Zombie Banks Marching

Many of us in the turnaround world have been frequently repeating the same phrase day after day to describe the environment we are in, “Extend and Pretend”. Large and small lenders are modifying and extending troubled loans instead of forcing a necessary resolution. Turnaround professionals and distressed investors are waiting patiently for the banks to finally say no more to their borrowers that are upside down. See my last post on this topic. However, it appears the wait may be much longer than anyone could have imagined. Simply put the zombie banking system is not allowing assets and capital to clear. Instead what we see are many regional banks that are loath to sell a loan at a discount or restructure. There is a widespread fear among the nations banks that when the feds come in for examination they will penalize management for what they deem reckless restructuring decisions. As a result bank executives take no action. This leaves tens of thousands of small and midsize companies as zombies since they are unsure what will happen to their credit lines, often they’re only source of working capital. If this were not bad enough, deep down inside many bank executives and even the FDIC realize thousands of so called healthy banks with sound capital ratios are hopelessly insolvent. Why is this the case? In 2009 the philosopher kings at Treasury and FDIC decided that banks could classify commercial real estate and other loans as performing even though market values of the underlying assets have fallen as much as 40%. All that is required is the loan be current on interest and principal. Thus the term extend and pretend came about as the banks rushed to loosen the terms of bank agreements so most loans would meet this definition. Bankers understand the simple mathematics of insolvency. If 30% to 40% of assets are commercial real estate loans which are now 40% under water, this means that loan value on the balance sheet has declined by 12% to 16%. Given that a normal bank equity ratio is 8% to 13% of total assets, many banks are insolvent when marked to market. The feds solved that problem in a pen stroke with its new guidelines but created more zombies for the real economy. The reason being that now bankers have no incentive to deal with a buyer of a building or a loan if the bank is forced to take a sizable write down to fair market value. Buyers such as myself are locked out of the market from purchasing and rescuing companies whose loans are worth substantially less than 100 cents. Thanks to the bureaucratic regulators we have created an army of zombie companies and real estate in order to try and save banks that in reality will never lend again because they are insolvent on a mark to market basis. We are killing our economy because politicians are scared of facing reality.