Are You Financing OREO Property?

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Changes for 2019

Beginning in 2019, with the issuance of Accounting Standards Update 2014-09, community banks will have to change the way they account for seller financing of Other Real Estate Owned (OREO). This supersedes the current methods used under Accounting Standards Codification (ASC) 360-20, the long-standing Statement of Financial Accounting Standards No. 66 guidance.  There is also an option to early adopt the standard in 2018.

Below, we will walk through the key decisions that should be made in determining if a sale of OREO has occurred under the new guidance. Under ASC 610-20, the bank will have an accounting sale with full gain or loss recognition and derecognition of the OREO at the time of sale – if the transaction meets certain requirements within ASC 606. Otherwise, at the transaction date a bank will generally record any payments received as a deposit liability to the buyer, and continue reporting the OREO as an asset until the requirements in ASC 606 are met.

When the transaction doesn’t qualify for a sale, but a loss would have been recognized if it did, the bank should evaluate whether a loss should be recognized on the OREO through a valuation allowance to reflect fair value less costs to sell.

Key Determinations of an OREO Sale

Does the seller have a controlling financial interest in the legal entity purchasing the OREO?

If the seller has a controlling financial interest in the buyer, then the performance obligation can’t be satisfied, as the buyer won’t have control over the OREO sold.

Does the transaction meet the definition of a contract for ASC 606?

In determining whether the transaction meets the five contract criteria, the bank should consider all facts and circumstances. In particular, consideration should go to the amount and character of buyer’s equity and existence of recourse provisions. The bank shall account for a contract with the loan customer only when these criteria are met:

  • The parties to the contract have approved it in writing, orally, or in accordance with other customary business practices, and are committed to performing their respective obligations.
  • The bank can identify each party’s rights regarding OREO to be transferred.
  • The bank can identify the payment terms for OREO.
  • The contract has commercial substance, i.e., the risk, timing, or amount of the bank’s future cash flows are expected to change as a result of the contract.
  • It’s probable the bank will collect the consideration to which it will be entitled in exchange for the OREO that will be transferred to the customer.

Has the selling entity satisfied its performance obligation by transferring control?

Control of an asset refers to the ability to direct the use of and obtain substantially all the remaining benefits from the asset. To satisfy the performance obligation and thus transfer control in the sale of OREO, the bank should deliver possession to the buyer. The buyer can benefit from the property in accordance with the standard if it could be used or sold for an amount greater than salvage value or otherwise held in a way that generates economic benefits.

Are the terms of the transaction at market terms?

A transaction with an insignificant down payment and nonrecourse financing generally wouldn’t meet the definition of a contract unless there’s considerable support from other factors.

 If it’s determined to meet the definition of a contract, the transaction price is the amount of consideration to which the bank expects to be entitled in exchange for transferring the property. In determining the transaction price, the bank should consider whether a significant financing component exists. The bank should adjust the promised amount of consideration for the effects of below-market terms, considering both the rate provided and timing of payments.

A significant financing component may exist regardless of whether the promise of financing is explicitly stated in the contract or implied by the payment terms agreed to by the parties.

Should you have any questions regarding the determination of an OREO property sale, please contact a K·Coe Isom banking advisor.

Sandy Sporleder
Sandy enjoys working with community banks because of bankers’ intelligence, business savvy, and curiosity in the form of their asking really tough questions. Sandy helps banks across the Midwest achieve success – her deep knowledge, passion for service, and thinking outside the box increases banks’ success.
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