Given the real estate-rooted disaster America’s lenders have witnessed over what feels like a half-decade, the new collateral appraisal and evaluation rules that mostly go into effect on April Fools Day for federally regulated institutions are, well, no laughing matter.
The handful of regulatory bodies still overseeing commercial banks, thrifts, credit unions and the like are serious about preventing another economic melt-down driven by aggressive underwriting disconnected from real-world collateral values.
The new regulatory approach, presented in 70-some pages of revised Interagency Appraisal and Evaluation Guidelines, push lenders to re-emphasize soundness and safety in ongoing monitoring of collateral values as well as market trends. And they press lenders to select and engage – and monitor performance of – eminently qualified appraisal and evaluation professionals.
Accordingly, rule revisions imposed by the agencies we know as the Fed, FDIC, OCC, OTS and NCUA identify several key areas where many lenders need to improve:
- Establishing clearer monitoring criteria for collateral values and market conditions;
- Stressing true market values, rather than likely “stabilized” values, of distressed properties;
- Selecting proficient valuation professionals qualified for any given engagement;
- Avoiding conflicts of interest that lead to excessive valuations;
- Monitoring performance of valuation professionals; and
- Re-emphasizing physical inspections for collateral evaluations.
The regulators are clearly endeavoring to generate stronger ongoing monitoring of internal collateral valuation policies and procedures, and also of the professionals they engage to perform and review appraisals and evaluations, observes George Mann, chief appraiser with Collateral Evaluation Services. Mann, who instructs financial institutions on regulatory matters, has analyzed the new guidelines along with colleague Robert Ely, and made an extensive presentation to lender representatives at a late-January banking forum.
At that forum sponsored by the American Bankers Association and the Appraisal Institute, Robert Parson, appraisal policy specialist with the Office of the Comptroller of the Currency, stressed that lenders should strive for “meaningful” appraisals and evaluations. Just going through the motions, with staffers mechanically completing review sheets, will no longer be acceptable to examiners.
No doubt the guidelines reflect expectations that lenders be more prudent, deliberate and professional when it comes to determining and monitoring collateral values. For instance while they leave in place rules governing when an evaluation is allowed in lieu of a full appraisal, they identify situations under which lenders are strongly advised to consider commissioning an appraisal even when not required.
Among them: Loans with combined loan-to-value ratios in excess of the supervisory loan-to-value limits. Atypical properties. Properties outside the institution’s traditional lending market. Transactions involving existing extensions of credit with significant risk to the institution. And borrowers with high-risk characteristics.
When appraisals are required, the guidelines clarify the agencies’ expectations that appraisals must specify an “as is” market value, i.e., based on “the real property’s actual physical condition, use, and zoning as of the effective date of the appraiser’s opinion of value.”
The gist is that appraisals can’t base the current value of a transitional property on a hypothetical future stabilized or completed value. However, it’s okay for a lender to request that an appraiser provide – in addition to the “as is” value – a projected stabilized value.
As for the emphasis on policy reviews, the guidelines require regulated lenders to develop procedures promoting effective appraisal and evaluation review, including engaging third-party reviewers if internal staffing is insufficient.
And regulators are also clearly pressing lenders to play more responsible roles in making sure professionals conducting appraisals and evaluations are highly qualified for the particular tasks at hand, adds Bill Garber, the Appraisal Institute’s director of government affairs. To wit, agencies are requiring lenders to regularly review appraiser competency with respect to characteristics such as timeliness, report quality and responsiveness.
Conflict-free valuation independence is another focal area in the new guidelines, which stress that institutions are expected to “establish reporting lines independent of loan production” for staffers that administer collateral valuation. In other words, anyone involved in generating or approving loans – as well as their subordinates and supervisors – should steer clear of collateral valuation activities.
That means no hints from production types regarding a lender’s “predetermined” valuation or LTV preferences, or communication of a minimum figure needed for approval of a proposed loan – or, of course, any insinuation that compensation or continued engagements depend on meeting valuation expectations.
Where evaluations are permitted, regulators are supplementing required contents of reports, further emphasizing physical inspections as well as identification of the information sources underlying the valuation analysis.
More specifically the guidelines state: “An institution should consider performing an inspection to ascertain the actual physical condition of the property, and market factors that affect its market value.”
In fact OCC’s Parson stressed to bankers that their examiners may well inquire whether a valuation or inspection professional has actually visited a collateral property under evaluation. If not, bankers will likely be asked to explain how the property’s condition was otherwise determined.
Lastly, the guidelines stipulate that Broker Price Opinions are not acceptable substitutes for evaluations, because they produce potential selling prices rather than market values.
While such new constraints will likely require banks to upgrade certain appraisal and evaluation policies, institutions still retain some latitude in the choice of techniques for monitoring trends in collateral values and their impact on portfolio risk.
