Straight Talk — OREO and capital

Banks with significant holdings of defaulted commercial real estate are needlessly suffering at the hands of FASB and bank regulators. While the rules that govern banking are supposed to protect customers, investors and taxpayers, the rules that force banks to take immediate write-downs on collateral are, in fact, only jeopardizing banks.. I have written before about the need to decouple GAAP rules for valuing collateral-dependent impaired loans from regulatory calculations for determining capital ratios. When a borrower falls too far behind on loan repayment, the bank takes possession of the collateral. Real estate values have declined so dramatically recently that banks often find the value of that collateral has dropped significantly since the loan was made, sometimes to a value even lower than the outstanding balance of the loan. GAAP requires the bank to book the asset at that lower value. Fair enough.. The problem is, regulators figure capital ratios in relation to those assets. As the value of assets decline, regulators demand greater levels of capital. And that's a big problem. This is a tough environment for raising capital. And once a bank's capital ratios begin to deteriorate, the bank runs into all kinds of restrictions for making additional loans and seeking additional funding.. What banks need is a more reasonable approach for figuring the impact of OREO on capital ratios. Rather than applying the full write-down immediately to the capital calculation, bankers should have the ability to apply it over a 10-year period. This would help banks preserve their capital ratios and therefore maintain their levels of lending. It makes no sense to impede a bank's ability to lend simply because it is holding real estate. In most cases, banks are prepared to hold that land for years until its market value comes back. A bank's ability to lend should not be dependent upon cycles within the real estate market.. Even though the FDIC understands this issue and during the 1980s offered some banks capital forbearance, the agency does not seem sympathetic at this time. Certainly the FDIC is under a lot of pressure now and is therefore reluctant to do anything which might be perceived outside standard accounting practices. Limit the practice to loans already made by closely-held banks and you have no public accounting issues.. Congress is going to have to make this happen. Financial reform legislation is progressing. Whether in the Senate or in conference, lawmakers should direct regulators to come up with more accommodative calculations for capital ratios, at least until we get through the depression in commercial real estate values.