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Lender perceptions of appraisal quality: after FIRREA.

The Financial Instifutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) was enacted as a governmental attempt to improve the standards of lending practices in the nation's lending institutions. Portions of the legislation were aimed at improving and standardizing the quality of real estate appraisal reports. This survey, completed in April 1992, provides the first measure of appraisal quality after FIRREA regulations were enacted. Mortgage lenders were surveyed to assess their perceptions regarding the quality of appraisal reports they received. While the results indicate that appraisers are doing a good job overall, some areas in need of improvement are identified.

The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) was enacted to revise lending policies and procedures of the nation's banks and savings and loan institutions. A portion of the legislation was aimed at improving the quality of appraisal reports used in mortgage lending decisions. The purpose of this research is to measure the perceptions held by mortgage lenders regarding the quality of residential appraisals they receive. To measure lender perceptions, a survey was completed in April 1992, which provides the first measure of appraisal quality after FIRREA regulations were enacted. In addition to the appraisal quality issue, lenders were also asked about their confidence in the precision and reliability of the three approaches to value and whether the FIRREA regulations specifically have improved appraisal quality.

The results of the survey identify areas of the appraisal process that are currently being executed well by appraisers and also identify areas in which the services are provided less satisfactorily. Areas where a need for improvement is identified have the potential to become the subjects of new courses or educational materials for the appraisal profession.


A survey was designed to measure lender perceptions in regard to the following questions:

1. What impact have FIRREA and li-

censing/certification requirements

had on the quality of appraisal re-

ports received by your institution?

2. Which specific components of res-

idential appraisal reports have the

least/most errors or shortcomings?

3. Which of the three approaches to

value provides the greatest/least

precision and reliability in residen-

tial appraising?

The survey was sent in April 1992 to 500 banks in the largest cities in the following states: Arizona, Arkansas, Georgia, Kansas, Massachusetts, and Oregon. The survey was addressed to the "senior real estate lender" in each of the banks, and the cover letter requested that the person responsible for reviewing real estate appraisals fill out the survey. A total of 77 bank officials completed and returned the survey. It is important to note that this survey was not intended to be a national survey from which global generalizations could be inferred, but it does provide some useful information and insights about current attitudes and perceptions of the lending community about appraisal quality.


The banks in the sample

This section provides demographic details of the commercial banks that responded to the survey. The surveyed firms were selected from the Rand McNally Bankers Directory. Questionnaires were sent to a sample of institutions located in the largest urban areas of the states previously listed. As shown in Table 1, banks from all size categories are represented in proportions similar to those found in the industry nationwide, with only the very smallest of banks being slightly underrepresented. A possible explanation for this is that the survey cover letters were addressed to the senior real estate lender at each institution, and many of the small institutions may not have had an individual designated with such a title.

TABLE 1 Bank Size Distribution (dollar volume of total assets)
Total Assets of U.S.
(in millions Banks as of
of dollars) Frequency Percentage June 1990
Less Than $25 8 10.8% 27.8%
$ 25-$100 34 45.9% 46.5%
$101-$500 22 29.7% 20.0%
Over $500 10 13.6% 5.7%
No Response 3 -- --

All respondents indicated that real estate is a significant part of their lending portfolios, but the relative concentration of real estate loans in their portfolios is widely dispersed, as can be seen in Table 2. The range of responses is from 10% to 80%, and the average bank in the sample had 43.65% of their loan portfolio in real estate. This average is slightly higher than the real estate concentration for all banks, which as of December 31, 1989, was equal to 36.8%(1) of their total lending. Some of this difference may be a result of the sample selection and response bias; however, continuation of the 1985--1989 trend in bank lending practices to dramatically increase real estate lending is another potential cause for the difference between 1989 and 1992.(2)

TABLE 2 Real Estate Lending at Commercial Banks as a Percentage of Their

Loan Portfolio
Real Estate Lending Percentage
(percentage of of
total assets) Frequency Respondents
Less than 20% 5 7.6%
20%-39% 22 33.3%
40%-59% 19 28.8%
60%-79% 17 25.8%
80%-100% 3 4.5%
No response 11 --

The respondents were also asked to indicate what percentage of their real estate lending could be classified as residential or commercial. Residential lending comprises an average of 44.4% of the respondents' portfolios, with a range of 0% to 100%.

Commercial lending by the institutions ranged from 2% to 95%. A more detailed breakdown of this information is provided in Table 3.

TABLE 3 Residential Lending as a Percentage of Real Estate Lending
Residential Lending
(percentage of
real estate lending) Frequency Percentage
Less than 20% 15 23.4%
20%-39% 15 23.4%
40%-59% 10 15.6%
60%-79% 14 21.9%
80%-100% 10 15.6%
No response 13 --

The commercial banks in the survey were expected to be primarily urban because the institutions contacted were selected from urban areas. A surprising result of the survey was that 37% of the respondents perceive themselves as rural in their primary exposure. The survey question was: "The market served by your institution is primarily rural or urban?" Some respondents checked both, as shown in Table 4.

TABLE 4 Market Served by Sample Rural versus Urban
 Frequency Percentage
Rural 27 37.0%
Urban 39 53.4%
Both 7 9.6%
No response 4 --

The median population of the cities in which the respondents' banks are located was 85,000. A more complete description is provided in Table 5. Twenty-eight banks responded that they serve communities with populations below 30,000. Many of these banks must be located in the suburban areas of major cities because all surveys were sent to banks in the largest cities in each of the states surveyed.

TABLE 5 Population of Community Served by Commercial Bank
Range Frequency Percentage
1,000-30,000 28 38.9%
40,000-100,000 14 19.4%
125,000-500,000 18 25.0%
Over 500,000 12 16.7%
No response 5 --

The appraisal process of the sampled banks

In an effort to better identify the appraisal practices of the lending institutions, the survey included questions concerning the appraisal process and the appraisal review process used by each bank, as shown in Table 6.

TABLE 6 Appraisal Process Employed by the Firm
Process Frequency Percentage
Outside fee appraisers
 for all appraisals 49 63.6%
Separate appraisal
 dept. in our firm 2 2.6%
Loan officers may also
 perform real estate
 appraisals if not
 involved in
 transaction 2 2.6%
Both outside fee
 appraisers and loan
 officers 22 28.6%
Other 2 2.6%

Nearly 64% of the respondents indicated that their appraisals for eal estate lending are done by independent, outside, fee-based appraisers. Few allow loan officers to conduct appraisals or have separate appraisal departments within their firm, thereby eliminating the potential for appraisals conducted at less than a full arm's length. Almost all of the institutions that allow loan officers to conduct appraisals also use outside fee appraisers, which provides an independent mechanism for self-monitoring appraisal outcomes and consistency.

Banks were also asked to estimate the percentage of their appraisals that is reviewed by review appraisers. Table 7 shows that approximately 24% of the responding firms review all appraisals ordered by their firm. Over 56% of the lenders, however, review 10% or less of the residential appraisals received.

TABLE 7 Percentage of Appraisals Reviewed by Review Appraisers
Percentage Reviewed Frequency Percentage
 0% 25 35.2%
 1%-10% 15 21.1%
11%-50% 9 12.7%
51%-95% 5 7.0%
100% 17 23.9%
No response 6 --

Some firms, which may use statistical sampling techniques, review only a small number of the appraisals they receive. Overall, it seems that even with increased requirements for certification under FIRREA, some lenders do not feel that in-house review of residential appraisals is necessary to further enhance the quality of the appraisals they receive.

An increasing number of commercial banks, as shown in Table 8, require their appraisers to carry errors and omissions insurance, in what seems to be an effort on the part of the industry to spread around the risk associated with the appraisal process.

TABLE 8 Firms Requiring Fee Appraisers to Carry Errors and Omissions

Errors and Number of
Omissions Insurance Banks Percentage
Yes 21 27.3%
No 37 48.1%
Uncertain 19 24.7%

Overall perceptions of appraisal report quality

Lenders were asked two questions about the overall quality of appraisal reports received by their institutions. The lenders were asked to agree or disagree with the following statements:

1. Appraisers used by our institution

provide us with high-quality


2. Recently enacted appraisal certifi-

cation/licensing requirements have

improved the quality of appraisals

in our market area.

The results shown in Table 9 indicate that almost 92% of the responding lenders feel that they are currently receiving high-quality appraisal reports. With such a large number of respondents indicating high degrees of satisfaction with appraisal quality, it is easy to see why less than 40% of the respondents agreed that certification/licensing requirements would be effective in increasing the quality of appraisal performance, as shown in Table 10. These results indicate that the residential appraisal process had been providing high-quality, reliable appraisals even before the implementation of FIRREA legislation. The results also show that many of the lenders think that FIRREA has not provided significant improvement in residential appraisal quality. (Some lenders did not respond to questions reported in Tables 9--14.)

TABLE 9 Appraisers Provide Us with High-Quality Appraisals
 Number of
Response Banks Percentage
Strongly agree 11 15.1%
Agree 56 76.7%
Undecided 2 2.7%
Disagree 3 4.1%
Strongly disagree 1 1.4%

TABLE 10 Appraiser Certification/Licensing Has Improved Appraisal Quality

in Our Area
 Number of
Response Banks Percentage
Strongly agree 5 6.8%
Agree 23 31.1%
Undecided 22 29.7%
Disagree 18 24.3%
Strongly disagree 6 8.4%

TABLE 12 Which Methods of Estimating Value Provide the Greatest Precision

and Reliability
Approach to Number of
Value Banks Percentage
Sales comparison
 approach 68 97.1%
Cost approach 2 2.9%
Income approach 0 0.0%

TABLE 13 Which Methods of Estimating Value Provide the Least Precision

and Reliability
Approach to Number of
Value Banks Percentage
Income approach 46 64.8%
Cost approach 25 35.2%
Sales comparison
 approach 0 0.0%

TABLE 14 Percentage of Reports That Satisfy All FIRREA Requirements When

First Reviewed
Percentage of
Meeting FIRREA Number of
Requirements Banks Percentage
91%-100% 22 35.4%
81%-90% 15 24.2%
71%-80% 6 9.7%
61%-70% 2 3.2%
51%-60% 3 4.8%
41%-50% 2 3.2%
31%-40% 1 1.6%
21%-30% 6 9.7%
11%-20% 0 0.0%
Under 10% 5 8.1%


Quality of specific components of the residential appraisal

Lenders were also asked for information regarding the quality of specific components of the residential appraisal reports they receive to identify areas of strength and areas for improvement within the residential appraisal report itself. Systematic deficiencies in specific areas of the residential report could be the topics of future appraisal education courses. The lenders were asked to estimate the percentage of their residential appraisal reports that have errors or shortcomings in 25 different parts of the report. The aggregated responses to this series of questions are presented in Table 11.

A substantial majority of the lenders reported that less than 20% of their reports contained errors in any of the 25 areas analyzed. In many of these areas, over 50 of the responding lenders indicated that less than 20% of their reports have the listed shortcomings. This indicates that overall residential appraisers are providing high-quality appraisal reports in a consistent manner.

Some of the identified areas for improvement include

* Delivering the report when promised

* Analyzing market trends in sales prices

* Analyzing market trends in rental rates and vacancies

* More discussion of entrepreneurial profit

* Better quality comparable sales

* Discussion of positive/negative features of the property

Perceptions of the precision and reliability of the three approaches

Lenders were also asked about their confidence in the precision and reliability of the three approaches to value in the residential appraisal process. Specifically, they were asked which of the three estimates of value provides the greatest precision and reliability and which approach provides the least. The results provided in Table 12 and Table 13 indicate that the lenders have the greatest confidence in the precision and reliability of the sales comparison approach and the least confidence in the cost and income approaches.

The lenders were also asked to estimate the percentage of appraisals ordered by their institutions that satisfy all FIRREA requirements when first reviewed. The results shown in Table 14 indicate that 22 institutions report that over 90% of their assignments satisfy all FIRREA requirements when first reviewed. Several banks, however, reported that a substantially smaller amount of their appraisals meet all requirements when first reviewed.

General comments from lenders regarding appraisal quality

Finally, lenders were asked what appraisers could do to improve the quality and usefulness of their appraisal reports. Their answers to this open-ended question are categorized and listed in five general areas below.

Quality of information (comparable sales)

* Take more time, research comparables more thoroughly.

* Thoroughly research available comparables.

* Do a better job on comparables, search for most recent sales. They should collect data on computer to facilitate the process.

* Work on getting detailed information about subject and comps.

More subjective analysis

* Need more space in the narrative on FNMA-FHLMC report forms. Research zoning, flood areas, and comparable sales in more depth.

* More specific reasons of why some statement was/was not used (for example, why were best comps not used?).

* Provide a more detailed, in-depth narrative about the history of the property and market conditions affecting the property today.

* Be better educated on market conditions; majority of residential appraisers use "canned" adjustments to determine adjusted value.

* Take more time in their narrative discussions, rather than "checking the boxes."

* Substantiate and support the "reasonable marketing period" and current economic conditions.

* A good working knowledge of our economy and local market is necessary.

Scrutinize reports before delivering to client

* Be more thorough and check information completely before performing the appraisal process.

* Review appraisals more closely to minimize errors.

* Take more time and maybe charge a little more.

* Review their reports for a second time.

Potential conflicts of interest

* Avoid all influence of interested third parties.

* Have no knowledge or prior consideration of sale of subject.

* Have no contact with real estate agents or brokers following completion of appraisals.

Simplify the form of information

* Have a short form to lower cost of appraisals for properties under $50,000.

* Cut through the "b.s." and tell us what the property will sell for in 90 days.

* Work on eliminating regulation and requirements so that the appraisal reports can be shorter. One page in length is desired optimum.

* Eliminate the superfluous information and deal with the information that truly relates to the final conclusion.

* Less emphasis on the cost approach.

(1)Federal Reserve Bulletin (July 1990): 479, 489--499.

(2)According to the Federal Reserve Bulletin (July 1990): 479, 489--499, real estate loans have been the fastest growing component of bank lending, averaging a 15% annual growth rate.
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.

Article Details
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Title Annotation:Financial Institutions Reform, Recovery and Enforcement Act of 1989
Author:Dotzour, Mark G.; LeCompte, Richard L.B.
Publication:Appraisal Journal
Date:Apr 1, 1993
Previous Article:Appraisal considerations in distressed markets.
Next Article:The process of arbitration.

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