The OCC issued a bulletin (OCC 2011-10, the “Bulletin”) concerning the safety and soundness, legal and accounting concerns raised by what the OCC characterizes as “an increasing number of programs [the “OREO Exchange Programs”] targeted at banks to exchange [other real estate owned, “OREO”] for other assets to reduce nonperforming assets.”
The OCC states that in the typical OREO Exchange Program, the bank’s OREO asset is to be exchanged for a so-called “performing asset” which, the OCC states, is frequently “an equity interest in the entity acquiring the OREO or a trade for a large volume of loans such as home equity lines of credit.”
Safety and soundness, legal and accounting issues frequently raised in these exchanges of OREO assets for a minority equity interest in such an LLC include:
- the bank’s loss of control over its OREO assets;
- the questionable liquidity and value of the asset for which the OREO has been exchanged;
- the commingling of the bank’s OREO with poorer quality real estate assets;
- significant up-front and management fees;
- unfavorable priority of payments between the banks and equity investors;
- the entity acquiring the assets may be involved in activities that are not permissible for national banks; and
- the exchange transaction may not be a “true sale” for accounting purposes.
Another type of OREO Exchange Program that the OCC has been seeing is a program that offers an “adjusted price trade,” where a bank’s OREO or nonperforming loans would be purchased at book value provided that the bank purchase other assets at inflated values. The OCC notes that a transaction of that type is not only unsafe and unsound, but may involve fraud if it results in misrepresentations on the bank’s financial statements.
The OCC notes that in a limited number of circumstances a national bank may acquire a noncontrolling equity interest in an LLC in exchange for its interest in an OREO property.
Finally, the Bulletin provides a list of actions a bank should take before entering into an OREO exchange for other assets. Some of the steps identified by the OCC involve:
- documentation of purpose and legal permissibility of the transaction;
- determination of accounting treatment of the transaction;
- documentation as to why the exchange will increase the aggregate value of the real estate held by the Bank;
- confirmation of accurate valuation of the OREO and the assets for which it would be exchanged;
- verification that adequate risk management, measurement and tracking systems, and monitoring systems are available or in place; and
- putting processes in place to dispose of the interest in the entity (for which the OREO was exchanged) within five years from the date the bank acquired the OREO (unless the OCC grants an extension).