CRE Loss Amortization "Zombies"

In April, we discussed round 2 of the efforts of Rep. Ed Perlmutter and a bi-partisan group of Colorado representatives to push a bill through the US House of Representatives that would allow commercial banks under $10 billion to write off losses on commercial real estate loans and OREO over an extended period of time. Round 1 ended last year in initial victory in the House and ultimate defeat when Democrats in the Senate stripped the provision out of the small business lending act before it was passed. The American Banker (paid subscritpion required) focused on the story this week and labeled the bill a "kick the can" effort. That's a true statement, as evidenced by the cheerful agreement of the bill's sponsors. They want to give community banks the same opportunity to gradually recover as real estate markets recover as folks in the current administration and federal banking regulators like Sheila Bair advocated giving residential loan borrowers. As we predicted, American Banker reporter Robert Barba picked up all kinds of static about the proposed law from federal bank regulators, who raised the "zombie bank" meme. One opponent argued that the same scheme didn't work in the late 1970s and early 1980s "for savings and loan associations." I was in-house counsel for one of the largest savings and loans in Colorado from 1977 to 1981, when I left to join the law firm that represented the Colorado Savings and Loan League and many savings and loans in Colorado and surrounding states. I subsequently was a partner in two law firms, one regional and one national, where I represented scores of savings and loan associations and a lobbying group that helped add the forbearance provision to the Competitive Equality Banking Act of 1987. I don't know what the person making this allegation was doing during that time period, but there was never a 10-year (or even 7-year, as was the case with ag banks) amortization period for CRE losses in the late 1970s and early 1980s that was allowed for s&ls. So, no, the loss amortization scheme during that time period didn't work because it never existed. There was a concept that was tried called "supervisory goodwill," which involved extended amortization of the "negative goodwill" that was created when a healthy savings and loan took over a broke one with a negative net worth. If what this "expert" is addressing is that issue, then the "zombie" banks that he's referring to became "zombies" only when Congress wiped out the extended amortization period in August 1989 with the enactment of the Financial Institutions Reform, Recovery and Enforcement Act. With their capital accounts devastated, most of those savings and loans sued the US government in the US Court of Claims and most won big money from the government for breach of contract. They weren't zombies, they were pissed off plaintiffs. If what the critic is referring to are the forbearance plans allowed by CEBA, only a few were approved, and when Senator Proxmire criticized them on the floor of the US Senate, the Federal Home Loan Bank Board suddenly determined that the subject banks weren't living up to their forebearance plans and yanked its approval for those plans. Those banks subsequently died, but they were few in number and they were not beneficiaries of an extended amortization of CRE losses. So-called "zombie s&ls" were the result of the fact that the losses suffered by savings and loans on CRE were so massive that the Federal Savings and Loan Insurance Corporation didn't have the funds to resolve them, other than to let them stay afloat in a lake of insolvency while awaiting a miracle, which the FSLIC and its operating head, the FHLBB, tried to concoct via creative solutions like The Southwest Plan, which involved less immediate cash outlays but the issuance of a bunch of notes that the FSLIC couldn't pay when the bill came due without a bailout from Congress. Congress punished both entities by abolishing them, shifting FSLIC's fund into the FDIC and creating the OTS (which officially dies tomorrow). Zombies were not created by a 10-year CRE loss amortization scheme. As to another criticism of the bill, that such banks wouldn't be able to raise capital because the financial statements of these banks would deviate from GAAP, it must be based on conversations with an entirely different group of private equity players than I have been talking to. Banks would still have to calculate the loss under GAAP, but would not have to recognize it immediately for regulatory capital or earnings purposes. Instead, they would take the hits in installments over a 10-year period. Financial statements would be required to show both GAAP and regulatory accounting calculations. Unless your ability to read a financial statement is at the level of a not-so-smart Rhesus monkey, you should be able to easily determine the gap between GAAP capital and earnings and regulatory accounting capital and earnings. The critical determination will be whether the initial determination by the bank of the amount of the "loss" with respect to each CRE asset was "correct," but you've got that crap shoot with all banks who have CRE in their portfolio, whether they recognize the loss immediately or not. In fact, extended amortization of the loss may actually encourage banks to take a more healthy "loss" than they otherwise would have taken, because the result isn't instant obliteration. Reasonable people can disagree on these issues, and obviously do. I just wish the critics would get their facts straight and quit raising bogus arguments. Of course, none of these arguments will make a whit of difference. In the end, I don't see community banks having enough clout in D.C. to win this war this year anymore than they had last year. I admire the gang from Colorado for trying, however. At least in one state, the legislators are listening.

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