Other Real Estate Owned (OREO) Ė Hold or Sell?
December 8, 2011
By Jim Swanson and Dave Anderson, Associates, Bank Strategies LLC
In better economic times, bank OREO from debts previously contracted was infrequent and institutions didnít need to inflict a lot of brain damage determining disposition strategy. After obtaining title to a property, a bank would typically market it, and in most cases, a qualified buyer was found within a reasonable period at a price that mitigated loss to the bank. Perhaps the biggest decision a bank faced was whether to offer financing to the new buyer in order to generate another earning asset.
Things have changed. In todayís economic and banking environments, the hold/sell decision is often less straight forward, with the decision process complicated by a number of factors, including issues specific to the property itself, as well as broader issues.
From a property specific perspective, banks should put pen to paper and perform an analysis to help determine whether a hold or sell strategy makes the most sense.
Hold Strategy Considerations
Under a hold scenario, analysis should include assessment of the feasibility to maintain the property given its type and location; and include cost estimations for items such as insurance, real estate taxes, deferred maintenance, routine and unexpected maintenance, and updated appraisals. The analysis should also include an assessment of the income earning potential of the asset during the holding period. Also, do not forget to consider the opportunity cost of holding and maintaining a potentially nonearning asset for a sustained period, versus alternative investment options for this capital.
Bank employees can spend a considerable amount of time administering, maintaining, and monitoring OREO during the holding period. Obviously, the more OREO you have and the longer you hold it, the greater the personnel commitment needed. As a result, while it can be difficult to quantify the cost of this human resource commitment, it should not be overlooked in your analysis.
Arguably the largest variables in the hold equation are the estimates of the duration of the holding period and future real estate market conditions. Prudent analysis should include best, worst, and most-likely case estimations on these key variables. Under a hold scenario, banks should ensure that the analysis is updated on a periodic basis to reflect evolving conditions and reassess if the hold strategy remains appropriate.
Other Factors to Consider
Although performing property specific hold/sell analysis is important, other broader issues can affect or override the results of the transactional analysis. Some of these broader issues that must be taken into consideration when formulating hold/sell strategies include: current market valuations, direction of market valuations, bank asset quality, regulatory pressures to improve asset quality, impact of asset quality on FDIC insurance premiums, reputational risk from asset quality issues, monetary and human resource costs spent complying with regulatory enforcement actions due to asset quality concerns, sufficiency of bank capital/access to capital to absorb losses on OREO sales, availability of credit to OREO buyers, and statutory holding limits for OREO.
Holding OREO can also bring on unexpected risks that are difficult to capture in standard hold/sell analysis. For example, in one instance we are aware of, a bank incurred significant costs defending a sexual harassment claim against the property manager hired by the bank to operate a bank-owned resort property.
Establishing OREO disposition strategy in todayís banking world can be anything but straightforward. However, your institution stands a better chance of making prudent decisions and minimizing loss related to OREO if procedures are in place ensuring that thorough hold/sell analysis is performed rather than making off-the-cuff guesses or emotional decisions. Sound OREO disposition programs also require officers working and managing OREO to collaborate regularly with senior management, who typically has the most insight into the broader issues discussed above that impact an institutionís OREO disposition strategy.
We at Bank Strategies LLC can help you put a hold/sell determination process in place and assist you in determining the proper strategy for your OREO assets. Please call us for assistance at (303) 903-9369 (Jim Swanson) or (720) 205-1336 (Dave Anderson) for assistance.
To be added to our email list, email Jim@bankstrategiesllc.com with your name and email information.