OREO (Other Real Estate Owned) Acquisition, Holding, and Disposition
April 26, 2011
By Dave A. Anderson
Banks are not in the real estate investment business, nor should they be. They are not allowed to develop, construct on, or lease real estate for an extended period of time. Most banks now carry some OREO as a result of the significantly depressed real estate market and disposing of it has been a challenge depending on the type, location, and condition of the property. We at Bank Strategies LLC have a few thoughts to convey on this subject, and while we are not experts on this matter (who is), we offer these thoughts and suggestions on what you should consider in the OREO acquisition, holding and disposition process.
While there are several ways the bank could end up with OREO, the most common are through a foreclosure sale or a deed-in-lieu of transaction. Banks are encouraged to weigh the pros and cons to each of these possession approaches before choosing the path to obtain title. In Colorado, under a public trustee foreclosure, the bank should bid at least the bank’s good faith estimate of the fair market value (FMV) of the property being sold. Be careful, because if the bank bids less than the a good faith estimate of the fair market value of the property, and a deficiency results, the maker of the note may defend against the deficiency based upon the bank’s improper bid. Remember though that the costs of holding, marketing and selling the property (as well as unpaid real estate taxes) are appropriate deductions from the good faith estimate of fair value in arriving at the written bid. If a senior lien exists, this lien should be factored into your bid.
Your bid amount will likely have no relationship to your carrying/acquisition value because the amount on your books should be the FMV (usually determined by an appraiser) less the cost to sell. If your FMV less cost to sell is more than your book value (assumes full satisfaction of the loan) you generally cannot capitalize accrued interest, as well as legal fees and other expenditures incurred to acquire clear title to the property. However, it is permissible to capitalize the amount the bank expends prior to foreclosure for real estate taxes or insurance, if FMV less cost to sell exceeds your book value at the time of foreclosure. All write-downs at foreclosure should be charged to the ALLL; however, all subsequent write-downs should be considered “noninterest expense”.
Many bankers are struggling with the decision whether to sell or hold OREO (in accordance with banking laws applicable to holding OREO) which can have a significant impact on the level of classified assets the bank is holding. Many banks have decided to hold OREO and wait for the market to return to previous pricing levels. This thinking may be misguided since real estate values are based on supply/demand and assessment of risk. In several areas of the mountain region the decrease in values of certain types of properties is expected to continue and/or not increase in the next several years. Additionally, vacant improved real estate can carry additional costs and time commitment due to deterioration of improvements for various reasons including location/distance from the bank, age, weather, vandalism, etc. This is not to say that bankers should succumb to aggressive buyers who sometimes negatively exaggerate an OREO’s value. It is important that bankers work with real estate brokers who approach them in an advisory role; providing feedback and setting realistic expectations. Brokers/realtors and bankers should realize that holding OREO for a prolong period of time could be costly to the bank and delay a CAMELS upgrade and as such, the removal of a formal or informal supervisory action. Banks are encouraged to do a sell versus hold analysis on each property keeping in mind the ramifications of regulatory action/ratings if they continue to decide to hold OREO.
Regulator’s views on readying OREO for sale on vacant or damaged/unfinished OREO vary so before you do anything, check with your bank supervisors when making significant changes or improvements to OREO. Currently it appears the FDIC is the most lenient with regard to permitting banks to develop/improve real estate to a more salable status and with the Federal Reserve being perceived as the least lenient. Several banks have formed separate entities within or outside of the bank’s parent company to purchase distressed assets for several reasons including reducing the level of classified assets at the bank, making the property more marketable since it is not bank owned, etc.
Disposing of OREO
As previously alluded to, marketing OREO can be challenging since several buyers want to take advantage of banks in a precarious position. Therefore, appropriately marketing OREO is an important step in restoring a bank’s asset quality to an acceptable level. Many bankers are reporting success in disposing of income producing property and average priced residences and condominiums. However, very few sales of land development properties have been observed since the supply significantly outweighs the demand in several areas of our region and in several areas of the country. It is important to partner with brokers who have prior experience marketing distressed assets. A broker’s familiarity with various disposition strategies and an understanding of which strategy to utilize in each situation can maximize an OREO’s sale price.
Regulators expect banks to be actively marketing OREO properties and will review efforts to do so at each examination. Actively report your successes to ensure examiners are aware of your commitment to dispose of OREO. Banks that are reporting success are those who make brokers/realtors aware that the bank is willing and able to finance the sale of OREO if the potential buyer qualifies and has the ability to provide a sufficient down payment. Most of these financing arrangements have been at less than market rates, but the borrowers/buyers have been creditworthy and able make down payments of at least 10 to 15 percent. Bankers should ensure that the buyers/borrowers initial investment is sufficient enough (depends on the type of property per FAS 66) to remove it from OREO status and substandard classification. Several banking organizations in the country are actively marketing their vast holdings of OREO on their bank or OREO specific websites. One Colorado bank started a campaign that was in essence a “Parade of Homes” that was advertised through a website, on television, and through flyers sent to potential buyers. This bank reported several sales of high end homes through this campaign and indicated that the bank financed approximately 50 percent of these sales. Some of these sales were of homes still held by the spec builder.
One example listing OREO parcels can be located at (http://bankofhamptonroadsoreo.com/index.php), but many banks in our region are also employing websites to dispose of OREO.
So remember, holding onto OREO until the market recovers may not be in your best interest due to holding costs and associated risks. Find brokers and realtors who are experienced in disposing of distressed assets and partner with them in your effort to clean up the balance sheet. Be innovative in selling real estate and offer financing when possible and feasible. Finally, regulators will expect you to maintain thorough, well documented files that demonstrate your efforts to dispose of the property in a timely manner.
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