SEC set to call time on banks’ soft-touch approach to real estate loans. By Matt Byrne
US bankruptcy teams are gearing up for a potential wave of insolvencies in the second half of 2011 following a warning earlier this month by the Securities & Exchange Commission (SEC) that it will no longer tolerate so-called ’amend and pretend’ practices by banks.
According to a report earlier this month in The Wall Street Journal, the SEC recently sent out notices to a number of banks requesting information about the commercial real estate loans they hold.
The SEC is understood to be concerned about the way some banks are accounting for these loans, the implication being that some financial institutions are making them appear more robust than they really are.
Last year’s collapse of Chicago’s ShoreBank is understood to be related to troubled debt restructurings, in which the terms of existing loans are changed so the reserves required to be set aside by banks are reduced.
As the Journal reported, another financial institution – Cincinnati’s Fifth Third Bancorp – has been subpoenaed by the SEC.
In its annual report published earlier this month, Fifth Third confirmed that it was under investigation by the SEC for the manner in which it accounted for and reported some of its commercial loans. The result of any enforcement proceeding could be civil charges brought by the SEC.
According to Marc Abrams, co-chair of Willkie Farr & Gallagher’s business reorganisation and restructuring department, the SEC’s decision to focus on these loans is “a win-win situation”, as it should prevent the problems associated with these toxic loans being “kicked down the road”.
“This is not detrimental at all,” added Abrams. “When banks extend maturity dates it doesn’t really help the companies because they’re being charged big fees – there’s not really more liquidity. And for the banks it’s time to fess up and realise there’s a large pool of capital out there and someone will buy their paper.”
The SEC has not yet launched a formal investigation into the practices, but the mere fact of its move could lead to banks taking a more conservative line on lending, Abrams added.
The possibility remains that this could lead to more failures later this year both among banks and their clients.
“We understand [the SEC is] just soliciting views and will then decide whether to take any action,” said Abrams. “But as a result some banks may become more conservative merely because the SEC’s looking at this. One potential consequence is that companies that would otherwise have their credit lines extended under amend and pretend will have them withdrawn or reduced, which could lead them into bankruptcy.”
On the other side of the Atlantic White & Case restructuring partner Mark Glengarry said the problem of banks’ provisioning, particularly with respect to real estate exposure, could be even worse than in the US.
“The EU stress tests haven’t been seen by the markets as credible,” argued Glengarry. “My impression is that the problem’s more acute than in the US. There are detailed rules around provisioning from an accounting perspective, and within the restructuring of leveraged corporates we’ve seen impairments taken. The position is more complicated in relation to the real estate market, where the loans can be left untouched even though there are serious LTV [loan-to-value] breaches.”
Despite a general softness in the res market in the US, bankruptcy remains one of the biggest money-spinners for a select group of US firms, with Lehman Brothers and General Motors the standout matters during 2010. Weil Gotshal & Manges appeared on both matters, acting as lead debtor counsel and earning a total so far
of $286.6m (£178m) in fees – $254.6m and $32m respectively.
Other top earners include Milbank Tweed Hadley & McCloy, Jenner & Block and Alvarez & Marsal, which billed $89.9m, $57.9m and $393.4m respectively last year on Lehman alone.