This past Friday the FDIC introduced new guidance to reevaluate performing loans forced into impaired status. Here is a statement by CEO Delaney of CSE that puts the ramification of these new guidelines in practical perspective:

"A new policy statement issued last Friday by the FDIC and other banking regulators, however, suggests a change in the accounting and classification treatment for performing loans on which current appraised values have declined below the outstanding loan amount. We are still analyzing these new guidelines which run 33 pages but expect that some of our legacy loans in CapitalSource Bank will be positively affected.

A good example that we think puts this situation and this new guidance in context is a loan to a Raleigh, North Carolina, hotel operator that we have that’s operated by a national flat. Despite softer operating performance the borrower has continued to cover its debt service, in other words, it has positive debt service. As the loan neared maturity, consistent with bank underwriting guidelines, we commissioned an appraisal this past quarter. The new appraisal indicated the building was worth $5.5 million less then our loan, obviously the appraisal is dramatically reduced from the original appraisal.

This $5.5 million reduction of value less then the loan forced us under prior banking guidance to incur a $5.5 million charge, impair the entire $32 million loan balance, and place the loan on non-accrual, despite our belief that we will recover the entire loan and despite the fact that the loan is current and has positive debt service coverage. This “appraisal event” which caused a loss and added to our credit stats in this quarter is typical of the commercial real estate environment we are dealing with.

Absent the new regulatory guidance the forced classification of this performing asset solely based on appraisal will tend to force banks to sell performing assets at discounts, harming the bank, and contributing to selling pressure in commercial real estate. The new policy will help mitigate the automatic re-characterization of an extending performing loan as a classified asset at CapitalSource Bank due to these appraisal events and will likely improve our credit statistics. We will not, however, use the new guidance to artificially delay inevitable losses inherent in our portfolio.

I would also like to say that we applaud the actions of the regulators. It is smart, measured, and fair. It aligns a banks interest and incentives with economic reality and does not allow a bank to defer true problem situations. It in no way encourages the extend and pretend practices that the media and other parties interested in banks dumping loans, likes to allege. The new rules provide banks with needed latitude to retain loans viewed as “money good” but for these appraisal events." (end statement)

I expect these new guidelines will also offer some relief to how TONE and other banks have had to classify some of their loans too.