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Are Your Appraisal/Evaluation Policies and Procedures Compliant? – Examiner’s Viewpoint

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The Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency very recently agreed to raise the threshold for commercial loans requiring real estate appraisals from $250,000 to $500,000. This is the first change to the appraisal threshold in 23 years. As a result of the new rule, thousands of commercial real estate loans are exempt from appraisals but will require “evaluations”—and that raises many questions
At this timely track, PRISM attendees will hear the answers from Robert Parson, a respected appraisal expert and former OCC Senior Appraisal Policy Advisor. Parson closely followed the rule’s development, the industry’s public comments and how the agencies ultimately responded to that input.

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Are Your Appraisal/Evaluation Policies and Procedures Compliant? – Examiner’s Viewpoint

  1. 1. EDR Prism Conference May 10, 2018, Scottsdale, AZ Bank Collateral Risk Management Robert L. Parson Valuation Management Compliance LLC © Copyright 2018 Robert L. Parson. All Rights Reserved 1
  2. 2. Subtitle: Are Your Appraisal/Evaluation Policies and Procedures Compliant? – Examiner’s Viewpoint May 10, 2018 Robert L. Parson Valuation Management Compliance LLC © Copyright 2018 Robert L. Parson. All Rights Reserved 2
  3. 3. Some Issues for Today •Are Your Appraisal/Evaluation Policies and Procedures Compliant? •What are some best practices for success in your Valuation Program? •What are some Hints to avoid being tripped up? © Copyright 2018 Robert L. Parson. All Rights Reserved 3
  4. 4. Overarching Principle: Competency Title XI: FIRREA State credential does not connote competency • State licensure or certification is a necessary prerequisite, but not sufficient. • 34.46 (b) … a State certified or licensed appraiser may not be considered competent solely by virtue of being certified or licensed. Any determination of competency shall be based upon the individual’s experience and educational background as they relate to the particular appraisal assignment for which he or she is being considered. © Copyright 2018 Robert L. Parson. All Rights Reserved 4
  5. 5. Credential does not connote competency: (subtitled: WHO you hire is CRITICAL) • Legal profession: JD degree, admitted to bar • Would you hire a divorce attorney to represent you at a closing? • Medical profession: M.D. • Would you hire an Internist to treat a newborn? • Appraisal profession: State credential • Would you hire a Maine credentialed appraiser to appraise an apartment building in Westmont? • To repeat: “Any determination of competency shall be based upon the individual’s experience and educational background as they relate to the particular appraisal assignment for which he or she is being considered.” (Guidelines, Regulation) • This means the decision comes at the front end of the process (Selection) © Copyright 2018 Robert L. Parson. All Rights Reserved 5
  6. 6. Parson’s Maxim #1: In a bank appraisal and evaluation program: Nothing is more important than the selection and engagement process Consequently your policies need to reflect how you address this issue. Overarching Principle: Appraisal Program © Copyright 2018 Robert L. Parson. All Rights Reserved 6
  7. 7. Foundation Documents (OCC): 1) 12 CFR Part 34 (Appraisal Regulation) 2) OCC 2010-42: Interagency Appraisal and Evaluation Guidelines – December 10, 2010 1) Rescinded: 1) OCC 94-55: Interagency Appraisal and Evaluation Guidelines 2) AL 2003-09: Independent Appraisal and Evaluation Functions 3) OCC 2006-27: 2006 Revisions to USPAP 3) OCC 2011-12: Risk Modeling-Model Validation – April 4, 2011 4) OCC 2013-29: Third-Party Relationships – October 30, 2013 (2017) 5) OCC 2017-21: FAQ’s to Supplement OCC Bulletin 2013-29 6) OCC 2005-6: Frequently Asked Questions on the Appraisal Regulations and the Interagency Statement on Independent Appraisal and Evaluation Function – March 22, 2005 7) OCC 2005-22: Credit Risk Management Guidance for Home Equity Lending – May 16, 2005 8) OCC 2005-32: Frequently Asked Questions on Residential Tract Development Lending – September 8, 2005 9) CFR/Vol. 71, N0. 238 p. 74580 ff, 12/12/2006: Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices 10) An Analysis of the Impact of the Commercial Real Estate Concentration Guidance [Friend (OCC), Glenos (OCC), Nichols (FRB)]: https://www.federalreserve.gov/bankinforeg/cre-20130403a.pdf © Copyright 2018 Robert L. Parson. All Rights Reserved 7
  8. 8. Three “Valuation” Categories Anchored in Not Appraisal Regulation Appraisal Evaluation Other © Copyright 2018 Robert L. Parson. All Rights Reserved 8
  9. 9. 1989: FIRREA signed into law by George H.W. Bush 1990: Each Regulatory Agency published a Real Estate Appraisal Rule 1994: • Interagency: joint Real Estate Appraisal Rule (current Rule) Old, and frayed • Interagency Appraisal and Evaluation Guidelines (“Guidelines”) 2010: Interagency Appraisal and Evaluation Guidelines (“Guidelines”) © Copyright 2018 Robert L. Parson. All Rights Reserved 9
  10. 10. Basic concepts captured in the redrafting of Interagency Appraisal and Evaluation Guidelines (“Guidelines”2010): Independence (Appraisers/Evaluators) Competency (Appraisers/Evaluators) Requirements on the “bank” (“institution”) with “reach” to third party service providers/agents: Bank must in Control, do not “dust your hands” of responsibility Banks can’t offload their responsibility for any aspect of their Appraisal/Evaluation Program © Copyright 2018 Robert L. Parson. All Rights Reserved 10
  11. 11. Recent Exam Compliance Issues: Start withValuation function and challenges: 1. Risk management; identify non-compliance areas and “fix” 2. BankValuation” function- Operational Risk (Find and fix the “holes”) 3. Issues relate to objectives for safe and sound lending: 1. Policies: Principles and philosophy 2. Procedures: How to implement policy 3. Practices:What is actually done (do practices reflect stated procedures) © Copyright 2018 Robert L. Parson. All Rights Reserved 11
  12. 12. POLICY ISSUES: Who is Driving theTrain? Operational Risk Issues (people) within the bank that you might not have expected: •Governance (who’s in charge? where in organization?) •Authority •Independence •Personnel •Qualifications •Competence (bank personnel, service providers) •When is a valuation “stale”? •Selection, engagement •Communication channels (don’t get tripped up!) © Copyright 2018 Robert L. Parson. All Rights Reserved 12
  13. 13. Common Areas Where Banks get into trouble Plenty of areas where banks can trip up, but some causes are: •Confusion due to language •Confusion due to Legacy: changes from 1990 to 1994 versions of the appraisal regulation (carry-over) •Some things as confusing conceptually •It is easy to be confused due to the “Lemming Principle” (Bank A does it this way so it must be O.K.) © Copyright 2018 Robert L. Parson. All Rights Reserved 13
  14. 14. When are Evaluations Allowable? 12 CFR 34.43 (b) Evaluations Required For a transaction that does not require the services of a State certified or licensed appraiser under paragraph (a)(1), (a)(5), (a)(7), or (a)(13) of this section, the institution shall obtain an appropriate evaluation of real property collateral that is consistent with safe and sound business practices. (April 9, 2018) © Copyright 2018 Robert L. Parson. All Rights Reserved 14
  15. 15. (a)(7)SubsequentTransactions (Simplified DecisionTree): New Funds? •NO: Evaluation Allowable •YES: Need to ask 2 more questions: •Change in General Market Conditions? • YES: Appraisal Required • NO: GoTo Next Question •Change in Physical Aspects of the Property? • YES: Appraisal Required • NO: See Bottom Line •Bottom Line: If A Change in Either Physical Aspects or General Market Conditions, or Both: Appraisal Required •If No Change in Either: Evaluation Allowable •Hint: BE SURE to document the file re: decision © Copyright 2018 Robert L. Parson. All Rights Reserved 15
  16. 16. (a)(5) Business Loan Exemption •The transaction is a business loan that: •(i) Has a transaction value of $1 million or less; and •(ii) Is not dependent on the sale of, or rental income derived from,real estate as the primary source of repayment; Notice the comma (in red) Notice that it is a comma, not the word “the” •“real estate” as an asset class, not “the” collateral © Copyright 2018 Robert L. Parson. All Rights Reserved 16
  17. 17. (a)(1) and (a)(13)Managing the AppraisalThreshold •Recent Events •EGRPRA Report to Congress: (FFIEC Docket No. FFIEC- 2017-0001, Federal Register/Vol. 82,No. 60/Thursday, March 30, 2017) •April 9:Title XI Increase in commercial loan threshold to $500,000. Who decides when an evaluation is performed? (If SB 2155 passes, new dimension will come into play) What is an Evaluation? Who can perform evaluations? Who can review evaluations? © Copyright 2018 Robert L. Parson. All Rights Reserved 17
  18. 18. Running up against State Laws •Many Sates require that ANYONE providing a real estate value for a fee must be an appraiser credentialed in the home state (The Reach) • Usual exception if Real Estate agent: • Trying to secure a Listing • Establishing a Listing Price •Some states at other end of the spectrum (e.g. Tennessee) • Credentialed appraiser can perform an “Evaluation Appraisal” • NOT an “Appraisal” • NO requirement to comply with State licensing laws regarding USPAP • Therefore no Reach by any State credentialing agency •Federal preemption issue © Copyright 2018 Robert L. Parson. All Rights Reserved 18
  19. 19. Sidebar: New challenge? •Economic Growth, Regulatory Relief, and Consumer Protection Act. •Appraiser shortage issue (rural): •SB 2155, section 103 (b)(2)[no asset valuation required] •Rural •$400,000 cap •3 appraisers from approved appraiser list •HUH?? •BIG QUESTION:What will Banks Do? © Copyright 2018 Robert L. Parson. All Rights Reserved 19
  20. 20. Evaluations 1990 (original) OCC Appraisal Regulation – Any transaction for which a State certified or licensed appraiser is not required, nevertheless must have an appropriate evaluation of real property collateral consistent with the OCCs Guidelines for Real Estate Appraisal Policies and Review Procedures (Banking Circular 225). OCC Appraisal Regulation was published on August 24, 1990 Banking Circular 225 was published on 12/21/1987, revised 9/28/1992. © Copyright 2018 Robert L. Parson. All Rights Reserved 20
  21. 21. Banking Circular 225 © Copyright 2018 Robert L. Parson. All Rights Reserved 21
  22. 22. Evaluations BC 225 (REV) 9/28/1992 – As with an appraisal, an evaluation is an integral part of the decision-making process. – An evaluation need not meet all of the detailed requirements of an appraisal…however file documentation should support the estimate of value and include sufficient information to allow an individual to fully understand the evaluator’s analysis – The evaluation should include the evaluator's calculations, supporting assumptions for the estimate of value, and, if utilized, a discussion of comparable property values. © Copyright 2018 Robert L. Parson. All Rights Reserved 22
  23. 23. Background: Guidelines Evaluation Development A valuation method that does not provide a property’s market value or sufficient information and analysis to support the value conclusion is not acceptable as an evaluation. Hints: •Banks are easily tripped up, and this is serious •These are important concepts at the very heart of compliance with regulatory expectations •Drive the bus, don’t take a back seat (can’t “dust your hands”) © Copyright 2018 Robert L. Parson. All Rights Reserved 23
  24. 24. Background: Guidelines (OCC 2010-42) Further, the person who selects or oversees the selection of appraisers or persons providing evaluation services should be independent from the loan production area. …”Persons who review appraisals and evaluations should be independent of the transaction and have no direct or indirect interest, financial or otherwise, in the property or transaction, and be independent of and insulated from any influence by loan production staff.” © Copyright 2018 Robert L. Parson. All Rights Reserved 24
  25. 25. Evaluation concepts (Guidelines) Start at the beginning: i. Competency requirements for the preparer (who) ii. Evaluation analysis – (no shortcuts): • Can’t “assume” normative property condition • Can’t ignore neighborhood and other factors that affect value • must consider elements that impact market value: • Actual physical condition of property • Market and other factors that affect value (on and off-site) • Inspection? If no inspection, how are these property and market conditions known and considered i. Reviewer: Must be competent to address sufficiency of information and analysis (easy trip-up) © Copyright 2018 Robert L. Parson. All Rights Reserved 25
  26. 26. Evaluation Scenario: Market Value 1) FIRST and FOREMOST driven by WHO: a) Experience relevant to type of property being valued b) Education/Background (appraisal or collateral valuation) c) Competency d) Independence e) Capability of rendering an unbiased opinion © Copyright 2018 Robert L. Parson. All Rights Reserved 26
  27. 27. Then there is the “What” The research and analysis must result in a credible market value opinion In any valuation analysis the objective is to reflect market behavior At it’s core this means: simulate or infer purchaser calculus Purchasers (and sellers) act in similar fashion: •Sales Comparison Approach: Inference from recent market activity • Purchaser submarket reaction to property characteristics: • Bedroom count, Bathroom count, Square footage, Appeal © Copyright 2018 Robert L. Parson. All Rights Reserved 27
  28. 28. Then there is the “What” (p.2) •Income Approach: Simulation of purchaser behavior •Income stream: •Quantification •Anticipated stability •Anticipated expenses •Cost Approach: Simulation of alternative to buying an existing property •If Applicable •“Cost” of the alternative •Again: Purchasers (and sellers) act in similar fashion: © Copyright 2018 Robert L. Parson. All Rights Reserved 28
  29. 29. Then there is the “What” (p. 3) •Reconciliation of any valuation approaches used in the analysis •Draw conclusions •(Best Practice): provide confidence level (how confident is result?) •Data quantity •Data quality •Data reliability •How do the applicable analyses align with one another •Confidence band © Copyright 2018 Robert L. Parson. All Rights Reserved 29
  30. 30. Can Appraisers Perform Evaluations? Advisory Opinion 13 (AO 13): Performing Evaluations of Real Property Collateral to Conform with USPAP: 1)An Evaluation is an Appraisal when performed by an appraiser a) Appraisal: the act or process of developing an opinion of value 2) Reporting can be via Restricted Appraisal Report 3) Restricted Appraisal Report may not meet all conditions for an Evaluation © Copyright 2018 Robert L. Parson. All Rights Reserved 30
  31. 31. Other Professions 1) Medicine: Abbreviated Services, not “Complete Physical” 2) Accounting Practices have various levels of services 3) Legal Profession has menu of services 4) But NOT Appraisers 5) Is This Bad? 6) What constitutes an acceptable Evaluation (irrespective of State laws)? a) Service Provider, first and foremost b) Analysis performed: i. Market Value is scenario ii. Credible (support the estimate of value) iii. Report contains sufficient information and analysis to make informed decision © Copyright 2018 Robert L. Parson. All Rights Reserved 31
  32. 32. Form-Centric Concept Inquisitive or proactive questions: 1)Is this form OK? a) Repeatedly asked question b) Example of a form presented to me 2)SO what is an acceptable form for an evaluation? 3)These questions don’t seem to arise regarding the FNMA 1004/FM Form 70 © Copyright 2018 Robert L. Parson. All Rights Reserved 32
  33. 33. Next Question 1) Will Third Party Providers Develop an Evaluation Form? 2) Will third parties advocate the use of their Evaluation Form to comply with requirements? 3) Will Bank Regulators accept, approve, condone a third party vendor’s Evaluation Form? © Copyright 2018 Robert L. Parson. All Rights Reserved 33
  34. 34. Credible Evaluations Focus on a FORM is inappropriate: • A form isn’t competent • A form doesn’t have any experience • A form does not have any background in subject matter • A form doesn’t have market knowledge • A form cannot apply judgment • Beware of any vendor who makes claims to you that a federal banking regulatory agency endorses or approves “our form” © Copyright 2018 Robert L. Parson. All Rights Reserved 34
  35. 35. Comparison Appraisals 1) performed in writing 2) in accordance with uniform standards 3) Competency 4) professional conduct will be subject to effective supervision Evaluations 1) performed in writing 2) no uniform standards (no USPAP for Evaluations) 3) Competency 4) No credentialing, therefore no way to cull out bad actors © Copyright 2018 Robert L. Parson. All Rights Reserved 35
  36. 36. Central Concept Parson’s Maxim #3: Evaluation is a Process, not a Form © Copyright 2018 Robert L. Parson. All Rights Reserved 36
  37. 37. This is corollary with what you already know about appraisals: Parson’s Maxim #2: Appraisal is a Process, not a Form © Copyright 2018 Robert L. Parson. All Rights Reserved 37
  38. 38. Universal Fact: •A form (appraisal, evaluation, or review “form”) is merely the medium used to transmit information to a reader. It is a blank canvas. •Any reporting medium (form?) should result in a reader understanding the judgment of the analyst in arriving at a credible conclusion. •This is the whole reason for documenting the task. •Lead a reader to understand the conclusions. • Hint: As a reader do you find yourself doing the positive head shake? © Copyright 2018 Robert L. Parson. All Rights Reserved 38
  39. 39. Credible Evaluations 1) Recipe Analogy: A recipe is only successful when the ingredients are gathered and combined in a logical manner, by someone who has the knowledge, background and skills to understand food chemistry. a) Just putting cake ingredients in a bowl doesn’t result in a cake, just a blob of goo 2) An evaluation is only successful when the data are gathered and combined in a logical manner by someone who has the knowledge, background and skills to understand valuation theory and practice. © Copyright 2018 Robert L. Parson. All Rights Reserved 39
  40. 40. Reviewing Appraisals and Evaluations: “An institution should establish qualification criteria for persons who are eligible to review appraisals and evaluations.” “Reviewers also should possess the requisite education, expertise, and competence to perform the review commensurate with the complexity of the transaction, type of real property, and market. Further, reviewers should be capable of assessing whether the appraisal or evaluation contains sufficient information and analysis to support the institution’s decision to engage in the transaction.” (Federal Register Vol. 75, No. 60/Friday, December 10, 2010 p. 77462) © Copyright 2018 Robert L. Parson. All Rights Reserved 40
  41. 41. Reviewing Appraisal Reports •An appraisal reviewer must use Qualitative Judgment. •This has always been true for commercial reviews and is a realization creeping into residential reviews. •The “OLD days” of finding “appraisal defects” is coming to an end (although you wouldn’t believe it from reading appraiser blogs) • “appraisal defects” – underwriters • Use of Collateral Underwriter (judgment or data point?) • The “WHO” is critical (who is the reviewer, what is his/her background?) • Hint: be prepared to address examiner questions about this • A reviewer: from rote actions to using Qualitative Judgment © Copyright 2018 Robert L. Parson. All Rights Reserved 41
  42. 42. • FROM: rules-based Quantitative rote behavior • e.g. Net and gross adjustments of 15% and 25% (residential) • TO: the use of appropriately supported judgment • EMERGING MAJOR SHIFT IN APPROACH: Use of Qualitative Judgment • This shift has universal impact on all areas of collateral valuation: • Appraisal, Evaluations and Review • Hint: Bottom line for successful reviews: • Don’t concentrate on a form, instead • Use competent personnel and have them document the use of qualitative judgment Overarching Principles GSE objectives evolved to into align with federal banking agencies: © Copyright 2018 Robert L. Parson. All Rights Reserved 42
  43. 43. Central Concept Parson’s Maxim #4: Review is a Process, not a Form Not a checklist, Not a score © Copyright 2018 Robert L. Parson. All Rights Reserved 43
  44. 44. Questions ? QUESTIONS ? rparson@valmanco.com (571) 420-3240 © Copyright 2018 Robert L. Parson. All Rights Reserved 44

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