Management of Non-Performing Real Estate Assets Owned by Financial Institutions

With the signing of the Financial Institutions Reform and Recovery Enforcement Act (FIRREA) in 1989, and the resulting establishment of the Resolution Trust Corporation (RTC) to dispose of the distressed real estate of savings and loans taken over by government regulators, management of troubled real estate assets and foreclosed real estate has dominated the news recently. Foreclosure and efforts to resolve troubled real estate loans have, however, always been a part of real estate lending. The RTC was created as a temporary solution because of the large number of assets which the federal government has seized recently. Once the RTC is gone and media coverage subsides, the problem will still exist. Non-performing assets will remain a significant issue for all real estate lenders. A standard tenet of banking is that if a bad loan is never made, a financial institution has left money on the table”. If a financial institution seeks a level of zero defaults and zero foreclosures, it would have to tighten its credit policies so far that many good loans would not be made. This would reduce fee and interest income as well as corporate profits to well below levels achievable with less stringent credit policies. The challenge for lenders is to seek the level of credit risk which will maximize income. This level necessarily includes some defaults. Management of these defaults can have a significant effect on the level of risk which can be taken. If a typical delinquent loan can be recovered up to 90% once all costs are considered as opposed to 70%, a financial institution may be able to reduce their credit requirements in order to make more fee and interest income. This thesis study will analyze the various challenges facing lenders in maximizing their return on non-performing real estate assets