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Subject: Other Real Estate Owned
Date: March 24, 2011
To: Chief Executive Officers of All National Banks, Department and Division Heads, and All Examining Personnel
Description: Exchanging Other Real Estate Owned for Other Assets
The deterioration in asset quality due to the weak economic environment has led to an increase in nonperforming assets, including other real estate owned (OREO), on bank balance sheets. Several companies have started marketing OREO exchange programs to national banks as a means to reduce problem assets. These programs purport to reduce nonperforming assets by exchanging OREO for an interest in another asset, which is represented to be performing. This “performing asset” is often 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. These programs can raise significant safety and soundness, legal, and accounting concerns and the Office of the Comptroller of the Currency (OCC) strongly encourages national banks to consult with their supervisory offices before entering into any such agreements.
Common issues associated with the exchange of OREO assets for an equity interest (generally in a limited liability company (LLC)) include
In addition, the entity acquiring the OREO is often involved in activities that are not permissible for national banks, making the exchanged asset acquired by the bank an impermissible asset. Moreover, the structure of the exchange transaction typically does not meet the accounting definition of a true sale. Thus, rather than improving its position, the bank ends up in an economically inferior situation, with additional legal and accounting issues.
Another example of transactions offered to national banks to reduce their nonperforming asset balances is an “adjusted price trade.” This type of transaction involves an offer to purchase the bank’s nonperforming real estate loans or OREO at book value, with the stipulation that the bank purchase other assets, at inflated values, from the same party. The “adjusted price trade” is not only unsafe and unsound but may constitute fraud if it results in the misrepresentation of the bank’s financial statements.
In a limited number of circumstances, a national bank may acquire a noncontrolling equity interest in an LLC in exchange for its interest in OREO. The OCC has approved only one type of exchange, in which an LLC was established as a means for the participants in the original loan to hold the real estate collateral acquired through or in lieu of foreclosure. In this case, the participants in the original loan were the members of the LLC, and each participant held an interest in the LLC equivalent to its participation interest in the loan and OREO. The LLC was established specifically to manage and dispose of the OREO. The member banks retained control over the OREO asset and maintained the same level of risk as before the exchange. The exchange, however, enabled the participants to manage and dispose of the OREO more efficiently than if each bank had to manage its own partial interest in the property.
A national bank wishing to complete such an exchange of its loan interest for an equivalent LLC interest has two alternatives. The bank may follow the well-established licensing procedures in 12 CFR 5.36 for making a noncontrolling investment by submitting a notice (limited to well-capitalized, well-managed banks) or application, as appropriate.1 Alternatively, the bank may seek approval from its supervisory office under the standards established in OCC Interpretive Letter No. 1123 (September 18, 2009).2 The supervisory office approval under the standards established in Interpretive Letter No. 1123 is available only for those instances, as described previously, in which the participants in a loan form an entity to hold, manage, and dispose of the OREO collateral acquired for debts previously contracted. Interpretive Letter No. 1123 does not provide legal support for national banks to exchange OREO for equity interest in an entity aggregating various unrelated OREO parcels from multiple banks.
Banks need to use caution when looking at novel methods of trading nonperforming OREO balances for other assets. Before entering into any type of OREO exchange, the bank should have a detailed, documented plan. Bank management and the board of directors, at a minimum, should
Although the transaction may be marketed as a simple way to reduce nonperforming assets, these transactions can be very complicated and must be reviewed thoroughly before entering into them.
Please contact your supervisory office with questions on specific exchange programs or processes. You may also direct questions or comments to Darrin Benhart, Director of Commercial Credit Risk, at 202-874-4564; or Steven Key, Special Counsel, Bank Activities and Structure, at 202-874-5300.
Timothy W. Long