Appraisals Revisited

The appraisal regulations are not new. Neither is safety and soundness. Recently, however, appraisal practices have become a regulatory concern. The regulatory concerns are driven by mortgage fraud activities as well as the need to maintain sound lending practices. When the loan is secured by real estate, the appraisal is a key component of sound underwriting.

The regulatory agencies have issued answers to Frequently Asked Questions (FAQs). Issuance of these responses accomplishes the dual goal of answering the often-asked questions while simultaneously stressing the importance of the appraisal rules. While many of the responses are common-sense, the responses reinforce agency policies and provide guidance for situations that fall in the grey areas.

Selecting Appraisers
The first set of Q&As deals with selecting appraisers and ordering appraisals. Independence of the appraiser is a central message in this set of Q&As.

First, the agencies make clear that the appraisal standards apply to both commercial and residential transactions. Both loan types expose the institution to safety and soundness risk. Failures in appraising and underwriting for both loan types generated the current appraisal rules. That being said, however, the type and nature of the transaction may influence the type of appraisal and the appraiser selected. The institution does not have to maintain a single procedure for appraisals but may have flexibility depending on the loan and property type. In every situation, however, independence must be maintained in selecting appraisers, ordering appraisals, and reviewing appraisals.

Independence is an issue not only in the selection of the appraiser but also in the use of appraisals provided through third parties. In some situations, it may be acceptable to use an appraisal prepared for another financial institution if the institution determines that the appraisal is current and meets skill and independence requirements. It is never acceptable to use an appraisal prepared by or for an interested party. Several of the agencies' answers provide more detail to these questions.

For example, when a developer has already ordered appraisals, the financial institution may not accept or use the appraisal prepared for the developer. Similarly, the lender may never accept an appraisal ordered by the borrower - even if it is current and ordered for a related transaction. It simply lacks the independence from influence that is required.

Another aspect of independence that generated responses was the relationship of the staff ordering the appraisal to either the appraiser or the loan decision. The only exception to this procedure is using a revolving list of approved appraisers. The list must be out of the control and influence of the lender making the appraisal request and in any situation that the lender skips over an appraiser on the list, the reason for doing so should be documented.

The appraiser selected and the person making the selection should have no financial connection to the transaction. The appraiser should be completely independent of the transaction. For this reason, the institution should maintain documentation showing how it determined that the appraiser was independent. In addition, documentation should show that the transaction details, such as the amount of the loan requested, were not provided to the appraiser.

Independence is lost by involvement in generating loans and making loan decisions. Loan production staff - including anyone whose responsibilities or compensation is based on loan generation - should not be involved in selecting appraisers.

There is recognition that in small institutions, available skilled staff for purposes of independence is limited. In those situations, the agencies strongly recommend that the individual responsible for selecting the appraiser refrain from taking part in the loan decision.

Re-using Appraisals
There are some situations when an institution can use an existing appraisal. First and foremost, the appraisal must meet independence requirements when ordered by the original user. Before using the existing appraisal, the institution must determine that the appraisal was in fact ordered by the previous financial institution.

When an appraisal is re-used, it must be transferred directly from the original institution to the lender that will re-use it. The appraisal must not pass through the borrower's hands. In short, when the borrower delivers an appraisal, the appraisal is suspect.

Documentation
Any consumer or commercial real estate loan file should contain more than just the appraisal. There are documentation requirements to establish that the appraisal was properly ordered, met the independence tests, and was properly reviewed and used by the institution before making the loan.The loan file should include the institution's request (engagement letter) for the appraisal.

This is to establish that the lender and not the borrower controlled the process. Next, the file should include documentation of the appraisal review or analysis. This may be in checklist form or memorandum form. The procedure need not be the same for different types of loans, but should be clearly established for each product type.

There are some other useful answers in the publication, such as confirming that a lender may make a conditional loan approval before conducting the appraisal. The situations presented in the Q&As could be useful for training. So get your copy now.

ACTION STEPS

Review your appraisal policies and procedures for compliance with the regulations and policy guidance.
Take a hard look at the approved appraiser list. Look for any connections that could undermine appraiser independence. Also check appraiser qualifications.
Pull a sample of loan files for both consumer and commercial lending. Review the appraisal process and make sure that the file contains the request for appraisal and documentation of the appraisal review as well as the appraisal itself.
Schedule training on the appraisal rules. Plan to give special attention to any problems you have identified.