The Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA) requires that at least once every ten years federal banking regulatory agencies review their regulations and consider how to reduce the regulatory burden. The second EGRPRA review was submitted to Congress on March 21, 2017. That report identified at least four appraisal-related areas for action by the regulators, including appraisal thresholds, appraiser shortages in rural areas, evaluations, and appraisal management companies. Each identified area has subsequently been subject to change or clarification in bank valuation programs. Professional appraisers must be well-informed about relevant changes in federal valuation regulation and guidance as well as in the administrative program processes pertaining to lender clients and real estate loan underwriting concepts. This article provides insights as to what examiners expect of financial institutions in conducting safe and sound valuation practices under current regulations and guidelines.
An appraiser's knowledge of loan underwriting concepts is essential when an appraisal report's intended use is to assist in loan underwriting purposes. Credible valuation information plays a critical role in financial institutions' ability to identify, measure, monitor, and manage credit risk in real estate-related transactions. Institutions that engage in real estate lending are required to have a valuation program that consists of policies and procedures annually reviewed and approved by the board of directors or a designated committee. The key elements of effective valuation programs should be tailored to the type and level of risk in an institution's real estate lending activities and should be consistent with the institution's strategic goals. Such programs facilitate a more comprehensive understanding of the potential loss exposure if a default occurs due to a decline in the primary source of repayment.
Federal and state supervisory banking agencies perform periodic on-site bank examinations. Examinations may be ongoing or there may be as long as eighteen months between exam cycles, depending on the individual banking institution. Regulatory agencies may combine federal and state staffing resources for a joint supervisory examination. Agencies may target a specific area of banking such as real estate loans and have an exam duration of days, weeks, or months, depending on the type and risk of the loan portfolio, size of the institution, and other factors. Examiners have ongoing informal discussions throughout the exam with lending officers, valuation staff, and bank management. These informal discussions during the examination process permit management and examiners to have an open dialogue regarding all aspects of credit risk, including the key elements of effective valuation programs. Federal Deposit Insurance Corporation (FDIC) examinations reflect that institutions' valuation programs are generally satisfactory. (1) That said, it is possible that one or more aspects of a valuation program could be enhanced or better tailored to an institution's real estate lending activities or strategic plan. This article highlights key elements of a valuation program and provides insights on operational issues that may be raised by institution management or observed by examiners during the examination process.
Valuation Policies and Procedures
Real estate lending regulations of federal banking agencies (2) (Agencies) require each institution's board of directors, or a designated committee, "to adopt and maintain written real estate lending policies that are consistent with principles of safety and soundness and reflect consideration of the real estate lending guidelines" related to the Agencies' regulations.' The Agencies' supervisory guidance, such as the Interagency Appraisal and Evaluation Guidelines (Guidelines), does not have the force and effect of law. However, when examiners cite violations of law or regulation, or noncompliance with enforcement orders, they may reference the supervisory guidance as examples of "safe and sound conduct" for compliance with laws or regulations.
As explained in more detail in this article, the written policies of institutions should establish procedures that address the key appraisal and evaluation program elements listed in Exhibit 1. The real estate lending policies also should incorporate information contained in the Uniform Standards of Professional Appraisal Practice (USPAP). (4) Management should customize the written procedures based on loan volume, location, property type, collateral complexity, internal expertise, and the availability, expertise, and cost of third-party arrangements. Regardless of whether an institution outsources all or a part of its valuation program through third-party arrangements, management remains responsible for maintaining adequate valuation procedures.
Exhibit 1 Key Valuation Program Elements * Maintain up-to-date written valuation policies and procedures consistent with program elements stated in the Interagency Appraisal and Evaluation Guidelines (December 2, 2010), 2-3, and with the institution's strategic goals; * Establish an independent and competent organizational structure and staff; * Develop appropriate processes for procuring a valuator's services and workfile storage systems; * Ensure appraisal and evaluation reviewers are knowledgeable and well-trained; * Safeguard electronic valuation report files and work papers with confidential information or personally identifiable information; and * Provide an appropriate valuation resource library specific to the type of valuation activities performed by internal staff. The procedures should include a system of internal controls (5) that monitor and assess the valuation program and functions, including those performed by a third party. (6) The procedures also should implement processes to verify that appraisals, evaluations, and reviews are performed independent of influence by loan production staff and provide credible market values.
Although both appraisals and evaluations must provide credible market values, key differences exist between these products. The Agencies' appraisal regulations require financial institutions to obtain an appraisal completed by a competent and qualified state-licensed or state-certified appraiser who complies with USPAP and meets other requirements for federally related transactions, unless an exception applies. (7) Some exceptions permit the use of an evaluation. The Guidelines define an evaluation as "A valuation permitted by the Agencies' appraisal regulations for transactions that qualify for the appraisal threshold exemption, business loan exemption, or subsequent transaction exemption." (8) An evaluation is not required to be completed by a state-licensed or state-certified appraiser or to comply with USPAP. However, as appraisal thresholds increase, it is increasingly important that competency of the preparer stands as a focal point of risk mitigation.
Organizational Structure and Staffing: Ensuring Independence and Competence
Credible appraisal and evaluation results require that appraisers and evaluation preparers are independent and competent, and that institutions have sufficient staffing to maintain the integrity of their valuation programs.
To ensure independence in the appraisal and evaluation functions, an institution's reporting lines for loan production staff and for administration of collateral valuation should be separate and independent. (9) Program standards should ensure that internal valuation staff involved in ordering, performing, reviewing, and approving appraisals and evaluations do not report to an individual who approves real estate loans or whose compensation is associated with real estate loan production. When close physical proximity of valuation staff to loan production staff cannot be avoided, an institution should carefully review the arrangement and establish procedures to avoid potential instances of lender influence, pressure, or coercion on valuation staff. Examiners will review an institution's loan approval processes to ensure that anyone who orders, performs, or reviews valuation assignments abstains from the specific credit approval process. (10)
Selection of a competent as well as independent valuation provider who supports the market value conclusion is the most critical decision of the valuation process. Credible market value conclusions, which also are referred to as assignment results, begin with engaging a competent appraiser or evaluator. The Guidelines offer specific direction on the selection of appraisers and evaluators and guidance for special circumstances; the Guidelines' key points are summarized below. (11)
Selection of an Appraiser. An institution should have minimum standards for qualifying appraisers for placement on the institution's approved list, and this should include an understanding of and adherence to USPAP's Competency Rule. (12) Institutions should review their approved appraiser list to confirm that appropriate procedures and controls exist to ensure independence in the development, administration, and maintenance of the list. (13) An institution should review an appraiser's geographical and technical work experience. Submission of work samples may assist valuation staff in determining appraiser competency. Institutions should remove appraisers from the approved list when the appraisers refuse to correct issues of noncompliance with USPAP or other significant report deficiencies.
Appraiser Shortages in Rural Areas. Transactions requiring an appraisal for real estate in rural areas can pose challenges for an institution if a shortage of qualified appraisers exists. Existing appraisals...