CUNA Regulatory Comment Call

December 1, 2008

Proposed Interagency Appraisal and Evaluation Guidelines

EXECUTIVE SUMMARY

Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Senior Vice President and Deputy General Counsel Mary Dunn at mdunn@cuna.coop and to Senior Assistant General Counsel Jeff Bloch at jbloch@cuna.coop; or mail them to Mary and Jeff c/o CUNA’s Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, South Building, Suite 600, Washington, DC 20004-2601. You may contact us at 800-356-9655, ext. 6732, if you would like a copy of the interim final rule. You may also access it here.

BACKGROUND

In 1994, the federal banking agencies jointly issued the Interagency Appraisal and Evaluation Guidelines to provide banks and thrifts with guidance on prudent appraisal and evaluation policies and practices. NCUA was not a party to these 1994 guidelines, although credit unions have been subject to appraisal rules and other guidance that NCUA has issued over the years.

Since 1994, the Agencies have issued supervisory guidance in an effort to promote sound practices with regard to an institution’s appraisal and evaluation programs. Since that time, there have been advancements in collateral valuation practices, as well as other significant developments regarding appraisals.

For the above reasons, the Agencies are now issuing the proposed Guidelines to provide further clarification and details concerning the Agencies’ expectations with regard to an institution’s appraisal and evaluation program and practices.

DESCRIPTION OF THE PROPOSED GUIDELINES

The following describes the proposed Guidelines, as well as the three appendices:

Supervisory Policy
Examiners will consider the following when examining the institution’s real estate activities:

Appraisal and Evaluation Program
The institution’s board of directors, or designated committee, is responsible for establishing the appraisal and evaluation program, which should:

Independence of the Appraisal and Evaluation Program
Those who perform appraisals and evaluations should be independent and be isolated from influence by the loan production staff. They should also have no direct or indirect interest in the property or transaction. Institutions may provide the appraiser with a copy of the property sales contract, but must not provide an estimate of the property value, the loan amount, or a target loan-to-value ratio.

For smaller institutions, it may not be practical to separate the valuation from the loan production process. In these situations, the institution should demonstrate that it has appropriate safeguards to isolate the collateral valuation program from influence from the loan production process. This may include the lending official abstaining from voting on an approval of a loan if he or she was involved in the appraisal or evaluation.

Selection of Persons Who May Perform Appraisals or Evaluations
Institutions should establish criteria to select, evaluate, and monitor the performance of those who perform appraisals or evaluations, which should ensure that:

Institutions should use written engagement letters when ordering appraisals, which should be in the permanent credit file. Appraisal or evaluation work should not begin until the institution has selected the person for the assignment.

Transactions that Require Appraisals
The appraisal regulations determine transactions in which appraisals are required. The Agencies also reserve the right to require an appraisal for other transactions to address safety and soundness concerns.

Minimum Appraisal Standards
The Guidelines provides details on the five minimum standards for appraisals, which are required under the Agencies’ appraisal regulations. Under these standards, the appraisal must:

Appraisal Development
Appraisals must comply with the USDAP, which requires the appraisal to reflect an appropriate scope of work that includes the extent to which the property is identified and inspected, the type and extent of data researched, and the analysis that is used. Lower costs or speed of delivery should not influence the appraiser’s scope of work. The institution should discuss its needs and expectations with the appraiser and this should assist the appraiser in establishing the scope of work and form the basis of the engagement letter.

If applicable, the appraisal should include three approaches, which includes cost, income, and sales comparisons. These results should be reconciled to estimate the market value. The appraisal should also include an analysis of the property’s sales history and an opinion as to the highest and best use of the property. In addition, USDAP requires the appraiser to disclose if the property was inspected and whether anyone provided significant assistance to the appraiser.

Appraisal Reports
The institution is responsible for identifying the appropriate appraisal reporting option, based on the risk, size and complexity of the transaction and collateral. The USDAP outlines the various reporting options that an appraiser may use to present the information in the appraisal. These vary based on the level of detail required. Regardless of the option chosen, the appraisal should contain sufficient detail to allow the institution to understand the scope of work performed. This should include the disclosure of the research and analysis performed, as well as the research and analysis that were not performed, along with the rationale for its omission.

Qualifications of Persons Performing Evaluations
Institutions should select those who are independent of the loan production process and the transaction and who have the real-estate training, knowledge and experience to perform evaluations. Institutions should document the qualifications and experience of those selected to perform evaluations. Institutions should also have sufficient controls to confirm that the person performing the evaluation is qualified and independent. If an institution uses a third-party, it should communicate its evaluation criteria and have controls to confirm compliance with its internal policies and these Guidelines.

Evaluation Content
An evaluation should provide an estimate of the market value of the collateral. The institution should establish policies and procedures for determining the valuation methodology for the transaction, given the associated risks. These policies and procedures should address the process for selecting the most reliable evaluation method, rather than the method that renders the highest value.

These evaluations should at least:

The institution should establish criteria to identify the extent to which an inspection of the property is necessary to determine if it is in acceptable condition for its current or projected use. More detailed evaluations should be obtained for higher risk transactions, or as the institution’s portfolio risk increases. Higher risk transactions may include loans with combined loan-to-value ratios that exceed supervisory limits, atypical properties, properties outside the institution’s traditional lending market or those in a transitional location, and borrowers with high-risk characteristics.

Accepting an Appraisal from Another Institution
An institution may use an appraisal performed by an appraiser who was engaged by another institution, provided the user determines that the appraisal is valid and acceptable and conforms to the Agencies’ rules. This determination should be documented in the credit file and be made before the appraisal is accepted. The user should also obtain documentation that the appraiser was engaged directly by the institution transferring the appraisal and that the appraiser had no interest in the property or transaction. An institution must not accept an appraisal that has been altered with the intent to conceal the original client.

Validity of Appraisals and Evaluations
Institutions may use an existing appraisal or evaluation for a subsequent transaction. To do so, they should establish criteria for assessing whether the existing appraisal or evaluation is valid. The criteria will vary depending upon the condition of the property and marketplace, as well as the nature of the transaction. The credit file should contain documentation that provides facts and analysis to support the validity of the existing appraisal or evaluation. Factors that would lead to a new appraisal or evaluation include the passage of time, volatility of the local market, availability of financing, inventory of competing properties, improvements or lack of maintenance of the property or competing properties, changes in zoning, or environmental contamination.

Third Party Arrangements
An effective program oversight should address arrangements with third parties. Institutions should periodically assess these arrangements for compliance with program standards and with the Agencies’ guidance on third party arrangements. Any deficiencies should be addressed in a timely manner.

Reviewing Appraisals and Evaluations
An institution should assess the acceptability of the appraisal or evaluation, as well as its compliance with the appraisal rules, the Guidelines, and the institution’s own internal policies. This review should be performed prior to the final credit decision. This review procedure should address the role, independence, and qualifications of the reviewer; the techniques, timing and level of review; documentation requirements, and the appropriate resolution of deficiencies. These procedures should also address the reviewer’s responsibility to verify that the methods, assumptions, data sources, and conclusion are reasonable and appropriate for the transaction.

Reviewers of appraisals and evaluations should be independent of the transaction and possess the appropriate education, expertise, and competence to perform the review, based on the complexity of the transaction. Smaller institutions should implement safeguards for accepting appraisals and evaluations when absolute lines of independence cannot be achieved. In these situations, the review may be part of the loan officer’s credit analysis, as long as the officer does not approve or vote to approve the loan.

Institutions should implement a risk-focused approach to determine the level of review needed to ensure the appraisals and evaluations are acceptable. This will depend on the size, type, complexity, and risk of the transaction and whether the appraisal and evaluation is obtained directly or from another institution.

With approval from the primary regulator, an institution may employ techniques, such as automated tools or sampling methods, when performing pre-funding reviews of appraisals or evaluations that support lower risk single-family mortgages. With these techniques, the institution should maintain sufficient data and employ appropriate screening techniques that provide adequate quality assurance and should ensure that the appraisers and evaluators are reviewed periodically.

The institution should document the content of the review in the credit file. A checklist or narrative format may be used, as appropriate. Deficiencies noted in a review should be addressed by the person who prepared the appraisal or evaluation or by another qualified, independent person. Unreliable appraisals or evaluations should be replaced prior to the final credit decision.

An appraisal review performed by a state-certified or licensed appraiser must comply with USDAP and any changes to an appraisal’s estimate of market value is only permitted as a result of a review conducted by an appraiser with these qualifications.

Program Compliance
An institution’s appraisal and evaluation policies should establish effective internal controls that promote compliance with regulatory requirements and guidelines. This should include adequate controls, verification, and testing to ensure reliability of appraisals and evaluations. These controls should be commensurate with the risk of the institution’s overall real estate lending activities, and those responsible for compliance should be insulated from influence by the loan production staff. Appraisers and evaluators should be subject to periodic evaluation of the quality of their work, which will form the basis for deciding whether to retain the services of these individuals.

Portfolio Monitoring and Updating Collateral Evaluations
A prudent portfolio monitoring program should include criteria for determining when to obtain a new appraisal or evaluation, in accordance with the Agencies’ real estate lending standards. These criteria should be based on changes in market conditions or deterioration in the credit since origination. An institution’s policies and procedures should ensure that timely information is available to management for assessing collateral and associated risks. Examiners have the right to require an appraisal or evaluation when there are safety and soundness concerns on existing real estate loans, and examiners are expected to provide institutions a reasonable amount of time to obtain the new appraisal or evaluation.

Referrals
An institution should make referrals to state appraiser regulatory authorities if it suspects that a state-certified or licensed appraiser has failed to comply with USDAP, State laws, or otherwise engages in unethical or unprofessional conduct. Examiners who find evidence of unethical or unprofessional conduct should forward their findings and recommendations to their supervisory office

Appendix A – Appraisal Exemptions

The Guidelines discuss the following exemptions to the requirement for obtaining appraisals:

Appendix B – Evaluation Alternatives

If the appraisal rules allow for an evaluation instead of an appraisal, institutions should maintain policies and procedures for determining whether an evaluation alternative is appropriate for a given transaction, based on the associated risk. These procedures should address risk criteria, such as transaction size and purpose, borrower creditworthiness, and the loan-to-value.

The institution should demonstrate that the evaluation alternative, such as an AVM or tax assessment valuation, provides a reliable estimate of the collateral as of a stated date prior to the decision to enter into a transaction. The institution should also establish criteria for determining the extent in which an inspection of the collateral is necessary to determine that the property is in acceptable condition for its current or projected use. The method used for valuation should not be selected solely on the basis that it will result in the highest value. Below outlines more specific guidance for AVMs and tax assessment valuations.

AVM – AVMs may be used, as permitted by the Agencies’ appraisal rules. For credit unions, AVMs may be used to meet the requirement to provide an evaluation of value, as long as there is also a review by a loan officer or person with knowledge, training and experience in the real estate market in which the loan is being made. An institution should conduct testing to ensure that the AVM provides credible values and related information. In selecting a specific AVM to use, the institution should perform due diligence to:

An institution should establish appropriate practices for the use of AVMs and should indicate its AVM performance criteria. In establishing these practices, the institution should:

Determining AVM Use – Institutions may consider the following in determining whether an AVM is appropriate for a specific transaction:

Validating AVM Results – Institutions should establish procedures for independently validating an AVMs results on a periodic basis. The depth and extent of the validation should be consistent with the materiality and complexity of the risks. An independent model validation process should at least specify the expectations for an appropriate sample size, level of geographic analysis, testing frequency and criteria for re-testing, standards of performance measures, and range of acceptable results. AVM values should be compared to data from sales transactions prior to being recorded in public records. Institutions should document the validation testing and audit findings and use them to analyze and update their practices regarding AVM use.

Tax Assessment Valuation (TAV) – Institutions may use data provided by local tax authorities as the basis for estimating the value of the collateral. The institution should document how the tax jurisdiction calculates the TAV and how frequently revaluations occur. The institution should also analyze the relationship between the TAV and the market value within a tax jurisdiction for each property type and price tier. This correlation between the TAV and the market value should be tested and documented and institutions may then use TAVs if a reliable correlation can be established.

Appendix C – Glossary

Appendix C provides an extensive glossary of terms that are used in the Guidelines.

QUESTIONS TO CONSIDER REGARDING THE APPRAISAL AND EVALUATION GUIDELINES

  • Do you have any comments on the expectations that are outlined in the proposed Guidelines with regard to reviewing appraisals and evaluations? Would the use of automated tools and sampling methods that the Guidelines allow for reviews of appraisals or evaluations supporting lower risk single-family mortgages be appropriate for other low-risk mortgage transactions? Can appropriate constraints be placed on these methods to ensure the integrity of the appraisal process for these transactions?
















  • Are the appraisal exemptions outlined in Appendix A clear? What additional guidance is needed?
















  • Do you have any concerns regarding the risk management expectations and controls in the evaluation process that are referenced in the Guidelines, including those outlined in Appendix B?
















  • Do you have any comments regarding the exemption from the appraisal requirements for residential real estate transactions involving U.S. government-sponsored agencies?
















  • For credit unions, AVMs may be used to meet the requirement to provide an evaluation of value, as long as there is also a review by a loan officer or person with knowledge, training and experience in the real estate market in which the loan is being made. Do you agree with this requirement, which does not appear to be required by federal banking agencies?
















  • Other comments?
















    Eric Richard • General Counsel • (202) 508-6742 • erichard@cuna.com
    Mary Mitchell Dunn • SVP & Deputy General Counsel • (202) 508-6736 • mdunn@cuna.com
    Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 • jbloch@cuna.com
    Lilly Thomas • Assistant General Counsel • (202) 508-6733 • lthomas@cuna.com
    Luke Martone • Senior Regulatory Counsel • (202) 508-6743 • lmartone@cuna.com