The OCC closed out the month of August with an updated “Other Real Estate Owned” (OREO, primarily real estate acquired via foreclosure) portion of the Comptroller’s Hand-book. The handbook is intended to provide guidance to examiners but serves as a tool for bankers and real estate investors as well.
The part we honed in on was “Risks Associated With OREO”. Risks can be anything that has the potential to affect a bank’s earnings, capital or value. For supervisory purposes, the OCC defines five such risks when looking specifically at OREO:
1) Price Risk is the primary risk of OREO. The longer a bank holds onto the property, the greater the likelihood the property will decline in value, particularly if poor economic conditions caused the bank to take the property in the first place. It may be difficult to sell the property for the full value, or even to cover the amount of the loan.
2) Liquidity Risk. Since real estate is not a liquid asset, if a bank has too much and/or doesn’t know how to dispose of OREO properly, it could have a negative affect on the bank’s overall liquidity.
3) Operational Risk. Without having the proper tools to dispose of OREO, a bank risks collateral deterioration that will reduce the revenues that could be earned from the property.
4) Compliance Risk. Those proper tools must take into consideration all local and federal laws pertaining to the foreclosure process, from non-discriminatory treatment of tenants to property preservation. The bank may be held liable for damages to other parties during the process.
5) And finally, Reputational Risk may be the most difficult to overcome. If dealings are perceived to be unfair or even just unpopular, a bank could have trouble getting new business as well as keeping the relationships it already has.
Those are the primary risks that OREO poses to a bank. In a perfect world, bankers don’t want any OREO. If loans are underwritten properly and the economy doesn’t falter, OREO should be minimal. But that is not the case for the banks listed on page 7. Each has OREO valued at 2.5% of total assets or greater.
You’ll notice that most of them are poorly rated, but not all. That’s because, as we always say, you cannot look at just one item on a bank’s Call Report to evaluate it.
For example, as of June 30, 2018 Zero-Star Beach Community Bank, FL, had an OREO to assets ratio over 23%, the highest in the country. Its leverage capital ratio of just 2.11%, gave it absolutely no cushion. In fact its regulatory capital classification was “Significantly Undercapitalized”. Its reserves to delinquencies ratio was a paltry 5.8% AND it had another $45 million in delinquent loans with the potential to become even more OREO. Its delinquency to asset ratio (which we generally like to see under 1%) was 32.8%.
Since June 30th, Beach Community Bank has successfully completed a $100 million capital raise. We look forward to seeing what this new capital will do for the bank. Its neighbor, however, Zero-Star First City Bank of Florida, has not had any such capital infusions to help it out. These two banks, that looked so similar at June 30th, will likely have very different destinies.
If you glance down a little farther on the list you’ll notice 4-Star California Pacific Bank. With an OREO to assets ratio of 5.7% you may ask yourself how can it be rated 4-Stars. It is very simple. California Pacific Bank’s nonperforming assets are ALL OREO. It has no delinquencies. Its leverage capital ratio exceeds 40% as does its Bauer’s adjusted capital ratio (which factors in nonperformers).
Industry OREO is 1/7th of what it was eight years ago so the timing of the OCC Handbook update may seem a bit off, but there is still plenty of bank owned property out there. If you want to know which banks have the most OREO, order Bauer’s Statewide Banks with Repossessed Real Estate Report. Those that are most impacted by their OREO (highest OREO to assets ratios) are listed here.