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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.

It is imperative that the lender examine and thoroughly understand both the loan documents for the particular loan and foreclosure laws in the area where the collateral property is located.   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 lender has decided to foreclose, the bank needs to have its foreclosure department ready to go.In the common language of a commercial bank, foreclosures are known as “OREO” (Other Real Estate Owned), as separate from the properties the bank uses and operates, such as their own offices.  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 lost to fire where there was no insurance coverage due to failure to monitor this activity.)
• Assign the responsibility for managing foreclosed properties to one person.If the amount of foreclosures is large enough to be the sole focus of one or two people fulltime, then almost certainly you will need a new-hire.Don’t depend on the mortgage consultants that helped create the predicament to somehow solve the problems that they didn’t see coming.  It is advantageous to have some “distance” between the OREO/REO managers and the original borrowers.
• Have the properties secured immediately after either foreclosure or abandonment.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.There are no buyers who enjoy unattractive properties.
• 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.
• Get “For Sale” signs up immediately 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 REO or OREO team will know the ins and outs of the property better than any real estate professional, and your financing will be an attractive consideration for the buyer.You should be one making the calls on financing, instead of a real estate agent.
• Talk to the neighbors of the foreclosed property.  Often, their families and friends are prospective purchasers.  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.Keep in mind that the sooner you make a sale, the sooner the property can make money back instead of spending it.
• 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

This article was written by a professional banking expert witness. He is a manager and banking regulator, has successfully managed millions of dollars of distressed and foreclosed properties including single-family houses, condos, and land developments, apt complexes, and many others across the country.  He is available on a contract basis to discuss your bank’s particular needs at an expert witness services company. See all professional and legal expert witnesses with full C.V.’s.