What Lurks on the Books of Banks

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At BofA, fee income swelled largely because of the acquisition of four smaller lenders since 2007, says spokesman Scott Silvestri. Demand for loans lagged during the past year, causing fees to grow as a proportion of the bank's revenue and income, he adds.

In response to these challenges, many credit-card companies have hiked interest rates—to as high as 30% in some cases. But the new federal rules will also make it harder to raise rates further without borrowers' agreement.

Commercial real estate presents another potential hazard. Prices have dropped 39% since the market peak in October 2007, according to the Moody's/REAL Commercial Property Price Index. Banks own some $1.8 trillion of commercial real estate loans. In many instances, the outstanding debt exceeds the property's value. Some borrowers are simply walking away, leaving lenders to take a nasty hit.

Trying to forestall disaster, some lenders are granting temporary extensions on commercial loan payments. The strategy has become so common that industry players now refer to it as "extend and pretend." In May, MGM Mirage got extensions on $5 billion in credit until 2011, which allowed the Las Vegas casino to finish its new CityCenter project. MGM Mirage didn't respond to requests for comment.

"HOPE IS NOT A STRATEGY"

Some analysts fear that a number of banks are cutting desperate deals with property owners unlikely to repay. "If you're reissuing loans when it's clear the borrower can't pay, that's just disingenuous," says Rachel Barnard, managing partner of Midway Capital Research & Management, a Chicago investment firm. Recent moves by the government may have encouraged the banks' dubious conduct. In late October, federal regulators said that banks don't necessarily have to write down commercial loans when the underlying properties lose a big chunk of their value. That leeway may give some banks an excuse to adjust loan values in inappropriate ways, according to industry analysts.

Dean DeBuck, a spokesman for the U.S. Office of the Comptroller of the Currency, which regulates national banks, says the guidance was intended to ensure consistent reporting and doesn't allow extend-and-pretend maneuvers. Still, says David Iannarone, president of CWCapital Asset Management: "Hope is not a strategy."

With Christopher Palmeri and Mara Der Hovanesian

Francis is a correspondent in BusinessWeek's Washington bureau. Silver-Greenberg is a reporter for BusinessWeek.com.

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