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Banks Not Happy Becoming Landlords of Commercial Property

Growing weakness in commercial real estate is poised to transform banking companies into accidental landlords with a new set of headaches.

Lenders have already endured trials from seizures of vast numbers of single-family homes. Properties that produce income and accommodate tenants office buildings, apartment complexes, shopping malls and the like carry a distinct set of problems, from "slip-and-fall" lawsuits to new varieties of public relations dust-ups.

Tenants have always had a fraught relationship with landlords. Following the blow to bankers' reputations from the financial crisis, the dual role could make for a particularly combustible mix. "You can imagine some of the places where you might get the most public reaction. Suppose that you had municipal buildings that had been mortgaged to a bank. Suppose you had a nursing home," said Ralph "Chip" MacDonald, a partner with Jones Day. "The more complex the business" hospitals are another example "the less anxious the banks are going to be to get involved."

By and large, strapped homeowners are likelier candidates for public sympathy than property moguls on the brink. But indignation over bailouts has intersected with commercial lending relationships to produce unwanted attention for institutions like Bank of America Corp. and Wells Fargo & Co. Their roles as creditors for the failing Illinois manufacturers Hartmarx Corp. and Republic Windows and Doors drew national headlines and political pressure for concessions.

"It has sort of become a rallying cry that somebody who receives" assistance from the Troubled Asset Relief Program "has different obligations than what they legally have," MacDonald said. "TARP has become a burden-sharing exercise as opposed to temporary assistance to stabilize the system." Reasons to Sell To be sure, the complexities of real estate ownership are vastly overshadowed by prospective losses on a widely anticipated crescendo of bad debt. If a lender is packed with souring loans that put it in a position to become a big landlord, there is a good chance it is insolvent anyway.

Lenders can avoid coming into possession of properties by selling loans headed for trouble. "There are some banks who would just rather sell their loans and get the loans off the books and not have to deal with it," said Jeffrey Lenobel, a partner with Schulte Roth & Zabel LLP.

"Lenders are generally not in the foreclosure mode because it's time-consuming, it's expensive, and then they obtain the property, and have to manage it, run it, lease it, sell it," he said. "They have to hire a managing agent. They have to deal with the economics of the property. If it's an office building, they have to lease it. If it's a hotel, you have to enter into a franchise or operating arrangement."

Mr. MacDonald said that when banks do foreclose, they often put the collateral "in special-purpose, bankruptcy remote entities so that they don't get exposed to the liabilities of operating the commercial property, where you have potential tenant and visitor risk."

For example, at an industrial plant, "you worry about environmental liability," he said.

Regions Financial Corp. focuses on "getting loans moved before they go to foreclosure," said Tim Deighton, a spokesman for the Birmingham, Ala., banking company.

In late 2007, the $142-billion-asset Regions set up a division to unload distressed assets. Evelyn Mitchell, a spokeswoman, said one reason for the approach is the difficulty of going through the legal process for foreclosure.

Synovus Financial Corp. Chief Executive Richard Anthony said his company was stepping up efforts to unload problem holdings to improve its credit profile. The $34.5-billion-asset Columbus, Ga., company has posted three consecutive quarterly losses as it increased its allowance for loan losses by 86 basis points from the year prior, to 2.32% of net loans at March 31. Reasons to Hold However, some market participants said banking companies are reluctant to sell distressed assets in general, including commercial real estate loans, because taking hits at current market values would ruin them.

The desire to hold assets until the market rebounds likewise provides an economic incentive to retain foreclosed real estate, plus the market for some properties is close to nonexistent.

David Gibbons, former deputy comptroller and chief credit officer at the Office of the Comptroller of the Currency, now a special adviser to Promontory Financial Group LLC, said that though holding onto foreclosed property risks price drops, "depending on your timing, you could be dumping your property at very low prices." That happened in "the early '90s when banks acquired a lot of 'other real estate owned' and sold it and eliminated problems from their balance sheets," but "then somebody else made money because the market stabilized and got better."

Eric Michael Anton, an executive managing director with Eastern Consolidated, a New York commercial real estate sales firm, said that over the last six months, he has observed a pattern where banks "go to market, and they'll get the offers, and then they'll say, 'You know what? We're not going to sell.' So they go through the exercise, they see that they're not going to get even close to" the amount of debt on the property, "and they pull it off the market."

Such a flip-flop can "taint the asset" by signaling that market interest in the property is weak, he said.

Bill Leseman, the chairman of Caldera Asset Management LLC, a real estate consulting firm with offices in Greenwood Village, Colo., and Atlanta, said that in the current market he expects lenders to hold most multifamily properties they take over for longer than the traditional 60 to 180 days. Harry Terris is a deputy editor for American Banker.