business revenue or third party investors receiving reduced rents either as a result of not being able to rent out vacancies or tenants vacating as a result of the economy.  With defaults expected to be at &5 at the end of this years, it appears that the worst is yet to come between 2010-2012 when many commercial loans begin to mature.

Many of the loans that have come through my office are of the portfolio variety.  Most are in default and the others are on the verge.  As these loans increasingly begin to default, these smaller banks will come under increasing pressure and many more will begin to fail.  Some of these banks have begun to open up to idea of modifying loans in order to cure or prevent defaults, but others are not as eager as a result of accounting rules that complicate the process.  Without a change in these accounting rules and/or government programs encouraging commercial loan modifications, a second wave of bank failures will occur and further dry up what is left of the credit markets.