When a bank’s level of non-performing loans and foreclosed assets increases to the point that the bank’s costs and expenses exceed its revenues, the resulting deficit erodes the bank’s net worth and reduces stockholders’ equity.  Depending upon the particular bank’s level of net worth, a serious problem will result at some point in time unless steps are taken to mitigate the problems.  This article deals with the administration of real estate properties that have already been foreclosed.

The lender must examine and truly understand both the regional laws of foreclosure, and the documents for the specific loan at hand.   Depending upon the various factors contained in loan documents and the nuances of state foreclosure laws, there are usually factors that dictate the timing of when a foreclosure must be initiated.  In some cases, a lender’s failure to initiate a foreclosure at the proper time might result in the postponement of the foreclosure to a much later time, allowing further arrearages to accrue and possibly further deterioration or damage to the collateral property.

Once the foreclosure decision is made, the bank needs to automatically involve its foreclosed property department.  In a commercial bank, foreclosed real estate properties are referred to as Other Real Estate Owned, or “OREO,” as distinct from real estate owned and used in the operation of the bank, such as the main bank building and bank branch properties.  The equivalent term at savings banks is Real Estate Owned or “REO.”

Here are some guidelines for the successful management of foreclosed properties:

• Make sure that the homeowners’ or fire and extended casualty insurance is cancelled and that the property is added to the bank’s blanket insurance policy for foreclosed properties.(Note: I have seen properties and profits literally up in flames where there was missing coverage due to not keeping track of this.)
• Assign the responsibility for managing foreclosed properties to one person.If the foreclosure volume is sufficient to occupy one or more people fulltime, then naturally you will need to hire someone fulltime for this project.  Don’t rely on the loan officers that initiated the problem loans to begin with to now miraculously solve the problems that they could not foresee in the beginning.It is very helpful to have some “distance” between the OREO/REO professionals and the borrowers.
• Once the properties are foreclosed or abandoned, secure them immediately.There must be a central key repository in the OREO or REO department.
• Keep the properties looking decent.  Do whatever is required to avoid deterioration of the properties.No property buyer, commercial or residential, wants to purchase an ugly piece of real estate.
• If the property has problems, find a specialist in buying and fixing up properties, and provide financing to make the deal workable and attractive.  Include a commitment to provide financing for the ultimate customer to whom the fix-up specialist will sell.
• “For Sale” signs should be put up right away after foreclosure.  (Note:  It is astonishing to me how many times I have gone into OREO and REO operations and found management amazed that a property has not sold, yet there is no “For Sale” sign on it!)
• Only list with a real estate agent if truly necessary.Your Department of OREO or REO will understand the property than any realtor, and your financing will be a major selling point to the purchaser.You are the one to control the financing, not the a real estate agent.
• Chat with the neighbors who live near the property.Friends and family of the owner will often be interested in the property.  Your offering favorable financing might be the factor that tilts the scales in favor of a relative relocating close to another relative.
• Inspect the properties regularly, and document what you find.  Take any needed corrective actions immediately.
• Offer helpful financing to persuade purchasers to jump on the deal.  Remember that a sale turns a cash consuming asset into a cash producing asset.
• Consider holding periods and the net present value of a probable future sale when setting a sales price.  The “net” part of net present value allows for the holding costs which include taxes, insurance, any required maintenance, lawn care or landscaping, and any expenditures such as painting, carpet, and any other cosmetic expenditures that may be required in order to market the property.
• Take note of OREO / REO events and issues at meetings of the Board of Directors.  Directors often have market knowledge and contacts that can help with OREO / REO problems.

Obviously, this list of items is a lot to think about.  It requires special expertise to initiate all of these various activities and to keep them moving toward the multiple finish lines

About the Author

This article was written by one of Consolidated Consultants Co’s Banking Expert Witnesses. He is a manager and banking regulator, has managed hundreds of millions of dollars of “problem properties” including duplexes, condos, subdivisions, office buildings, and many others across the nation.  He is available on a contract basis to discuss your bank’s particular needs, and works regularly with real estate experts.