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Many financial institutions may have to change their accounting practices if a proposal is implemented to clarify the definition of when a loan should be classified as other real estate owned (OREO) for financial reporting purposes.

Financial Institutions May Be Affected by Changes to ‘Other Real Estate Owned’ Definition

  • 8/6/2013

Financial Institutions May Be Affected by Changes to ‘Other Real Estate Owned’ Definition

The Financial Accounting Standards Board’s Emerging Issues Task Force (EITF) has proposed implementing new terms to clarify when a loan should be classified as other real estate owned (OREO) for financial reporting purposes. The EITF’s proposed accounting standard, issued on July 19, 2013, defines certain phrases that had led financial institutions to different interpretations of the rules.

“If this guidance is implemented, it could potentially be a drastic change from the current accounting policies of some financial institutions,” warns David Heneke, a financial institutions manager with CliftonLarsonAllen.

“There is a good chance the proposed standard will be implemented, but it will depend on whether comments are sent to the EITF supporting it. In addition, since the proposal is so new, it’s unclear at this point when it would become effective,” he adds.

Inconsistent reclassifications

The EITF has weighed in on this issue due to the significant increase in OREO recorded by financial institutions during the economic downturn, and the unclear accounting standards which led to inconsistent classifications. The result was varying accounting policies and procedures by financial institutions — some would reclassify loans into OREO on the date of a sheriff’s sale, while others would wait until the end of the redemption period.

Either method is technically legitimate, as an institution’s practice would be predicated on its interpretation of what current accounting standards refer to as physical possession.

Current U.S. generally accepted accounting principles outline the recognition of OREO in the following subtopics:

  • Subtopic 310-40, Receivables — Troubled Debt Restructurings by Creditors
  • Subtopic 310-10, Receivables — Overall
  • Subtopic 360-10, Property, Plant, and Equipment — Overall

Paragraph 310-40-40-6 defines accounting for a troubled debt restructuring as:

… in substance a repossession or foreclosure by the creditor, that is, the creditor receives physical possession of the debtor's assets regardless of whether formal foreclosure proceedings take place, or in which the creditor otherwise obtains one or more of the debtor's assets in place of all or part of the receivable.

The terms “in substance a repossession or foreclosure,” and “physical possession” are not defined in the current accounting guidance, which has led to different applications and interpretations of this standard.

New definition of terms

The EITF’s proposed accounting standard further clarifies these terms:

A creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon one of the following occurring:

  • the creditor obtaining legal title to the residential real estate property
  • completion of a deed in lieu of foreclosure or similar legal agreement under which the borrower conveys all interest in the residential real estate property to the creditor to satisfy that loan, even though legal title may not yet have passed

“If an institution’s current accounting policy defines physical possession as receiving the title, this proposed guidance will not affect its accounting practices,” says Heneke.

“However, if an institution’s policy defines physical possession as the date of the sheriff’s sale, this standard will significantly affect its accounting practices. For instance, the reclassification of a loan to OREO will be delayed until the end of the redemption period,” he adds.

Updating current loans

Per the new guidance, the proposed implementation of this standard would be on “a modified retrospective basis to residential consumer mortgage loans and foreclosed residential real estate properties held by the creditor at the date of adoption through a cumulative-effect adjustment as of the beginning of the annual reporting period for which the guidance is effective.”

In other words, if adopted, institutions would be required to reclassify current loans and OREO to comply with this standard on the date it is deemed effective.

Financial institutions should review their current accounting policies on reclassification of loans to OREO, and determine whether these loans need to be updated due to the proposed change. Institutions should also consider submitting a comment letter stating their view on this potential change, and its impact on the financial institutions industry. The comment period is open until September 17, 2013.

How we can help

Contact your CliftonLarsonAllen representative if you have any questions about the implications of the proposed guidance on your organization. We can assess how this may affect your institution by reviewing your current accounting policies and procedures surrounding OREO, and outline the changes you need make if this standard is issued.

David Heneke, Manager, Financial Institutions or 320-203-5621