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Appraisal management in today's regulatory environment.

This article explores the benefits of a staff appraisal department for a financial institution. Practical methods are suggested for structuring an appraisal department to best meet the institution's needs and to respond to the changed regulatory and economic environment.

In response to large losses of the Federal Deposit Insurance Corporation and the former Federal Savings and Loan Insurance Corporation, Congress enacted the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) of 1989. Title XI of FIRREA has mandated the six federal financial regulatory agencies to develop appropriate appraisal regulations, which were published in the Federal Register on August 23, 1990.

On January 30, 1991, the appraisal regulations of each of the six agencies were amended with an appendix containing excerpts from the Uniform Standards of Professional Appraisal Practice (USPAP) as promulgated by the Appraisal Standards Board of The Appraisal Foundation.

These changes in appraisal regulations mandated by Title XI of FIRREA increase the level of standards for appraisals prepared in support of federally related transactions. In addition, the regulations squarely place the responsibility to obtain proper appraisal reports with the management of the institution.

While the new federal regulations may seem onerous at first reading, they actually empower institutions to obtain, on average, higher quality appraisals than was possible prior to the passage of FIRREA. This is a result of the increased appraisal reporting standards and the new requirement that appraisals used must be ordered by a federally regulated financial institution. As well as being federal requirements, the federal appraisal regulations and the USPAP should be considered good business practice.

RESPONSIBILITIES OF MANAGEMENT

Each of the federal financial regulatory agency's appraisal guidelines specify the following responsibilities of management relative to appraisals.

* Management shall obtain appraisal reports in support of federally related transactions above a specified de minimus level (i.e., dollar amount).

* Management shall verify that appraisers providing appraisals in support of federally related transactions are either licensed or certified as required by the appraisal regulations.

* Management shall establish procedures to verify that the appraisals obtained meet the minimum standards of the appropriate appraisal regulation as well as any additional standards the institution may have.

* Management shall accept only appraisals prepared for the institution or another federally regulated institution.(1)

The most efficient and effective way for management to comply with appraisal regulations and obtain the best appraisal information for the institution is to establish or strengthen its appraisal department.

FUNCTIONS

An appraisal department has two functions in a regulated financial institution. The first is to assist the financial institution in making real estate decisions. Some of the responsibilities of the appraisal staff include

* Review of appraisal reports on significant properties (i.e., over a specified dollar amount)

* Identification of changes in rents, occupancies, and other trends that affect commercial property values to assist management in segmenting the commercial real estate market for new business

* Review of affiliated party transactions involving real property

* Review of disposition strategies and value-enhancement plans for real estate owned (REO)

* Training of the institution's nonappraiser staff in the proper use of appraisals and related issues to leverage the effectiveness of the appraisal staff

The second function of the appraisal staff is to verify that an institution complies with the appraisal regulations of the appropriate regulatory agency. The staff must develop appropriate policies and procedures that comply with federal regulatory requirements as well as with the institution's lending policy. The appraisal department must assure that management's responsibilities are met.

BENEFITS TO THE INSTITUTION

Because institutions require different types of appraisal administration, it is impossible to quantify the benefits of establishing an appraisal department. A competent on-site appraisal staff benefits an institution in several ways, however.

An appraisal staff that has enhanced knowledge of appropriate appraisal techniques will provide the institution with higher quality appraisal services. The development of a list of qualified appraisers, the ability of the staff to anticipate in detail the types of analyses required to solve appraisal problems, and the matching of appraisal assignments to the talents and experience of particular fee appraisers will contribute to this goal. An effective appraisal department will make fewer valuation mistakes and decrease the possibility of bad loans. Improving an appraisal department can be viewed as a way to limit portfolio risk.

Clearly, a more efficient loan approval process will result from the avoidance or quick resolution of appraisal problems. An appraisal department's policies and procedures will be aimed at avoiding appraisals that are not in compliance with the institution's appraisal guidelines, with the result that appraisals will be obtained in less time. A faster turnaround time for appraisal acquisition and approval is a competitive advantage for an institution.

An appraisal department can make an institution more credible when resolving regulatory concerns with respect to appraisal issues. In addition to reviewing the appraisals of problem assets, an appraisal staff should be responsible for reviewing asset value-enhancement and disposition strategies as well as for the preparation of fair values or net realizable values as appropriate. The federal regulatory agency examiners will appreciate a consistent approach to these issues and tasks.

With an appraisal department that fulfills management's responsibilities to comply with the federal appraisal regulations, senior management and lending officers will have more time to do what they were hired to do--manage the institution, develop new business, and make loans. Because the salaries of senior management and credit administration officers are at a higher level than the average salary of an institution's appraisers, this benefit to the institution is perhaps the most easily identified.

STRUCTURE

For an appraisal department to be effective, its placement in the institution's organizational structure is important. The chief appraiser should report directly to the chief operating officer. There are several reasons for this. Primarily, it is necessary to separate the lending function from the appraisal review function. Lending officers who are paid on a commission basis may view an appraisal as an obstacle to overcome rather than as a valuable underwriting tool. A secondary reason is to facilitate the checks and balances between the credit policy department and the lending department. Finally, senior management's responsibilities relative to appraisals require a close working relationship with the appraisal department.

The importance of the separation of the lending and appraisal departments is underscored by the language concerning requirements for additional certification contained in each of the appraisal regulations of the six federal financial regulatory agencies. The lack of specific language concerning the appraisal assignment in an appraisal prepared for a federally regulated institution indicates that the appraiser may not have read or complied with the appropriate appraisal regulations. The following representations from the USPAP must be added to the certification required for appraisal reports. "The appraisal assignment 1) was not based on a requested minimum value; 2) was not based on a specific (dictated) value; and 3) was not predicated in any way on the approval of a loan."(2)

APPRAISAL POLICY REQUIREMENTS

An appropriate appraisal policy is an important tool for helping management meet its responsibilities under the appraisal regulations. An appraisal department should amend the institution's appraisal policy from time to time to match the changing needs of the institution. Some of the more important requirements for appraisal policies are as follows.

* With certain exceptions for some regulatory agencies, one or more appraisal reports must be secured for all federally related transactions, as defined by the appraisal regulations.

* All appraisals must be in writing and completed in accordance with the USPAP. Limited-scope appraisals are not acceptable in support of a federally related transaction.

* All appraisals must be based on the appropriate definition of market value.(3)

* All appraisals should contain sufficient supporting documentation with all pertinent information so that an appraiser's reasoning, judgment, and analysis in deriving a conclusion indicate the reasonableness of the market value reported.

* All appraisals must report a reasonable marketing period and the prior sales history for the property.

* If an appraisal is prepared by a fee appraiser, the appraiser should be directly engaged by the institution or its agent. An institution may accept an appraisal secured for another federally regulated institution provided that the institution using the appraisal report has established appraisal review procedures, has reviewed the report under the procedures, and, finding the appraisal report acceptable, has documented the review in writing.(4)

APPRAISER HIRING POLICIES

As mentioned, the appraisal regulations of the six financial regulatory agencies require that appraisers be retained by financial institutions rather than by borrowers. While the vast majority of professional appraisers are not influenced in an estimation of value by the entity ordering and paying for the appraisal, some appraisers unfortunately have provided overly optimistic appraisals to borrowers or lending institutions.

If a borrower's primary objective is to obtain 100% financing on a property, the primary criterion for selecting an appraisal firm may be an inflated value estimate. Overall, the regulations that require a financial institution to order appraisals will have a positive effect on the quality of appraisals received by financial institutions.

An appraisal department should be responsible for hiring appraisers and paying the fees. The appraisal department should maintain a workable list of approved appraisers. One of the objectives of the appraisal department is to match an appraisal assignment to a fee appraiser who has the knowledge and experience to complete that appraisal most efficiently. Further, an appraisal department must maintain the appropriate documentation to determine whether appraisers have maintained state appraisal certification and licensing requirements.

An appraisal department should pay an appraiser's fee when the review appraiser concludes that the report has been completed in compliance with the institution's appraisal policies, the federal appraisal regulations, and the USPAP. The fact that the reviewer might disagree with the final value estimate should not be a reason for not paying for the appraisal on a timely basis.

If an appraisal does not meet the minimum standards of an institution's appraisal policy, the federal appraisal regulations, and the USPAP, the deficiencies of the appraisal should be communicated to the appraiser in writing. If the appraiser will not provide the data and analysis required to meet the minimum standards, the appraiser should be removed from the institution's approved list, and an appraisal from a different appraiser should be ordered.

An appraisal department should conduct an annual review of appraisers on the approved list. This review should report whether an appraiser completed appraisals in compliance with the institution's appraisal policies and procedures as well as whether the appraisals consistently required revisions to comply.

APPROVED APPRAISER QUALIFICATIONS

Financial institutions should use appraisers who have been approved after careful screening. This screening should involve investigation of professional competence and integrity as well as a review of appraisers' work products. There should be an established policy regarding this investigation and the qualifications required. Appraisers should be subject to extensive scrutiny prior to being placed on the approved list.

The minimum requirement for appraisers providing appraisals to a federally regulated financial institution is the appropriate state license or certification. This requirement is mandated by Title XI of FIRREA. Important qualifications of the appraiser that should also be considered include formal education, real estate appraisal education, experience in appraising specific property types, and experience in related fields such as mortgage lending, reviewing appraisals for government agencies, and brokerage.

In reviewing an application from an appraiser, the appraiser's professional designations should be considered. The appraisal regulations prohibit institutions from making the possession of a professional designation a requirement for placement on an approved list. Designations can be considered, however. A professional designation indicates that an appraiser has expended a great deal of time and energy to attain professional qualifications above the minimum level mandated by state certification and licensing.

REVIEW APPRAISAL REPORT REQUIREMENTS

The capabilities of an appraisal review staff should be consistent with the type of real estate lending business in which the institution is involved. If no one in the appraisal department is experienced in a certain type of property, an independent fee appraiser with experience in the appraisal review of that type of property should be retained.

All appraisals submitted to a financial institution should be reviewed in writing by an appraisal department. The reviews should be as detailed as the complexity of the appraisal problem requires. All review appraisal reports should be in compliance with Standard 3 of the USPAP. Standard 3 and the related standards are specific in their requirements regarding disclosure of a review appraiser's competency to perform a review as well as disclosure of all data and analyses leading to the review appraiser's conclusion. If a review appraiser concludes that the value of a property is different from the appraiser's estimate, the appraisal review becomes subject to other provisions of the USPAP that relate to appraisal reports, including ethics provisions.

Herbert L. Jourdan, Jr., MAI, SRA, is a staff appraiser with the Atlanta District of the Office of Thrift Supervision. A graduate of Indiana University, he has extensive experience in appraising all types of properties both independently and for government agencies.

Henry C. Entreken, Jr., MAI, is a principal in Entreken-Robertson Associates, Inc., an appraisal and consulting firm in St. Petersburg, Florida. A graduate of Emory University, he has extensive experience in both appraising and mortgage loan underwriting, and has published articles in several real estate journals.

1. OTS Reg. 564.5(b).

2. OTS Reg. 564.4(a)(10).

3. For example, OTS Reg. 564.2(f) or OCC Reg. 34.42(f).

4. For example, OTS Reg. 564.5(b) or OCC Reg. 34.45(b).
COPYRIGHT 1993 The Appraisal Institute
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993 Gale, Cengage Learning. All rights reserved.

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Author:Jourdan, Herbert L., Jr.; Entreken, Henry C., Jr.
Publication:Appraisal Journal
Date:Jan 1, 1993
Words:2244
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