Commercial Loans – Getting Notes “Called”

As the credit crisis continues, borrowers AND banks are suffering. One of the issues is existing commercial loans and their existing loan to values. As commercial real estate values begin to decline in some markets one of the unfortunate realities we are starting to see is commercial loans beginning to come close to being underwater; and in some cases actually underwater. Meaning that the loan balance exceeds the value of the property. This is due to its value dropping quicker than the loan balance.As a result, we are having to field one of the more unfortunate phone calls, it’s a frustrated borrower that is in complete shock that their commercial loan has been “called” – meaning that their bank is pre-maturing ballooning (forcing the borrower to pay off the balance) their commercial loan.The conversation normally starts off as “we’ve been with xyz bank for 22 years and have never been late on a single payment. Now that things are getting tough they turn around and call my note”. After more understandable venting and disbelief they normally ask if the bank really has the right to do this. Of course we are not attorneys, but almost all traditional commercial loan notes have provisions which give the bank the right to call the note for whatever reason they deem necessary.It’s normally called a “Call Provision”. This right is almost never exercised by banks that only use it during very difficult situations. For example, if the bank perceives that the borrower will go into bankruptcy shortly, if their industry in general is declining rapidly (think automotive) or as in this example the property values decline, among many other examples.However the current problem is twofold. Number one is the obvious fact that no bank will willingly go into the position where there’s little or no equity in the deal for the borrower. It has been proven over and over that borrowers with little or no equity in the deal, are much more likely to let their property slip into foreclosure. In the case of an investment property it only takes one month where the tenant defaults on the lease for the borrower to walk.The lesser known fact is that the Federal Government has sets standards for banks that must be strictly adhered to by banks. One of the rules is that banks have to have a conservative level of loan to values on all of their loans. The Fed has set this up to protect the entire banking system.So, it’s not just the bank, they are also adhering to the rules that have been set forth to them and trying to avoid penalties, fines and losing their banking licenses. Hopefully, this point will shed some light on the general question of “why would the bank turn away a loyal and good paying borrower”. Even if they wanted to ignore the problem, they are not allowed to and when audited that will have to face the music.