The federal bank, thrift and credit union regulatory agencies recently issued Proposed Interagency Appraisal and Evaluation Guidelines (proposed guidelines) intended to clarify real estate appraisal guidelines and promote a sound real estate collateral valuation program. There have been considerable developments pertaining to appraisals and advances in regulated institutions’ collateral valuation practice since the issuance of the 1994 Interagency Appraisal and Evaluation Guidelines (1994 guidelines). The proposed guidelines reflect revisions due to the evolution of real estate collateral valuation practices. They also provide guidance and expectations for risk management and control measures for appraisal and evaluation programs.

The proposed guidelines, if finalized, will replace the 1994 guidelines to reflect changes in industry practice, uniform appraisal standards and available technologies. The guidelines also incorporate recent supervisory issuances. The focal point of the 1994 guidelines remains unchanged:  a real estate lending program should include an appropriate real estate appraisal and evaluation program.

The proposed guidelines include:

• Clarification of the five appraisal standards in the agencies’ appraisal regulations
• Emphasis on a risk-based approach with respect to an institution’s review of appraisals and evaluations
• Expanded discussion on when a collateral valuation should be updated or replaced
• Detail on the agencies’ expectations for an independent appraisal and evaluation function
• Clarification on real estate transactions exempt from the agencies’ appraisal regulations
• Discussion of acceptable evaluation alternatives and use of automated valuation models

The complete proposed guidelines are available at:  http://edocket.access.gpo.gov/2008/pdf/E8-27401.pdf.

For additional information, see:  Appraisal and Evaluation Proposed Guidelines.

Tax Consequences of Selling Troubled Loans

With a number of troubled loans sitting in bank portfolios, many banks are considering selling these loans to their parent bank holding company (BHC) to avoid regulatory scrutiny. However, banks need to be aware of the tax consequences of such transactions.

A typical bank holding company structure includes the BHC, one or more commercial bank or thrift subsidiaries and possibly a variety of other non-bank or non-thrift subsidiaries. The issue is the difference in tax treatment, particularly the loss treatment on loans, when transactions are conducted between members.

When a bank sustains a loss on the charge off or sale of a loan, it receives ordinary loss treatment. When a non-bank member sustains a loss on the charge off or sale of a loan, it typically receives capital loss treatment. In general, capital losses can only be used to offset capital gain income.

Another trap to selling a troubled loan occurs when the BHC (which is typically not a financial institution) is ready to dispose of these loans and possibly recognize additional losses. These losses will give rise to capital treatment instead of ordinary treatment, and these capital losses carry forward if there are no net capital gains in the previous three years to offset them.

For a C Corporation, capital losses can only carryover for a maximum of five years before they expire and are lost forever. For an S Corporation, these losses pass to the shareholders. Individual shareholders can use these losses to offset capital gains only to the extent that annual net capital losses do not exceed $3,000. Any excess is carried forward. Currently, there are very few capital gains and many capital losses recognized in individual portfolios. Shareholders may possibly never fully utilize their capital losses.