ACCOUNTING FOR OTHER REAL ESTATE TRANSACTIONS CURRENT ISSUES AND EXAMINER OBSERVATIONS Paul Oseland, CPA Federal Reserve Bank of Kansas City Oklahoma City Branch Supervision and Risk Management
OREO Accounting Primer Part 1 Initial Timing and Recognition: Transfer to OREO when the institution takes physical possession of the property, regardless of whether formal foreclosure proceedings have taken place. Property received in satisfaction of a loan is recorded at fair value less estimated costs to sell. Deficiency is charged against ALLL. 3 OREO Accounting Primer Part 2 OREO Related Expenses: Operating expenses (legal fees, foreclosure costs, maintenance, insurance, real estate taxes, government assessments, etc.) should be expensed as incurred. Costs for project development (including taxes and insurance) may be capitalized until substantial completion up to fair value less cost to sell. 4
OREO Accounting Primer Part 3 Sale of OREO: Losses recognized immediately. Gains recognized based on method of accounting: Full Accrual immediate gain recognition. Installment gain recognized as payments received. Cost Recovery all gain is deferred. Reduced Profit portion of gain recognized with payments. Deposit OREO is not derecognized. Financing, Lease, and Profit Sharing Methods. 5 Issue #1 Sale of OREO to a Related Party Transaction must be recorded at fair value. Sale is permissible to a holding company or affiliate: Must comply with Regulation W. Holding period carries over from the subsidiary bank (5 years + 5 year extension). Financed sales to insiders are subject to Regulation O limitations. 6
Issue #2 Gain on OREO Acquisition A gain may be recognized immediately if the fair value (less costs to sell) exceeds the recorded loan amount and amounts previously charged-off (recovery). Before recognizing a gain, significant scrutiny should be applied to understand why the borrower would risk losing the equity in the property. 7 Issue #3 OREO Appraisals The transfer to OREO is considered a transaction involving an existing extension of credit and is exempt from Regulation Y s appraisal requirement. Under 12 CFR 225.63(b), the bank must obtain an appropriate evaluation of the real estate that is consistent with safe and sound banking practices. No Federal Reserve requirement governing when and how often to obtain a new appraisal. However, institutions should have policies and procedures for the monitoring of collateral values. 8
Issue #4 Redemption Periods Reporting is based on physical possession. If state law allows borrower occupation during the redemption period then the asset remains a loan until the institution takes physical possession of the property: Borrower has vacated the property or has been evicted from the property. Expiration of redemption period. 9 Issue #5 Income Recognition Methods Sales of OREO must be accounted for under ASC 360-20: Property, Plant, and Equipment Real Estate Sales : Initial and continuing investments must demonstrate a commitment to pay. Seller transfers usual risks and rewards of ownership and does not have substantial continuing involvement. 10
Proposed Accounting Standards Update #1 FASB Proposed Accounting Standards Update (Revised) Revenue Recognition (Topic 605): Revenue from Contracts with Customers : ED Issued November 11, 2012. Comments closed March 13, 2012. Potential impact on income recognition for seller financed sales of OREO. 11 Proposed Accounting Standards Update #2 EITF 13E: Reclassification of Collateralized Mortgage Loans upon a Troubled Debt Restructuring : Issued July 19, 2013. Comments closed September 17, 2013. Defines in-substance repossession or foreclosure as occurring when (1) legal title is obtained or (2) completion of a deed in lieu of foreclosure. 12
References Commercial Bank Examination Manual: Section 2200 Other Real Estate Owned ASC 310-40: Receivables Troubled Debt Restructurings by Creditors ASC 360-20: Property, Plant, and Equipment Real Estate Sales Instructions for Preparation of Consolidated Reports of Condition and Income (FFIEC 031 and 041) 13 References (Cont d) SR Letter 12-10 Questions and Answers for Federal Reserve-Regulated Institutions Related to the Management of Other Real Estate Owned (OREO) SR Letter 10-16 Interagency Appraisal and Evaluation Guidelines SR Letter 95-16 Real Estate Appraisal Requirements for Other Real Estate Owned (OREO) SR Letter 12-10: http://fedweb.frb.gov/fedweb/bsr/srltrs/sr1210.pdf SR Letter 10-16: http://fedweb.frb.gov/fedweb/bsr/srltrs/sr1016.pdf SR Letter 95-16: http://fedweb.frb.gov/fedweb/bsr/srltrs/sr9516.htm 14
Questions? 15