Banks still cautious on commercial real estate

Seven years ago, long before any hint of a commercial real estate crunch, Old National Bank’s lending within the sector
totaled a lofty $1.8 billion.

Fast-forward to June this year and the Evansville-based bank, which has 59 branches in the Indianapolis area, had sliced
the portfolio 44 percent, to just $1 billion.

Old National’s pullback from the choppy waters illustrates the extent to which banks have wrestled with the unstable
market since 2007—the year most experts say the meltdown began.

“If someone came in today, and the fundamentals of the project are sound, we’ll do it,” said Daryl Moore,
the bank’s chief credit officer. “We’re just not going to do it on projects that just don’t make sense
today.”

The commercial real estate craze led many banks to shed old habits, such as extending their limits from the more traditional
15- to 20-year lending terms to 25 years. Moreover, they eased restrictions by accepting letters of interest from potential
tenants of a project seeking financing instead of actual signed leases.

Now, with vacancy rates at or near all-time highs, tenants have the upper hand when negotiating reduced rents. That crimps
operating income from the project and drives down its appraisal. For banks, it’s a domino effect. Lower appraisals mean
banks have less collateral when they foreclose on projects.

Foreclosure sometimes is the only option for banks.

Old National foreclosed on a Fishers property where an $80 million hotel and water park were planned to be built.

The bank purchased half of the 104-acre parcel at State Road 37 and East 131st Street for $5.9 million during a December
sheriff’s sale that drew no other bidders. The bank used its debt in the property to acquire it—a legal maneuver
known as a “credit bid.”

But it’s not the only possible victim of the planned project. Cincinnati-based Fifth Third Bank sued the water park
developer, Indianapolis-based Puller Group, in an attempt to foreclose on the other half of the property.

Fifth Third filed a complaint in July 2009 against Puller and H20 Resorts II LLC, an entity formed to develop the hotel and
water park, and is seeking to collect nearly $8.6 million owed on the balance of the loan.

A lawyer for Puller, however, said the two sides are trying to resolve issues and that an agreement could be reached soon.

In another example, Pittsburgh-based PNC Bank in June filed to foreclose on the historic five-story Janus Lofts building
at 240 S. Meridian St. in downtown Indianapolis.

The bank is asking for a judgment of $3.2 million and the appointment of a receiver after the developer, an entity affiliated
with locally based Mansur Real Estate Services Inc., defaulted on a 2003 construction loan for renovations to the former Kipp
Brothers Wholesalers building.

The developer said it expects a forbearance agreement between it and the bank will be executed to give the company more time
to refinance the project.

For loans teetering on foreclosure, banks indeed are less inclined to work out a long-term agreement with a borrower and
instead are opting for forbearance agreements, said Henry Efroymson, an Ice Miller LLP attorney representing developers in
loan-workout negotiations with banks.

“They’re agreeing to stand still and not foreclose while the parties try to find a solution to the problem,”
Efroymson said.

The amount of troubled loans at many banks is beginning to level off but still remains high compared with the years preceding
the real estate crisis.

Take Muncie-based First Merchants Corp., which has grown its presence in the Indianapolis area to 24 locations following
its 2008 acquisition of Lincoln Bancorp.

Its portfolio of non-accrual loans—loans in which interest payments have not been made for a sustained period of time—declined
to $120 million in the second quarter from $122.9 million the previous quarter.

But the latest figure still is 7 percent higher than the $112.2 million of non-accrual loans First Merchants posted during
the same period last year and a whopping 252-percent increase from the second quarter of 2008, according to bank financial
statements.

Mike Stewart, chief banking officer at First Merchants, acknowledged the high non-accrual figure but said the amount includes
all loans, not just those for commercial real estate projects.

Still, the bank is more cautious. It has financed five real estate projects this year, a small fraction of activity in past
years, Stewart said.

“We find you can still put together some good projects,” he said. “But banks are going back to the traditional,
conservative approaches.”

Another reason banks are supporting fewer commercial real estate projects is that there’s simply too much supply on
the market, dampening demand. One benefit is that fewer projects translate to improved occupancy.

That signifies the start of a “slow crawl” back to stability, said Ice Miller’s Efroymson.•

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