Originally posted by David Peeples:
Josh/Jeff,
Can either of you guys comment on lender requirements to maintain reserves when they repossess property?
In other words, I have heard that if a lender (bank or servicer) forecloses and regains possession, then they must keep cash reserves on hand of 30% of property value.
I have also heard that the requirement to adhere to this rule hinges on the lenders standing as viewed by the FDIC.
True?
Fales?
Somewhere in between?
thanks,
Dave
Dave,
I emailed the FDIC a few months ago with the same question this is what I got back
Subject: RE: Loan Loss Reserves and Real Estate owned on a banks balance sheet
Jeff,
I am sorry for the long delay in getting back to you, but you caught me on vacation and I have had a very tight deadline on a project since I got back.
I hope I can help some, but I am not a capital expert or an examiner. Risk based capital guidelines govern how much capital must be on the books for a bank. The Call Report Instructions can be a good source for this and the web site www.ffiec.gov should have an area where you can find the instructions. Most loans are classified by the type of collateral that is taken to support the loan. A mortgage usually has a risk weight of about 50 percent while a commercial loans has a 100 percent risk weight. So for an 8 percent capital ratio, a bank would have to hold 4 percent against the mortgage and 8 percent against the commercial loan. Whether the loan is performing up to its terms or not is not usually a capital question, but a loan loss reserve issue.
Banks hold reserves for possible losses on loans. Loan loss reserve (LLR) guidelines are likely to be documented in examination standards and Financial Institution Letters (FILs). Examiners often classify loans as substandard, doubtful or loss. The level of reserves required gets greater as the loan gets closer to default. Once a loan is in default, it could be 30 days pass due, more days past due, or on a non-accrual status. Most banks stop their accruals after 90 days past due. A bank takes an expense to add funds to its LLR, but when they charge-off the loan it just reduces the LLR without an income hit. Of course, the income hit will reduce capital.
Once a loan is in default and the deed is received in a foreclosure, the asset stops being a loan and becomes other real estate owned. The bank transfers the loan to other real estate owned at its expected value and begins an effort to sell the property. Banks are not expected to be real estate holders and this is discouraged, but some bad portfolios do end up turning to other real estate owned. (The other is to differentiate it from real estate they meant to invest in, but most are not allowed to make direct investments into real estate). I believe the capital required for other real estate owned is in the 100 percent risk weight category. At one point, it might have been 200 percent, but I don’t think it is now. The asset value is often much lower than the loan value because all the expenses related to foreclosure and selling expenses have to be accounted for when its transferred to other real estate owned.
I hope this helps and it should give you some places to check out the details.
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Please take note of the word Guideline that is used, not rule
also they choose pretty much what to do based upon values they determine internally. Thats why all the BPO's are so high. They want them to be high. Until it hits their balance sheet, the reserve requirements are "manageable". When they get the deed is when it get ugly. That is why they are not really doing shortsales.
I can remember a "GURU" stating in his shortsale pitch that its was 3 times the asset for reserves that is why his "system" makes so much sense.
LOL :)
So if they do not understand that part of the equation, how can they understand the rest?
