Joint Statement            Office of the Comptroller of the Currency
                               Federal Deposit Insurance Corporation
                    Board of Governors of the Federal Reserve System

For immediate release 

Interagency Guidance on Accounting for Dispositions of Other Real Estate
Owned

July 16, 1993 

Purpose 

This issuance provides guidance with respect to the appropriate accounting
for dispositions of other real estate owned (OREO). This guidance
generally conforms regulatory reporting requirements for sales of OREO
with generally accepted accounting principles (GAAP).
 
Background 

Banks often sell parcels of OREO property and provide financing for these
transactions. These transactions should be accounted for in accordance
with the Instructions to the Consolidated Reports of Condition and Income
(Call Reports). Beginning with the June 30, 1993 report date, the
instructions for OREO in Call Report Schedule RC-M were revised to
eliminate certain minimum down payment requirements which exceeded those
required under GAAP. Accordingly, the primary guidance for sales of OREO
is Statement of Financial Accounting Standards No. 66, "Accounting for
Sales of Real Estate" (SFAS 66).

SFAS 66 establishes five different methods of accounting for sales of real
estate. The different methods are based on the legal form of the
transaction, the type of property sold, the amount of down payment and
other factors. However, in the past, many banks have only used two of
these methods: the full accrual method or the deposit method. While the
full accrual method accounts for the transaction as a sale of the real
estate, the deposit method does not.

The full accrual method under SFAS 66 requires an initial investment (down
payment) based on specific guidelines. Some banks have concluded that if
the initial down payment amount was insufficient to qualify for the full
accrual method, the deposit method must be used instead. Additionally,
although SFAS 66 provides criteria regarding when it is appropriate to
subsequently switch to another accounting method and recognize the sale,
these banks have generally continued using the deposit method and
classifying the asset as OREO until the transaction qualified for the full
accrual method.

Although the deposit method is appropriate in certain circumstances, the
inappropriate use of this method does not properly characterize a
transaction as a sale of the real estate when, in fact, a valid sale has
occurred. However, other appropriate methods specified in SFAS 66
recognize the sale. Furthermore, the full accrual, installment, and
reduced-profit methods permit, in appropriate circumstances, the recording
of the resulting loan as an earning asset.  The distinction between loans
and OREO is important to users of bank financial statements. Bank analysts
and others customarily include OREO in a bank's nonperforming assets and
often use the level of nonperforming assets as one of the factors in the
evaluation of a bank's financial condition.

Hence, the inappropriate use of the deposit method may cause a bank to
report higher levels of OREO than are required under generally accepted
accounting principles and regulatory reporting requirements, thereby
causing nonperforming assets to be overstated.

Accordingly, this issuance summarizes the circumstances when it is
appropriate to use each of the five methods prescribed in SFAS 66. The
actual accounting standard and other relevant guidance should also be
consulted as they contain specific and more detailed requirements and
guidance.
 
Accounting Guidance 

SFAS 66 establishes the following methods to account for dispositions of
real estate, and applies to all transactions in which the seller provides
financing to the buyer of the real estate. If a profit is involved in the
sale of real estate, each method sets forth the manner in which the profit
is to be recognized. Regardless of which method is used, however, any
losses on the disposition of real estate should be recognized immediately.

Full Accrual Method - Under the full accrual method, the disposition is
recorded as a sale. Any profit resulting from the sale is recognized in
full and the asset resulting from the seller's financing of the
transaction is reported as a loan. This method may be used when the
following conditions have been met:

* A sale has been consummated;

* The buyer's initial investment (down payment) and continuing investment
  (periodic payments) are adequate to demonstrate a commitment to pay for
  the property;

* The receivable is not subject to future subordination; and

* The usual risks and rewards of ownership have been transferred.

Guidelines for the minimum down payment that must be made in order for a
transaction to qualify for the full accrual method are set forth in the
Appendix A to SFAS 66. These vary from 5 percent to 25 percent of the
property sales price. These guideline percentages vary by type of property
and are primarily based on the inherent risk assumed for the type and
characteristics of the property. To meet the continuing investment
criteria, the contractual loan payments must be sufficient to pay the loan
off over the customary loan term for the type of property involved. Such
periods may range up to 30 years for loans on single family residential
property.
 
Installment Method - Dispositions of OREO that do not qualify for the full
accrual method may qualify for the installment method. This method
recognizes a sale and the corresponding loan. Any profits on the sale are
only recognized as the bank receives payments from the purchaser/borrower.
Interest income is recognized on an accrual basis, when appropriate.

The installment method is used when the buyer's down payment is not
adequate to allow use of the full accrual method but recovery of the cost
of the property is reasonably assured if the buyer defaults. Assurance of
recovery requires careful judgment on a case-by-case basis. Factors which
should be considered include: the size of the down payment, loan to value
ratios, projected cash flows from the property, recourse provisions, and
guarantees.

Since default on the loan usually results in the seller's reacquisition of
the real estate, reasonable assurance of cost recovery may often be
achieved with a relatively small down payment. This is especially true in
situations involving loans with recourse to borrowers who have verifiable
net worth, liquid assets, and income levels. Reasonable assurance of cost
recovery may also be achieved when the purchaser/borrower pledges
additional collateral.

Cost Recovery Method - Dispositions of OREO that do not qualify for either
the full accrual or installment methods are sometimes accounted for using
the cost recovery method. This method recognizes a sale and the
corresponding loan, but all income recognition is deferred. Principal
payments are applied as a reduction of the loan balance and interest
increases the unrecognized gross profit. No profit or interest income is
recognized until either the aggregate payments by the borrower exceed the
recorded amount of the loan or a change to another accounting method is
appropriate (i.e., installment method). Consequently, the loan is
maintained on nonaccrual status while this method is being used.

Reduced-Profit Method - This method is used in certain situations where
the bank receives an adequate down payment, but the loan amortization
schedule does not meet the requirements for use of the full accrual
method. The method recognizes a sale and the corresponding loan. However,
like the installment method, any profit is apportioned over the life of
the loan as payments are received.

The method of apportionment differs from the installment method in that
profit recognition is based on the present value of the lowest level of
periodic payments required under the loan agreement.

Since sales with adequate down payments are generally not structured with
inadequate loan amortization requirements, this method is seldom used in
practice.

Deposit Method - The deposit method is used in situations where a sale of
the OREO has not been consummated. It may also be used for dispositions
that could be accounted for under the cost recovery method. Under this
method a sale is not recorded and the asset continues to be reported as
OREO. Further, no profit or interest income is recognized. Payments
received from the borrower are reported as a liability until sufficient
payments or other events have occurred which allow the use of one of the
other methods.

The above discussion represents a condensed summary of the methods
included in SFAS 66 for accounting for sales of real estate. Bankers and
examiners should refer to SFAS 66 for a more complete description of the
accounting principles that apply to sales of real estate, including the
determination of the down payment percentage.