Ask any banker to name the thorns in their side, and chances are they’ll come up with a few usual suspects, like regulatory compliance and its increasing costs. Since the Great Recession, Other Real Estate Owned (OREO) has earned a spot among those familiar thorns.
OREO refers to real property acquired when a bank takes physical possession or legal title ownership in a loan foreclosure.
When I first started my career with HORNE in 2011, OREO was a hot topic. Initially, I didn’t appreciate the significance of OREO. I just nodded in agreement and mumbled something intelligible like, “Mmm, yeah, darn OREO.” But it was a subject of daily discussions, and grasping it didn’t take long. In fact, at one point, our knowledge and discussion of OREO was so intense, we held an OREO party. (We made OREO cookie balls and realized that other banking headaches might benefit from a delicious namesake - maybe Taxes Potato Chips or BSA Ice Cream.)
OREO remains a subject of conversation as banks continue to make progress in removing the properties from their books. Depending on the jurisdiction and type of bank, regulators expect banks to sell OREO within a designated timeframe. After that period expires, the bank may be able to apply for an extension. If the property is not currently in use, the bank may be required to depreciate it.
These requirements create a few predicaments. For instance, if it takes nine years to sell a property, it might be “worth” next to nothing on the books prior to the sale. Or, if the property held by the bank is in operation and providing a steady stream of non-interest income, the last thing the bank wants is to be forced to release a cash cow. Banks have two viable options for complying with OREO requirements:
Dividend the property to the holding company.
By transferring property to the holding company in the form of a dividend, the bank removes a non-earning asset from their call report, improving earnings performance indicators. Due to regulatory limits on dividend amounts and their capital dilution, this strategy works best with properties that have been on the books for a few years without much interest from potential buyers.
Establish a separate Holding Company subsidiary.
Banks that hold “non-traditional” OREO properties (e.g., mineral rights, manufacturing plant, restaurant, etc.) could apply to form a subsidiary of the holding company to manage the property, separating the liabilities related to the held entity. This action would appease regulators because the operations of the OREO property would be kept separate from the operations of the bank.
Even as we inch closer to the 10-year anniversary of the Great Recession, some of the financial wounds and challenges are still fresh on our minds. It is at these moments where reflection can be our greatest asset. As we turn the page on this chapter in history, capturing the lessons learned and turning to the opportunities ahead we can chart our course towards a successful future.
Do you have strategies in place to make sure the cookie doesn’t crumble? If not, call on HORNE to help you make sure your OREO party is sweet.