Banks write bad real estate loans for the worst of reasons. Lenders get burned more often by not doing their homework than they do by greed and corruption. Make no mistake, the current economic slowdown is not helping, but lender procedural inadequacies are turning what should be a cyclical slowdown into a disaster for some.
The Bank of New England is just the latest major financial institution to be felled by a rotting real estate portfolio. It won't be the last.And, unless commercial lenders realize what they are doing wrong today, a whole new wave of bad real estate loans will be made when the economic climate clears. Based on this writer's years of experience doing market studies for some of the nation's largest developers and lenders, most all real estate investment failures are foreseeable.
THE PROBLEMS. Lenders don't pay their lending officers enough. They entrust too much lending authority and responsibility to "youngsters" who have advanced degrees (and little else) and lenders don't control the data they use to make their lending decisions.
It's no secret that working for a bank is not the highest-paying career in the world. Should it be a surprise that lenders are taken to the cleaners when underpaid loan officers of moderate skill are expected to match wits with entrepreneurs who often are worth millions?
If a lending officer gets really good he leaves. In private business he can create a lifestyle that would be unimaginable while working for a lender, said Alfred Candrilli, principal with Wm. Mercer, Inc., the nation's largest compensation and benefits consulting firm. Until then, it's like sending lambs to the slaughter.
Commercial lenders entrust too much decision-making responsibility and authority to MBAs who are relatively young, inexperienced and in many cases simply immature. Too often these people are easily led, and their firms pay in the end, said Candrilli. Without experience, MBA and law degrees have limited or no value. (Candrilli has both degrees.)
The loan evaluation process is tainted from the start. Believe it or not, the volumes written that determine whether a loan is worth making are commissioned by and paid for by the borrower, not the lender.
To make matters worse, appraisers and market analysts working for developers face a terrible choice. Too often it's either write a favorable report or get fired. In any case, if a developer is determined to go ahead, he will never show his lender a negative report. He will hire another researcher who will write a favorable one.
Consumer loans are treated differently than big borrowers. The result is that consumer home mortgages are safer than commercial loans and don't threaten the nation's leading financial institutions.
Unlike commercial loans, if an individual consumer wants a mortgage for a house, the lenders will select an appraiser and pay him. Though the consumer is charged for the appraisal, the lender maintains complete control, said Sam Lyons, senior vice president for Great Western Bank in Beverly Hills, Cal., one of the nation's largest home lenders.
The more that you control the (evaluation) process, the better quality that you get. It serves no one well if a lender allows himself to get carried away by a borrower's unfounded optimism, said Lyons.
If lenders want good loans, they must pay for and control solid research and they must have experienced, competent, well-paid loan underwriters whose bonus/commission system pays them as much for saying no as yes.