By: Wesley Allen
Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure
The Financial Accounting Standards Board (FASB) released Accounting Standards Update No. 2014-04 in January 2014, as a consensus of the FASB Emerging Issues Task Force.
This guidance applies to lenders and other creditors who obtain physical possession of residential real estate property, either through foreclosure or a deed inlieu of foreclosure (i.e. turning in the keys), in satisfaction of a consumer mortgage loan. The primary applicants of this guidance will be financial institutions, mortgage companies, and other creditors who finance residential real estate.
Due to the rate of residential real estate foreclosure experienced during the financial crisis in recent years, accounting for other real estate owned and foreclosed assets became a frequent topic of discussion. Under US Generally Accepted Accounting Principles (GAAP), a creditor should reclassify a mortgage loan when it determines physical possession of the residential real estate has been obtained regardless of whether formal foreclosure proceedings take place. Certain jurisdictions have longer foreclosure timelines and require a creditor to jump through more legal hoops to take possession of the asset, leading to diversity in practice of when the foreclosure actually occurs and the financial asset should be de-recognzied. This Update clarifies when physical possession is determined to take place.
The amendments described in the ASU will be effective for public business entities within annual reporting periods, and interim reporting periods therein, beginning after December 15, 2014. Non-public entities apply the guidance in reporting periods beginning after December 15, 2014, and to interim periods within those annual periods beginning after December 15, 2015. Companies are allowed to use either a modified retrospective transition method resulting in cumulative effect reclassification adjustments, or a prospective transition method when adopting this update. Early adoption is permitted.
What You Need to Know
Specifically, a creditor (typically a bank or finance company) is considered to have received possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure, or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy the loan through completion of a deed in lieu of foreclosure, or through a similar legal agreement (turning in the keys). Essentially, the de-recognition of the financial asset occurs when the deed is legally transferred to the creditor and not when control of the property may have been obtained (e.g. borrower abandoned the property, but legal foreclosure hasn’t yet occurred). There are also additional disclosures required by the update. The update requires in interim and annual financial statements disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property in the process of foreclosure according to local requirements of the applicable jurisdiction. The presentation guidance itself may not be a big change for most creditors. In practice, most entities have not recognized the non-financial asset until legal title has passed. The additional disclosure requirements may be the most significant change as a result of this guidance as the financial reporting/accounting department will need to work with credit administration to accurately accumulate foreclosures in process across all the jurisdictions in which the entity operates and reports that information in the financial statements.
Wesley is a Director in the Financial Institutions Services Group at Dixon Hughes Goodman LLP, in Charlotte. He currently serves on NCACPA’s Accounting & Attestation Committee. Wesley can be reached at email@example.com.