Mike Kozak's take on modifying troubled commercial loans reflects that of many bankers — optimism with a hint of uncertainty.

"So far they have been performing reasonably well," said Kozak, the chief credit officer at First Midwest Bancorp in Itasca, Ill. "A substantial amount of these have been booked in the last month or two. They are not really time-tested yet."

But skeptical industry watchers say time and recent experience are not on bankers' side.
Frederick Cannon, co-director of research at KBW's Keefe, Bruyette & Woods, said commercial modifications have tended to fare as poorly as residential ones through the years.

"Historically, the default rates on commercial mortgages have been in excess of 50% in previous cycles," Cannon said. "It's hard, as analysts, to give the banks a lot of credit for curing a significant amount of these loans, simply because the history doesn't support that."
Bankers acknowledge the doubts but say their efforts are off to a promising start. Helping borrowers stay afloat during tough times is good business that will earn them money in the long run, they say.

A review of second-quarter filings shows commercial loan modifications at many regional and large banks spiked sharply as lenders granted lower interest rates, longer maturities and other temporary concessions to companies struggling to make ends meet.

Executives at companies with batches of recently restructured commercial loans — like Umpqua Holdings Corp., TCF Financial Corp., Susquehanna Bancshares and First Midwest — said they are optimistic that the modifications will work out.

Brad Copeland, the chief credit officer of Umpqua, in Portland, Ore., said the bulk of his company's $126 million in restructurings has been granted to developers that have the willingness and capacity to finish a project that has stalled because of the downturn.
"It's pretty early in the cycle," but "we haven't had any gone bad on us yet. I think it's a positive," Copeland said. "We don't restructure loans that we feel have the strong potential to go nonperforming."

Cannon said murky accounting and regulatory guidelines on restructured loans make it difficult to determine whether banks are setting aside proper reserves against potential loan losses in their modified loan books.

First Midwest said it still views its restructured loans as risky, and reserves against them accordingly.

Michael Scudder, First Midwest's president and chief executive, said modifying a loan is good for the company and its borrowers. So far most of its restructurings have been working out, with 63% of them classified as accruing interest. It had 62 restructured loans worth $30 million as of June 30, up from eight loans worth $7.34 million at yearend. About 73% of the portfolio's value — or nearly $22 million — is tied to some type of commercial loan. The rest are consumer and multifamily home loans.

"Appropriately used it is an effective tool," Scudder said. "It helps our customer. It mitigates our risk of loss. And it allows us to be able to reduce our nonperforming assets."

Jason Korstange, spokesman for TCF Financial, agreed.

He said working with a borrower has long-term benefits.

"You want to work with your customers," Korstange said. "These times are not going to last forever. You don't want to be a bank that just closes the door and says no."
TCF, of Wayzata, Minn., had $71.8 million in restructured loans at the end of the first quarter, up from $50.3 million at the end of 2008. About 14% of its restructurings have been given to commercial borrowers. Though all of its commercial restructurings are classified as nonaccrual, Korstange said that is mostly because they are still young. A restructured loan has to generate payments for nine months before it is classified as accruing. Overall, 72% of its restructured loan portfolio is performing at modified terms.

But analysts say potential pitfalls and unknowns abound.

Matthew Clark, another Keefe Bruyette analyst covering regional banks, said the industry could face "another wave of nonaccruals" should commercial modifications pan out like residential mods.

More than 52% of mortgages modified in the first quarter of 2008 were 60 days or more past due after 12 months, according to the Office of the Comptroller of the Currency's administrator of national banks.

Clark said commercial loans could fare better, since for the most part they are underwritten better than home loans. But the losses could be substantial nonetheless. "We don't know yet — they are not really that seasoned," he said.

But bankers are reluctant to throw in the towel just yet.

Michael Quick, the chief corporate credit officer at Susquehanna, in Lititz, Pa., said a restructured loan that may or may not go delinquent is still valuable to a company.

"If you can restructure a loan, even though it's a [troubled debt restructuring], at least you are getting interest as opposed to it going nonaccrual, where you are getting no interest," he said.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.