The Real Deal New York

Fear and lending in New York: With regulators on their backs, banks get too timid

By Adam Pincus | April 02, 2012 06:35PM

Much like the high-powered executives who race to get to the Hamptons in two hours on a summer Friday, commercial lenders disregarded regulators’ meek enforcement of lending speed limits during the boom.

Today, though, federal bank examiners are acting like traffic cops posted at every exit on the Long Island Expressway, forcing lenders to slow down.

While commercial real estate lending has increased in New York over the past year, banks still have federal regulators breathing down their necks. And, according to observers, financial institutions are wary because regulators can demand action if they think something is amiss.

Indeed, Yonkers-based Hudson Valley Bank was forced to sell $268 million in performing and nonperforming real estate loans at an auction last month — many of them on New York City properties. The bank acted in response to its regulator, the U.S. Office of the Comptroller of the Currency, which told them last year to cut its concentration of commercial real estate assets, as well as other weak loans.

Still, the total amount of loans on banks’ books in New York State jumped by 23 percent to $202 billion between 2010’s fourth quarter and the same time in 2011, data from the Federal Deposit Insurance Corporation shows. And borrowers and commercial brokers acknowledge that lenders are likely preventing some future loans from going belly up as the economy recovers.

But some New York real estate players, who have a healthy appetite for risk, say in many cases banks are still being too conservative, simply because they’re scared of getting called to the carpet by federal regulators.

“It’s prohibiting additional growth in the market,” said one lending officer at a mid-sized New York City commercial bank. “The financial disclosures that are required from the guarantors are substantially more than in the past. In my opinion it is overboard when you have a good paying customer for 10 years, and now you need a global cash flow and are going into [each asset] and every corporate tax return.”

Specifically, insiders complain that banks are not letting up — even in the slightest on requiring more liquidity, more experience and more partners. In addition, banks are deciding to lend less on some deals if an outside appraiser determines that a property should be valued at less than the buyer is willing to spend.

For their part, banks say they are simply doing their due diligence, keeping in mind that regulators are conducting tests to determine banks’ so-called CAMELS rating, an acronym for “Capital adequacy, Asset quality, Management, Earnings, Liquidity and Sensitivity to market risk.”

Lowell Dansker, chairman and CEO of regional bank Intervest Bancshares, noted that banks were also frequently selling loans in an effort to stay in line with regulators’ goals.

“There are asset sales going on all day. The market is filled with banks selling loans to rebalance, either under a directive [from regulators] or to avoid a directive,” he said.

A lender will put loans on the market for a number of reasons. They include: to decrease its nonperforming loans, to reduce the concentration of one type of loan, to reduce its investment in one geographic area or to free up capital, said Louis DiPalma, managing partner with Garnet Capital Advisors, which, along with Ackman-Ziff Real Estate Group, handled the sale of the Hudson Valley loans.

This month, The Real Deal took a closer look at the three key components — experience, liquidity and value — that banks have been looking for in the new, tougher lending environment to see what they really mean for developers on a daily basis.

Experience

During the boom, many first-time builders received financing because the land they were building on was deemed a valuable collateral in itself.

Now, developers need to be experienced and also bring equity approaching 30 percent to 40 percent, insiders said.

Last month, Gregg Winter, president of midtown-based real estate finance firm Winter & Company, was trying to find a lender to provide up to $10 million to a small developer to complete a stalled Williamsburg residential project. But Winter said “no construction lender will give a loan without [the owner] teaming up with [an experienced] developer with a successful history of building and selling similar product.”

Lenders, concerned about the periodic examinations from regulators who will camp out at a medium-size bank about once a year for as long as six weeks, have even come down hard on established development families.

In one case on a high-profile Manhattan project, a developer from a family with a long track record in New York real estate purchased a prime development site at a bargain price. But several industry sources say potential lenders are insisting that he partner with a more experienced builder.

In that case, Richard Ohebshalom — the son of Fred Ohebshalom, owner of residential and commercial landlord Empire Management — bought the note and took title to a potential development site at 111 Washington Street, two blocks south of the World Trade Center, through his firm, Pink Stone Capital.

Sources say major developers have offered to buy the site — where Ohebshalom announced plans to build a 430,000-square-foot, mixed-used tower — and that it is now worth far more than the defaulted $50 million note he bought.

The younger Ohebshalom disputed claims that his firm was running into hurdles getting financing, saying he’s still figuring out plans for the site, and is not yet looking for debt.

Liquidity

Regulators want banks to be sure that when they make the loan, there is money to cover an unexpected cash-flow gap in the event of a problem, said J. D. Parker, regional manager for the Manhattan office of mortgage and property broker Marcus & Millichap.

“Banks are looking at the worst-case scenarios,” Parker said. They want to be sure the borrower has cash on hand in case the building does not remain leased up or construction hits a snag, he said.

For example, his firm is working on securing a $5.5 million loan for a cash-flowing acquisition in Queens. During the peak of the market, typically the borrower would have needed reserves that would cover six months to a year of interest payments, or in this case, about $250,000.

That’s nowhere near enough today, he said. Today, they want about $1 million.

In some cases the banks, to increase their capital and improve their standing in the eyes of federal examiners, will demand borrowers open operating accounts in the lending institution as part of the loan conditions, said attorney Joshua Stein, who focuses on real estate financing.

In testimony before a U.S. House of Representatives subcommittee in February, Jennifer Kelly, a senior deputy comptroller with the OCC, underscored that regulators wanted liquidity, not simply performing loans.

Discussing construction loans that often have interest reserves that make loans look current and “performing” even if the project is in distress, she said, “Performance is certainly a key variable in making an assessment of collectibility, [yet] a banker must also consider the borrower’s continued capacity to meet the loan’s terms in the future.”

Bobby Bakhchi, president of mortgage brokerage Hybrid Capital, said he’s seen nearly a dozen instances over the past year in which banks have asked borrowers for a global cash flow, which provides a report on the property owner’s holdings across all the assets, to see if there are any weak spots.

“This is some of the tighter regulation and increased scrutiny taking place,” Bakhchi said.

The above-mentioned executive at the mid-size bank noted that some credentials used to determine liquidity, like tax returns, were often not a good indicator of a borrower’s cash positions — and that asking for them was a waste of time, or worse.

The potential borrower “might not be willing to go to that length,” he said, and instead drop out of the loan application.

Regulators — including the FDIC, the Board of Governors of the Federal Reserve and the OCC — also look at debt-service coverage ratios, the concentrations of loans in one area or available capital.

Dansker, of Intervest Bancshares, said regulations are not tighter today, but that enforcement is.

“There is more in-depth analysis being done by the regulators to make sure the banks are following the rules,” he said.

Building buyers in New York are growing increasingly frustrated with how banks are valuing their properties when they are hunting for a loan. Part of the issue is that lenders are often deciding to lend less than the borrower asked for.

The major shift, insiders say, is that regulators want lenders to underwrite based on in-place, dependable income, not on anticipated growth.

“Banks are underwriting to the current value of the asset, where it is [on] Day One, not based on promised increases,” said Jason Enters, principal with residential landlord Minuit Partners.

In addition, large national banks are being stricter than some regional lenders on their in-place underwriting, insiders said. For example, national banks, when projecting future revenue, often use a high 5 percent vacancy rate for rent-regulated apartment buildings — nearly double the city’s actual rate in 2011 — thereby lowering the property’s projected income and its value.

The federal government is watching appraisals like a hawk because inflated appraisals were partly responsible for fueling the high boom prices.

Garrett Thelander, managing director for Massey Knakal Capital Services, noted that even if potential buyers and their appraisers agree on a property’s net operating income, the appraisers might use a lower cap rate for the property — and thus determine a different value for it. (The cap rate measures the ratio between net operating income and the property’s valuation.)

There are some exceptions to the tighter lending regimen.

Regulators, and thus banks, have an easier time defending higher loan-to-value ratios on the city’s rent-regulated multi-family properties, in part because of the low vacancy and dependable rent increases. Yet some loans are being made on formerly distressed properties for more money than when they went into default, housing advocates said, raising questions as to why regulators would not raise flags for those loans.

Dina Levy, director of organizing and policy at the Urban Homesteading Assistance Board, pointed to a portfolio of buildings formerly owned by a group of Japanese investors and managed by Sam Suzuki, where Hudson Valley provided new loans in September last year at levels higher than the old loans.

“The loan did not work at $13.1 million. Why did Hudson Valley think it will work at $13.4 million?” she asked.

It’s unclear if those loans were part of the package sold last month.

While many in the industry see the regulations as overkill that is dampening a shaky recovery, most agree that it will strengthen the banking sector.

“Lots of local banks may have given a few dogs [or bad loans]” to long-time, dependable clients, one small landlord said, noting that nobody wants to take a hard look at those loans.

“The net impact is that those banks that were not following the rules have to rejigger their whole organization,” Dansker said. “[But] it ultimately leads to better underwriting and better portfolio management going forward, and that’s what we are all trying to get to.”