A Banker Sheds Some Light on Commercial Real Estate Loans

Post by the Hawthorne Hawkman, bank deposit image from the wiki Runescape page.

After Paul Koenig's James Michener impersonation yesterday, and my response, I thought I would check with one other commercial banker to glean more understanding on these Commercial Real Estate lines of credit (CRE). I have maintained from day one that the cross-collateralization of these loans looks extraordinarily fishy to me. Koenig, on the other hand, claims that doing so is standard practice in these types of loans.

This banker helped me get a much better handle on CRE's, and I'll try to pass that on to faithful JNS readers. Admittedly, this is much more enjoyable when using recently emptied glasses of beer and bloody Marys, but we'll have to make do.

The first question I asked this banker was...

"Is there a legitimate reason for individual properties to be on multiple lines of credit?"

Yes, there is, actually.

Explaining why would be far easier with the aforementioned glasses as a visual prop. But let's take five properties and group them together. In the spirit of Olympic hockey, we'll call this "Group A."

2420 Bryant Ave N
2400 Lyndale Ave N
1547 Hillside Ave N
2706 Colfax Ave N
2727 Girard Ave N

Group A has a collective loan-to-value (simple, hypothetical numbers: the cumulative value of these properties is, say, $500,000) AND a collective revenue stream ($1,500 per month from each property means $7,500 in income, minus whatever monthly maintenance costs are. For Koenig, those costs are quite minimal since he either doesn't maintain properties or doesn't pay the people who do).

A commercial banker might want to group such properties together because "rental properties are either 100% occupied or 100% vacant." This is not entirely true with Pamiko. Dream Homes aside, Koenig almost exclusively bought duplexes or multi-unit housing.

Now, let's say Koenig gets another few properties, we'll call them Group B:

2013 Hillside Ave N
1414 16th Ave N
4652 Aldrich Ave N
2321 Lyndale Ave N
2420 Bryant Ave N
2706 Colfax Ave N

Wait a minute...there are two properties in Group B that were also in the Group A loan. Why?

This hinges on the supposed strength of collective revenue streams, knowing that a vacant property produces no revenue or negative revenue (losses). So let's say that all of the properties in Group A are occupied, well-maintained, and have good tenants paying on time. (I know, we're suspending our disbelief even more than during a Michael Bay movie, but this is hypothetical.) But the first four properties in Group B are either unoccupied (negative revenue) or partially occupied or in need of some rehab (resulting in little to no revenue).

In this case, the successful performance of the Group A properties lends some revenue to the Group B loan. In that way, cross-collaterilaztion could make each loan stronger than it would be on its own. Doesn't that also increase the risk of fraud? Yes, the banker said, but that's why it's important to have a global view of your borrower's entire financial picture. Like, oh, did he declare bankruptcy or have other failed property ventures under different LLC's?

The other question I asked was about Koenig's claim that the bank just arbitrarily raised the interest rate ten percent. We've all heard horror stories of credit card companies doing this to their customers, so Koenig is definitely trying to play the common-man sympathy card here. But does this sort of thing happen on Commercial Real Estate loans?

No.

Even small increases have to be triggered by SOMETHING. That "something" could be rate resets built into an adjustable loan, but that wouldn't account for such a huge increase. Even though Minnwest Bank was getting hit with significant CRE losses, she said it would be highly unlikely that their apprehension about the market in general would or even could allow them to adjust the rate.

A hike that large was probably a "default rate." In other words, a punitive measure taken because something significant was triggered to make the lender believe the loans were no longer viable. Those "triggers" are also written into CRE loans, and include things like not making timely payments, fraud, not maintaining the properties, failing to pay taxes, or adding a second loan to the collateral without authorization. How many of these things sound like things Pamiko did?

So it turns out that perhaps part of what Koenig said was maybe half right. That still makes him all the way wrong for our neighborhood.