The Performing Non-Performing Loan: The Paradox Destoying Real Estate Wealth

The bank expects the client to pay the loan in full in a real estate market where the client cannot sell the property and cannot refinance the property with another bank because banks today are reluctant to extend new credit. The client wonders why his loan which has always been paid on time is suddenly called a “non performing” loan.

You would think that if you are current on your bank loans the bank would not want to call the loan or foreclose on the property. You would think that if you are performing your payment obligations and other requirements under a note and loan agreement that the bank would classify your loan as a “performing loan”, or a good loan. That’s what you would think. But that’s not the case in today’s lending world.

I have had many business clients over the past years facing potential litigation with banks over mature commercial loans. Typically, these loans were related to the real estate business including the construction business, land development, or income producing commercial and multi-family residential properties. The business client is current on the loan and has never missed or been late even though his business is suffering. Without warning, the bank sends the client a letter which says the bank will not renew the loan, or may call the loan as a default, because the loan has been reclassified as a non-performing loan.

In today’s lending environment there are many such performing non-performing loans. The problem is not that banks are stupid or vindictive (although it may seem that way to a layman), but the issue is bank regulation. A fully performing loan has two primary characteristics: current payments and adequate security. Commercial loans are usually well secured by low loan to value ratios because commercial property is less liquid than residential property. Real estate has declined so much that these commercial loans that were conservatively secured when issued are not under water. Banks and their regulators consider an undersecured loan to be a “bad loan” or a non-performing loan. Even though the borrower’s payments are current such under water commercial loans are a problem.

Bank regulators and auditors pressure banks to get these loans off their books. To get rid of the newly non-performing, upside down loans, the banks must demand payment in full. Obviously, the banks realize that small real estate businesses do not have surplus cash to pay off large loans and that calling a loan means foreclosing and taking back more property. I suspect that without bank regulators looking over their shoulder that commercial banks would not want to call a loan being paid currently and destroy banking relationships with their best and oldest customers, but that’s what is happening today. As a result of these banking policies, conservative and successful small businessmen are losing huge amounts of equity and savings. It’s sad. That’s the situation with the performing non-performing loans.

Last updated on May 22, 2020