Seller Financing of Bank-Owned Real Estate

Two bankers shaking hands

Notable changes are coming based on the issuance of Accounting Standards Update 2014-09. Beginning in 2018 for those entities meeting the definition of a public business entity (PBE) and 2019 for non-PBE filers (early adoption is permitted), entities will have to change the way they account for seller financing of Other Real Estate Owned (OREO). This supersedes the current methods used under Accounting Standards Codification (ASC) 360-20, the long-standing Statement of Financial Accounting Standards No. 66 guidance.

The chart below walks through the key decisions that should be made in determining if a sale of OREO has occurred under the new guidance. Under ASC 610-20, a bank will have an accounting sale with full gain or loss recognition and derecognition of the OREO at the time of sale if the transaction meets certain requirements within ASC 606. Otherwise, at the transaction date, a bank will generally record any payments received as a deposit liability to the buyer and continue reporting the OREO as an asset until the requirements in ASC 606 are met. When the transaction doesn’t qualify for a sale, but a loss would have been recognized if it did, the bank should evaluate whether a loss should be recognized on the OREO through a valuation allowance to reflect fair value less costs to sell.

Seller Financing of Bank-Owned Real Estate

Does the seller have a controlling financial interest in the legal entity purchasing the OREO?

If the seller has a controlling financial interest in the buyer, then the performance obligation can’t be satisfied, as the buyer won’t have control over the OREO sold.

Does the transaction meet the definition of a contract for ASC 606?

In determining whether the transaction meets the five contract criteria, an entity should consider all facts and circumstances. In particular, consideration should go to the amount and character of buyer’s equity and existence of recourse provisions. An entity shall account for a contract with a customer only when these criteria are met:

  • The parties to the contract have approved it in writing, orally or in accordance with other customary business practices and are committed to performing their respective obligations.
  • The entity can identify each party’s rights regarding the goods or services to be transferred—in this case, OREO.
  • The entity can identify the payment terms for the goods or services to be transferred.
  • The contract has commercial substance, i.e., the risk, timing or amount of the entity’s future cash flows are expected to change as a result of the contract.
  • It’s probable the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.

In evaluating whether collectibility of an amount of consideration is probable, an entity shall consider only the customer’s ability and intention to pay that amount of consideration when it’s due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable, because the entity may offer the customer a price concession. Entities may consider the example on assessing collectibility in a sale of real estate found in ASC 606-10-55-95 when evaluating whether it’s probable an entity will collect substantially all consideration to which it expects to be entitled under a financing arrangement. The example focuses on the ability to repay based on the borrower’s circumstances, such as income from businesses or other assets that could be used to satisfy the loan. Further, the example considers the loan’s structure and other factors that could limit the purchaser’s liability.

Has the selling entity satisfied its performance obligation by transferring control?

Control of an asset refers to the ability to direct the use of—and obtain substantially all the remaining benefits from—the asset. Control includes the ability to prevent other entities from directing the use of—and obtaining the benefits from—an asset. To satisfy the performance obligation and thus transfer control in the sale of OREO, an entity should deliver possession to the buyer. The buyer can benefit from the property in accordance with the standard if it could be used or sold for an amount greater than salvage value or otherwise held in a way that generates economic benefits.

Are the terms of the transaction at market terms?

A transaction with an insignificant down payment and nonrecourse financing generally wouldn’t meet the definition of a contract unless there’s considerable support from other factors.

If it’s determined to meet the definition of a contract, the transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring the property. In determining the transaction price, an entity should consider whether a significant financing component exists. The entity should adjust the promised amount of consideration for the effects of below-market terms, considering both the rate provided and timing of payments. A significant financing component may exist regardless of whether the promise of financing is explicitly stated in the contract or implied by the payment terms agreed to by the parties.

Visit our financial services industry page to see BKD’s articles and webinars related to the implementation of new accounting pronouncements, or contact John with questions.

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