Banks’ $300 Billion ‘Pretend’ Problem

by LJ Miehe on June 13, 2011

Some of the largest U.S. banks may face similar questions that are now being posed to Regions Financial as regulators crack down on so-called extend and pretend loan practices. But the practice is only a symptom of a much larger problem that eventually will force banks to digest billions in losses on commercial real estate loans that could eventually drown some bank balance sheets.

“At the moment it’s a game of musical chairs,” said Dan Gorczycki, managing director of commercial real estate broker Savills. “It just depends who will be left without a place to sit.”

The board of Regions is investigating whether bank management delayed the disclosure of loans that were losing value, according to an article in the The Wall Street Journal . The Journal cited court documents and people familiar with the matter, adding that the banks audit committee began the investigation after the Federal Reserve expressed concern.

At issue is the practice of extending a maturing loan while pretending its underlying book value hasn’t declined. The practice artificially deflates nonperforming loans and credit costs in the current reporting period since the loan doesn’t mature and losses aren’t realized.

But the practice also allows problem loans to build up over time until they can ultimately collapse a bank’s balance sheet.

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