A recent Federal Deposit Insurance Corp. (FDIC) policy statement on “prudent” commercial real estate (CRE) loan workouts gives financial institutions the go-ahead to restructure loans to creditworthy borrowers. “Financial institutions that implement prudent CRE loan workout arrangements after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for engaging in these efforts even if the restructured loans have weaknesses that result in adverse credit classification,” FDIC said in the policy statement. These restructuring efforts include applying the concept of “good bank/bad bank” workouts to individual loans, essentially creating a good asset/bad asset scenario, according to a review of the policy by Manhattan-based asset management, advisory, and capital markets firm NewOak Capital. NewOak managing director Andrew Akers sees the potential for institutions to use “creative retranching” to achieve this restructuring of distressed commercial loans. “When it comes to ‘partitioning’ technology (or tranching) in the credit marks, earlier cash flows are less risky than later, or back-end, cash flows,” Akers said. Using a commercial mortgage securing a shopping mall as an example, he explained the loan performance worsens as mall tenants leave, vacancy rises and meeting mortgage payments becomes difficult for the borrower. At some point, he said, the bank might need to put the loan on non-payment status. “Under the [FDIC’s] adopted guidelines, rather than putting the entire loan on delinquent status, the bank could partition the loan into a performing part and a non-performing part,” Akers said. “Such a retranching could conserve a bank’s capital by properly reflecting an institution’s risk.” Another NewOak managing director, Malay Bansal, explains this loan-level retranching process as a bank splitting a commercial mortgage into an A- and B-note piece. “You can take an existing loans that maybe got into trouble when the loan is worth $30m and the property’s only worth $25m,” Bansal tells HousingWire. “It may return to $30m at some point. There may be some value there in creating a $20m senior and $10m junior.” The larger, senior piece would be covered by the property’s current value and therefore seen in relatively high performance. The smaller, junior piece is worth less than $10m and only gains value when and if the property value increases with time. Bansal adds: “You’ve taken a loan that’s underwater, close to default and problematic and split it into two — one good and one not so good.” This scenario applies more to loans held by the bank rather than those that are securitized. In situations where the loan is securitized, he says, the restructuring becomes a bit more complicated, with the junior bondholders taking the loss. “Ordinarily if you restructure a loan, banks may worry regulators may view it negatively,” Bansal says. “The FDIC, [Office of Thrift Supervision] and other agencies came out together and said if you do something that’s prudent, we won’t penalize you. It gives banks a little more comfort to work out loans as long as the borrower is a good borrower and they’re doing it prudently.” Write to Diana Golobay.