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Appeal of Accounting Treatment of Real Estate Owned Valuation and Misapplication of Regulatory Guidance (First Quarter 2012)

Background

A federal thrift (Thrift) filed an appeal of alleged erroneous facts and conclusions in the most recent Report of Examination (ROE).  Specifically, the bank appealed conclusions regarding the Real Estate Owned (REO) General Valuation Allowance (GVA), REO carrying values and appraisal timeframes, the Allowance for Loan and Lease Losses (ALLL), and a litigation reserve.

Discussion

With respect to the supervisory office determination related to the REO GVA, the appeal requested the ombudsman to affirm:

  1. Using a regional look back analysis was safe and sound and GAAP compliant;
  2. A reversal of the directed allocation to the GVA was warranted;
  3. A reversal of the statement in the ROE alleging the GVA was undervalued and violated 12 C.F.R. § 163.170(c) was appropriate; and
  4. A reversal of the directed allocation to the ALLL was warranted.

With respect to the REO carrying values and appraisal timeframes, the appeal sought an opinion that failure to record an adjustment in REO carrying values did not constitute a violation of 12 C.F.R. § 163.170(c).  The appeal also sought relief from compliance with the ROE requirement to obtain an REO appraisal within 30 days of foreclosure; such a requirement was inconsistent with regulatory guidance in place at the time.  Therefore, to implement such guidance would mean applying a new standard retroactively.

With respect to the ALLL, the appeal sought reversal of a directed provision and the supervisory office determination that bank management violated regulations due to erroneous calculations.

Lastly, the appeal sought to reverse the supervisory office requirement to establish a full valuation allowance related to an account receivable for recoverable insurance proceeds.

Standards

The ombudsman’s decisions were based on guidance contained in the Office of Thrift Supervision (OTS) Examination Handbook Section 251, Real Estate Owned and Repossessed Assets (Revised December 2010), Interagency Appraisal and Evaluation Guidelines, 2006 Interagency Policy Statement on the Allowance for loan and Lease Losses (2006 IPS), 12 C.F.R. § 163.170 Examinations and audits; appraisals; establishment and maintenance of records, U.S. Generally Accepted Accounting Principles (GAAP), ASC subsection 360-10-35-40 Measurement of Expected Disposal Loss or Gain, ASC subtopic 450-20 (FAS 5), ASC subtopic 310-10 (FAS 114), and Thrift Financial Reports (TFR) instructions.

Conclusion

With respect to the remedies sought regarding supervisory office conclusions of the REO GVA, the ombudsman determined the concept of using regional look back analysis was not inconsistent with GAAP and OTS guidance.  However, the guidance requires bank management to support its methodologies.  The documentation contained in the appeal did not provide sufficient details to determine the regional look back analysis supported the REO GVA balance.  Without such details, the supervisory office appropriately applied the bank’s historical loss rate to the entire portfolio, which resulted in the need for an additional allocation.  Therefore, the ombudsman concluded the supervisory office appropriately applied regulatory guidance and the violation of 12 C.F.R. § 163.170(c) was well supported.

With respect to the remedies sought in connection with the REO carrying values and appraisal timeframes, the ombudsman determined the violation of 12 C.F.R. § 163.170(c) was based on the bank’s failure to maintain accurate and complete records related to individual REO property values as well as the calculation of the REO GVA balance.  Therefore, the ombudsman concluded that the number of properties with carrying values in excess of their market value as well as an understated GVA violated the requirements to maintain accurate and complete records.  The ombudsman also determined the ROE did not require the bank to obtain appraisals within 30 days of taking properties into foreclosure.  The ROE required the bank to mark properties to market value within 30 days of obtaining an appraisal.  The bank was advised to continue to abide by guidance noted in section 251 of the OTS Examination Handbook.