As workers and businesses affected by the oil leak devastating the northern Gulf of Mexico try to cope with its growing impact, banks located in the affected areas — and those located elsewhere that do business there — have very real interests that they, and their regulators, need to protect.
While many of the losses by banks may result only indirectly from the disaster through its effects on bank customers, there is one entry on banks' balance sheets that is directly affected by what is happening in the Gulf: the value of real property in affected areas that is carried by banks as other real estate owned. Typically, these properties are put on the books at values determined by appraisals conducted at the time they're acquired, and subsequent declines in those values have immediate effects that flow through to an institution's earnings and capital.
If a new appraisal shows that the value of a parcel of OREO has decreased, regulators require that its value on the bank's books be written down to reflect the decrease, and the writedown must be charged against the bank's earnings, which has the further effect of reducing its capital. For more than a few institutions, such writedowns can make the difference between profitability and loss.
Because of the drastic circumstances now affecting the Gulf Coast, the state and federal agencies that regulate insured depository institutions should declare a moratorium, for a period of 18 months, on requiring, solely on the basis of current appraisals, that those institutions write down the values of OREO situated in coastal areas affected by the BP oil leak.
Although similar issues arise from regulators' use of appraised values in assessing the adequacy of banks' loan-loss reserves, the numerous other variables that usually are present in that context put those issues beyond the scope of this discussion.
Since the real estate meltdown, regulators have been vigilant in insisting that banks regularly — not less than annually — obtain new or updated appraisals to bring current the carrying values of their OREO.
One result is that institutions which, because of general market declines, already have taken substantial writedowns on coastal properties, now are being required to take significant additional writedowns on the values of properties in coastal areas of Louisiana, Mississippi and Alabama, and in the Florida Panhandle, at the very time that, until the onset of this crisis, many were beginning to sense the onset of a recovery.
Even if the recent capping of the broken well remains effective until a permanent fix is in place, it is entirely unknown how much longer the oil, tar balls, dispersants and related chemicals and their byproducts will continue to wash ashore on Gulf beaches and invade coastal marshes, estuaries and other adjacent bodies of water and associated ecosystems, with effects of unknown scope and duration on the coastal environment and the people and businesses that depend on it.
Only after the flow of oil has been permanently stopped will authorities be able to concentrate fully on containing and overcoming the contamination. Among the few certainties is that this will be an uneven process, proceeding at different paces in different areas, and will require varying amounts of labor, materials and other human intervention in different areas of the coast, according to the nature of the coastal terrain and numerous other factors, including the type, duration, severity and frequency of the contamination experienced.
Amid such uncertainties, the reliability of current appraisals of real property in coastal areas inevitably is subject to question.
There are widespread anecdotal reports that scheduled closings of real estate transactions in coastal areas now are being suspended or canceled with unprecedented frequency.
An impact assessment compiled by a Gulf Shores, Ala., realty firm reports that the dollar volume of property sales in May and June of 2010 in Gulf Shores and neighboring Orange Beach declined more than 36% below the level of sales in those months a year earlier.
It is neither fair nor reasonable for regulators now to require that banks use appraisals conducted under such circumstances in a way that immediately can further depress the levels of their earnings and capital.
What is needed instead is, first, a chance for marine and environmental scientists, engineers, planning officials, economists and other knowledgeable professionals to more fully understand and assess the magnitude and impact of the contamination, formulate remediation plans and make informed assessments of how long it's likely to take. Second, the economies of the affected areas, including their real estate markets, need to have time to absorb and factor in this information, just as all significant new circumstances — such as the announcement of a new highway or new airport to be built — are incorporated into the functioning of local economies and markets.
Refraining for 18 months from requiring that banks use appraisals to revalue their OREO should provide time for affected real estate markets to at least begin accounting rationally for the effects of the contamination, as opposed to acting on the widespread fear that now seems to characterize those markets.
If property values have not at least stabilized by the end of that period, it likely will mean that genuine declines in value have occurred, and it then would be entirely appropriate that they be reflected in the financial results of banks holding affected properties.
It manifestly would be neither fair nor appropriate, however, for such losses to be imposed on banks at the present stage of the crisis, barely three months after the BP well began polluting the Gulf, and at a time when no certain end to the flow of oil is assured and when, as a result, no clearly discernible path to remediation is evident.
Eighteen months from now, Gulf Coast banks and their regulators will be far better informed, and therefore far better positioned to understand the condition of coastal real estate markets.
Reliable appraisals of real property in those markets should be obtainable by that time, making it appropriate for appraisals then to be used to account for the effects of declining property values on the levels of bank earnings and capital — but to accord such weight to appraisals under current circumstances is hardly reasonable.
The interests of affected banks, their depositors, their shareholders and the banking public, accordingly would be furthered by regulators' imposition now of an 18-month moratorium on requiring that banks, solely on the basis of current appraisals, write down the values of OREO located in areas affected by the Gulf's contamination.
