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Fed Cuts Banks Slack on REO Rentals

Policy statement issued

April 5, 2012

By staff

Given the current state of the housing market, the Federal Reserve is easing its policy for the banks it regulates to convert foreclosed properties into rentals.

A policy statement issued Thursday acknowledged that the inventory of distressed properties is large, while the demand is higher in many markets for rental properties.

Millions of properties have already made their way through lender real-estate-owned inventories. But with "stubbornly high" delinquency persisting, millions more properties are expected to convert to REO status during the coming years.

The conditions have prompted some banks to convert more REO assets into rental properties than they have in the past.

But federal and state laws and regulations, as well as supervisory expectations, limit the amount of time a bank can hold REO assets. Normally, the Fed requires good-faith efforts by regulated institutions to sell REOs at the earliest date possible.

"Consistent with this policy, in light of the extraordinary market conditions that currently prevail, banking organizations may rent residential OREO properties (within statutory and regulatory holding period limits) without having to demonstrate continuous active marketing of the property, provided that suitable policies and procedures are followed," the statement said. "Under these conditions and circumstances, banking organizations would not contravene supervisory expectations that they show 'good-faith efforts' to dispose of OREO by renting the property within the applicable holding period."

In addition, the regulator noted that REO assets which meet the definition of community development under the Community Reinvestment Act could be counted as credit toward the bank's CRA requirements.

Banks with more than 50 REO properties need to utilize a framework that systematically documents how they meet supervisory expectations. Policies and procedures need to be established that deal with all aspects of rental activities including compliance with laws and regulations, which properties are eligible for rental and how to determine which properties should be marketed.

Policies also need to be established to address tenant credit risk and other risks associated with property rentals.

Banks that do lease out foreclosed properties need to adhere to all laws and regulations that govern landlords. They can use property management companies, but they need to ensure necessary oversight and have policies that address this.

While REOs are typically treated as sub-standard assets based on generally accepted accounting principles, residential properties with leases in place and demonstrated cash flows with a reasonable rate of return "should generally not be classified" like other REO holdings.

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