Other real estate owned, or OREO, may also be referred to as ORE, short for other real estate. Dependent upon the amount of OREO held by the entity, it may be included in the “Other assets” line item on the balance sheet. This post provides an overview of the accounting for OREO. Grab a glass of milk and let’s get started!
If it isn’t a cookie, what is it?
Other real estate owned is just that – real estate that the bank owns that is not used in normal operations. Therefore, it is not included within property, plant, and equipment (PP&E). It can include real estate acquired through partial or full satisfaction of a debt or even a facility that is not going to be used (e.g. a bank branch building). OREO can even include property acquired for future expansion that was never used or has ceased being utilized.
Assets are good! So, why don’t banks want this asset?
Although assets are inherently good, unfortunately, the most common way a bank acquires an OREO asset is via foreclosure on a debt receivable, typically a loan. While acquiring any asset in partial or full satisfaction of a defaulted loan is better than recognizing a full loss, banks aren’t in the business of buying and selling real estate. Add to that specialized accounting for OREO and a slew of regulatory requirements, and it just means more headaches!
Additionally, holding OREO adds additional risk the bank must consider and manage. Typically, a borrower that defaults doesn’t “turn over the keys” to a home in a great location and in superb condition, in the midst of a hot real estate market. Instead, they strip the property of fixtures and even copper pipes, with unkept landscaping making it look, shall we say, less than desirable. As a result, these properties aren’t always easy-to-sell, causing the bank to worry about declines in real estate prices. Operational risk is also introduced with OREO, as the bank now needs to market the property for sale, ensure necessary insurance is in place, and monitor the property for deterioration. Lastly, since OREO isn’t a liquid asset, the bank must consider this in its regulatory capital calculations and when managing liquidity risk.
OREO is initially accounted for at fair value less costs to sell. Any excess of the amortized cost basis over the fair value of the assets received (less costs to sell) is recognized immediately as a loss (ASC 310-40-40-3). This establishes a new carrying amount, or basis, in the asset upon initial recognition. Real estate that was previously used as a bank facility should be reclassified out of PP&E and initially recorded at the lower of net book value or fair value.
When determining the fair value of the real estate, the market-based principles of ASC 820 are applicable. As a reminder, ASC 820 explains that fair value is the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. How is this usually determined when it comes to OREO? Typically, an independent appraisal or evaluation is used to determine the fair value of the property in its current, “as-is” condition. “As-improved” values should not be used when accounting for OREO.
Not so physical “physical possession”
When a bank should reclassify a residential mortgage loan to OREO can sometimes be confusing. Many states have “redemption periods” as part of the foreclosure process. These mandatory periods after foreclosure allow the borrower time to satisfy the debt and retain interest in the property. Often during this period, the borrower is able to occupy the real estate and the bank does not have the ability to access the property. In some states, such redemption periods can be up to a year!
The guidance in ASC 310-40-55-10A specifies:
Physical possession is considered to have been received by a creditor when either:
- The creditor obtains legal title upon completion of a foreclosure (this can happen even if borrower redemption rights are still outstanding), or
- The borrower conveys all interest in the property via a deed in lieu of foreclosure or other similar arrangement.
As you can see, “physical possession” for accounting purposes can occur even if the borrower still has a redemption right that allows them to continue to occupy the property before the bank has access to it.
Subsequently, OREO assets should be measured at the lower of the carrying amount or fair value less costs to sell (Remember, this carrying amount is the new basis established when it was booked into OREO!). A contra-asset valuation allowance account may be used to record changes in the value of the asset. These changes may be reversed through the valuation allowance as circumstances change; however, the gain recognition is limited to the amount of cumulative losses recognized.
Costs incurred by the bank to operate or maintain the property, such as insurance, taxes, utilities, and routine maintenance, are required to be recorded within non-interest expense. As OREO meets the classification of a long-lived asset, it should not be depreciated while it is classified as held-for-sale.
Banks should establish policies and procedures regarding the subsequent accounting for OREO assets.
Sale of OREO
Any difference between the carrying amount of the asset and the sale proceeds should be recognized as a gain or loss. Simple, right? Well, the guidance doesn’t stop there. Any sales must be evaluated to determine if they actually meet sale criteria. When it comes to bank financed sales or sales with a gain, the contracts must be closely examined. Any loss on sale should always be recognized immediately. If it is determined that the sale meets the revenue recognition criteria within ASC 606, the bank will derecognize the OREO asset at the time of sale and recognize any associated gain or loss. Any gains are to be recognized within non-interest income and should be rare and closely scrutinized.
Regulatory and legal requirements
As mentioned above, there is a slew of regulatory and legal requirements associated with OREO. Each bank’s regulator and state will have varying guidance. Below are a few tidbits of information from different guidance to keep in mind if you encounter OREO:
- Under OCC 12 CFR 7.1000(d), a bank should “normally use real estate acquired for future bank expansion within five years…If at any time during the five-year period such property is no longer being considered for banking use, the property must be transferred to OREO.”
- After holding a property for 5 years, the OCC requires national banks to request approval to hold the property for another 5 years. To receive this extension, a bank must demonstrate it has made efforts to dispose of the property.
- Keep state foreclosure redemption periods in mind (These redemption periods do not preclude accounting for a property as OREO – you should account for it in accordance with U.S. GAAP regardless of the redemption period!)
Not sure where to look? Below are some resources related to OREO. Feel free to give GAAP Dynamics a call with questions and we’ll be happy to help! Let's talk.
- FASB Accounting Standards Codification (ASC) Topics:
- ASC 310-40, Receivables – Troubled Debt Restructurings by Creditors
- ASC 360, Property, Plant, and Equipment
- ASC 606, Revenue from Contracts with Customers
- OCC Handbook
- FFIEC Call report instructions
- OCC's Bank Accounting Advisory Series
- FRB SR 12-10: Questions and Answers for Federal Reserve Regulated Institutions Related to the Management of Other Real Estate Owned
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