Questions and Answers (Q&As) on the Management of Other Real Estate Owned (OREO)

Transcription

1 Questions and Answers (Q&As) on the Management of Other Real Estate Owned (OREO) Guest Speakers: Donald Gabbai, Federal Reserve Board of Governors Carmen Holly, Federal Reserve Board of Governors Matthew Kincaid, Federal Reserve Board of Governors Tim Robertson, Federal Reserve Board of Governors Federal Reserve System September 27, 2012 Ask the Fed is a program of the Federal Reserve for senior officials of state member banks, bank holding companies, savings and loan holding companies, and state bank commissioners. Use of the presentation materials, including audio recording of a presentation, is strictly prohibited except by written permission of the Federal Reserve Bank of St. Louis. The opinions expressed in the presentations are statements of the speaker's opinion, are intended only for informational purposes, and are not formal opinions of, nor binding on, the Federal Reserve Bank of St. Louis, or the Board of Governors of the Federal Reserve System. Each participant is responsible for its own business, financial, investment or credit decisions.

2 Welcome everyone Today s session Questions: your question to: askthefed@stls.frb.org or Use the Ask a Question feature on the Ask the Fed website: This call is being recorded and will be available immediately following the session. A survey will be delivered via following the call. Let us know your thoughts or ideas for future sessions. 2

3 Our Presenters and Host Today Donald Gabbai Federal Reserve Board of Governors Carmen Holly Federal Reserve Board of Governors Matt Kincaid Federal Reserve Board of Governors Tim Robertson Federal Reserve Board of Governors Julie Stackhouse Federal Reserve Bank of St. Louis 3

4 Agenda Background Why the Board issued Q&As on OREO Reporting treatment Transferring assets to OREO Reporting treatment Sale and transfer of OREO Classification Appraisal concepts Community issues Questions 4

5 Background 5

6 Background: Why the Board Issued OREO Q&As Over the last several years, banks have experienced a rise in OREO as a result of: General weaknesses in the housing market Increases in delinquencies and defaults Declines in housing prices Weaknesses in the structure of a number of commercial real estate financings 6

7 Background: Why the Board Issued OREO Q&As (continued) Source: For foreclosure inventory, staff estimate from Mortgage Bankers Association; for REO, CoreLogic 7

8 Background: Why the Board Issued OREO Q&As (continued) QA is intended to address both safety and soundness and consumer compliance issues. Topics covered in the QA document: Financial reporting Loss recognition Management of OREO assets Consumer protection issues See SR letter 12-10/CA letter 12-9, Questions and Answers for Federal-Reserve Regulated Institutions Related to the Management of Other Real Estate Owned (OREO) 8

9 Reporting Treatment and Classification 9

10 Accounting and Reporting Guidance Accounting guidance ASC Subtopic , Receivables: Troubled Debt Restructurings by Creditors (formerly FAS 15) ASC Subtopic , Property, Plant, and Equipment: Overall (formerly FAS 144) Regulatory guidance FR Y-9C instructions, glossary entry for Foreclosed Assets Call Report instructions, glossary entry for Foreclosed Assets ASC Subtopic , Property, Plant, and Equipment: Real Estate Sales (formerly FAS 66) 10

11 Transferring an Asset to OREO An asset is re-categorized from a loan to OREO on the Call Report when an institution takes physical possession, regardless of whether formal foreclosure proceedings have taken place. An OREO asset is measured and reported at fair value (FV) less cost to sell at the time of foreclosure (it becomes a new cost of OREO asset). This determination must be made on an asset-by-asset basis. 11

12 Accounting for OREO After taking possession, each OREO asset must be carried at the lower of: The FV of the asset minus estimated costs to sell the asset The cost of the asset (described on slide 11) The write-down can be recognized as a valuation allowance against the asset, created through a charge to expense: Optional use of a valuation allowance Subsequently, increase or decrease of valuation allowance (but not below zero) for changes in the asset s FV or cost to sell 12

13 Accounting for OREO (continued) In the Call Report, operating income related to OREO (e.g., gross rentals) is reported as other noninterest income, while operating expenses (e.g., property taxes, insurance, maintenance costs) are reported as other noninterest expenses. 13

14 Example of Accounting for OREO 1/15/12 3/31/12 6/30/12 9/30/12 Assumptions: Loan 150,000 FV of collateral 110, , , ,000 Estimated cost to sell (10,000) (10,000) (10,000) (10,000) FV less cost to sell 100,000 90,000 95, ,000 Financial Statement Impact: Loan 0 Loss (50,000) OREO 100, , , ,000 Valuation allowance N/A (10,000) (5,000) 0 Net carrying value of OREO 100,000 90,000 95, ,000 14

15 Accounting for Sale of OREO Applies to all transactions in which the seller provides financing to the buyer of the real estate. ASC Establishes five methods to account for the disposition of real estate (described in more detail in the Call Report glossary entry, Foreclosed Assets): Full accrual Installment Cost recovery Reduced profit Deposit 15

16 Accounting for Sale of OREO (continued) This area of generally acceptable accounting principles (GAAP) is very complex and requires significant judgment. Thorough review of ASC is usually required when analyzing sales of real estate because it includes detailed guidance necessary to determine appropriate accounting for these transactions. 16

17 Accounting for Sale of OREO (continued) Sale financed by another institution results in immediate recognition of gain or loss. Sale financed by the bank as owner of OREO: Loss on sale of an OREO asset are recognized immediately Recognition of gain on sale of an OREO asset depends on the accounting method used in the transaction (e.g., the five methods from slide 15) 17

18 Accounting for Sale of OREO (continued) Examples of circumstances where the sale of OREO does not result in a sale for accounting and reporting purposes include, but are not limited to, the following: Initial investment is inadequate and recovery of the cost of the property is not assured Continuing involvement in the OREO asset The sale of OREO to a related party must be recorded at FV: Must also comply with the market terms requirement of Regulation W 18

19 Classification of OREO Assets Time of transfer Valuation of OREO asset Loss is recognized through the allowance for loan and lease losses (ALLL) OREO asset, given its well-defined weaknesses, should be adversely classified Holding period Decrease in the OREO asset s FV less cost to sell is considered a loss OREO asset would continue to be adversely classified 19

20 Classification of OREO Assets (continued) Pending sale OREO asset may be classified pass under certain conditions: A firm contract is in place that contemplates a sale in the reasonably near future Sale proceeds cover carrying value Purchaser has the financial resources to complete the purchase Bank has no contingent liability Other considerations OREO residential rental asset classified pass when the lease reflects a reasonable rate of return (refer to SR letter 12-5/CA letter 12-3, Policy Statement on Rental of Residential OREO Properties ) 20

21 Appraisal Concepts 21

22 Appraisal Concepts At a minimum, an evaluation is required when a property is transferred to OREO through foreclosure or deed in lieu of foreclosure. Refer to SR letter Real Estate Appraisal Requirements for Other Real Estate Owned (OREO). State banking laws or the internal policies of an institution may require an appraisal upon transfer to OREO. Interagency Appraisal and Evaluation Guidelines provide guidance on appraisal standards and evaluation content. Refer to SR letter Interagency Appraisal and Evaluation Guidelines. 22

23 Appraisal Concepts (continued) The appraisal or evaluation of OREO property should reflect the market value of the property as defined in the Board s appraisal regulation (12 CFR (g)). Definition of market value in the appraisal regulation and the concept of FV under GAAP are based on similar concepts. An evaluation and appraisal should address the as-is condition of the OREO asset in arriving at the property s market value, considering: Property s highest and best use Relevant risk and market factors 23

24 Appraisal Concepts (continued) Factors to consider in reviewing an appraisal or evaluation include: Condition of the property Use of the property Stability of the property 24

25 Appraisal Concepts (continued) The institution should have policies and procedures for monitoring the market value of the OREO asset over the holding period and determining whether an existing appraisal or evaluation is still valid, considering: Property type Current market supply and demand for similar properties Current use of the property or change in use The passage of time 25

26 Appraisal Concepts (continued) Key References and Documents The Board s appraisal regulations: Bank holding companies: Regulation Y (12 CFR 225 subpart G) State member banks: Regulation H (12 CFR 208 subpart E) Interagency Appraisal and Evaluation Guidelines (SR letter 10-16) State banking laws Uniform Standards of Professional Appraisal Practice Internal bank policies and procedures 26

27 Community Issues 27

28 General Community Development Expectations: Managing and Disposing of OREO OREO asset holders should have a clear and effective approach for management and disposition of OREO, including: Complying with all federal, state, and local laws and regulations Implementing effective property maintenance standards and third-party vendor oversight Considering practices that support neighborhood stabilization 28

29 General Community Development Expectations: Managing and Disposing of OREO (continued) Selling OREO properties to owner/occupants or donating them to groups involved in neighborhood stabilization efforts can help financial institutions receive credit under the Community Reinvestment Act. 29

30 General Community Development Expectations: Managing and Disposing of OREO (continued) If OREO is rented, asset holders should follow the provisions of the Federal Reserve Policy Statement on Rental of Residential OREO Properties (SR letter 12-5/CA letter 12-3). Institutions should have controls in place to comply with laws related to protecting the rights of tenants, including: The Protecting Tenants at Foreclosure Act of 2009 (CA letter 09-5) The Servicemembers Civil Relief Act (CA letter 05-3) The Fair Housing Act The Americans with Disabilities Act 30

31 To ask a question: your question to: askthefed@stls.frb.org Use the Ask a Question feature on the Ask the Fed website: 31

32 Additional Session Resources SR Letters SR Letter 12-10/CA Letter 12-9, Questions and Answers for Federal Reserve- Regulated Institutions Related to the Management of Other Real Estate Owned (OREO) SR Letter 12-5/ CA Letter 12-3, Policy Statement on Rental of Residential Other Real Estate Owned (OREO) Properties SR Letter 10-16, Interagency Appraisal and Evaluation Guidelines CA Letter 09-5, Information and Examination Procedures for the Protecting Tenants at Foreclosure Act of 2009 SR Letter 05-3, Servicemembers Civil Relief Act of 2003 SR Letter 03-5, Amended Interagency Guidance on the Internal Audit Function and its Outsourcing SR Letter 00-17,Guidance on the Risk Management of Outsourced Technology Service SR Letter 95-16, Real Estate Appraisal Requirements for Other Real Estate Owned (OREO) 32

33 Thanks for joining us. 33