A new piece of legislation, H.R. 3461, is being pushed in Congress by people in the hotel business, which would change the rules for how banks modify and restructure overleveraged hotel loans. Titled the “Financial Institutions Examination Fairness and Reform Act,” the bill would get owners off the hook from foreclosures on properties that are overleveraged and underperforming.
This is absolutely wrong-headed and should not be approved by Congress. Banks are not equity investors. They are not there as rescue capital. They are not friends and family investors. They are lenders with a first mortgage that must be properly collateralized or written down. It is not the job of the bank, or any lender, to subsidize your bad investment and overleveraging. It would be disastrously bad public policy to have Congress telling banks how to manage their lending book. It would politicize the lending process far more than it already is.
In 2009, in order to save the banking system, the Fed and Treasury told banks to end mark to market and to stop foreclosing on commercial loans. That was the initiation of extend and pretend. That time has long since passed, and now we are back to more normal rules. You default, you pay down the loan balance and modify it, or you lose your asset.
Asking for H.R. 3461 to be approved is like having Congress telling my stockbroker, “Joel made a bad stock investment, which is now below the margin guidelines, but don’t ask him for more cash to true up the margin account because we know the stock will rise someday.” Why should the hotel industry get subsidized by the banks and not every other business? Why shouldn’t the banks give every business a subsidy until times get better? Because they are not investors or the government welfare state. Banks are lenders that need to maintain proper capital ratios so they can stay in business and continue lending to responsible borrowers.
If the loan is matured and can’t be refinanced, then go ask the bank for a modification and pay down the loan balance to get them to make a modification and extension. If you don’t have the cash to do that, then you misallocated your cash flow when you had it coming in during the good times. You should have saved some for the tough times that always arrive. If friends and family or someone else will not risk giving you rescue capital to pay down the loan, then it is not the role of the bank to provide it by allowing the loan to be well in excess of the collateral value. That would be the same as investing equity in the hotel, which is not the purpose of the banks. If the value of your hotel has decreased way below the loan balance, then the bank is at major risk of a loss and is now forced by the regulators to take a reduction to its capital. The shareholders of the bank are not there to subsidize the owners of the hotel.
Risk in capitalism
Capitalism in America is all about assuming risks on investments; sometimes you win and sometimes you lose. The underlying concept of the growth of the American economy as the greatest in the world is creative destruction. The weak or less able get destroyed to make way for the more able and stronger. Everyone has an equal chance to try and be a winner and get rich, and an equal chance to fail.
Overleveraging is a bad investment strategy in most cases, so now you know why. Keeping banks strong and solvent is critical to the recovery of the economy. Asking Congress to have make-believe shareholder capital in the small community banks through not recognizing losses on bad loans, is wrong. These smaller banks already operate on thin capital bases from the start. If they do not carefully maintain real capital, they will collapse and close, and the economy will not recover. Then everyone loses.
The whole argument that employment will suffer unless this law is passed is just a red herring. If you lose your hotel, someone else will buy it and maintain the employees. If it is not worth somebody buying, then it is not viable anyway and should be shuttered. The bank should not be asked to extend the loan to keep the hotel open. Maybe a new owner will even operate it better than you and employ more people since you were not able to operate it well enough to sustain the mortgage or to generate the cash flow to pay down the loan to keep it in balance. If you don’t have the capital to balance the loan, then you don’t have the capital to meet your property-improvement plan, and business will decline for lack of properly maintaining the asset. You eventually will have fewer employees anyway and very likely will go out of business.
If someone wants to claim the new government home refinance program for people whose homes are underwater is the same thing and should be extended to businesses, I was the author of that program for the White House, and I would be happy to explain why they are very different matters. That answer and program have nothing at all to do with politics, as I am definitely not an Obama supporter. I did it because it made sense and purely to help the country.
Joel Ross is principal of Citadel Realty Advisors, successor to Ross Properties, the investment banking and real-estate financing firm he launched in 1981. A pioneer in commercial mortgage-backed securities, Ross, along with Lexington Mortgage and in conjunction with Nomura, effectively reopened Wall Street to the hotel industry. A member of Urban Land Institute, Ross conceived and co-authored with PricewaterhouseCoopers The Hotel Mortgage Performance Report. Ross is also the author of Ross Rant, a commentary on the economy, financial markets and politics that is available through his website, www.citadelrealty.com.
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