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Statement by John P. LaWare, member, Board of Governors of the Federal Reserve System, before the Subcommittee on General Oversight and Investigations of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, September 16, 1992.

Statement by John P. LaWare, Member, Board of Governors of the Federal Reserve System, before the Subcommittee on General Oversight and Investigations of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, September 16, 1992

I am pleased to appear before you this morning to discuss the implementation and effectiveness of the real estate appraisal requirements contained in Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). Title XI contemplates a dual state and federal role in fulfilling its goal, which, as indicated in its statement of purpose, is to provide "that federal financial and public policy interests in real estate-related transactions will be protected by requiring that real estate appraisals utilized in connection with federally related transactions are performed in writing, in accordance with uniform standards, by individuals whose competency has been demonstrated and whose professional conduct will be subject to effective supervision."

At the federal level, Title XI required that the federal financial institutions regulatory agencies issue regulations that prescribe appropriate appraisal standards for those real estate-related transactions that would require the services of a licensed or certified appraiser under the statute and, therefore, are federally related. The agencies were also required to distinguish between those transactions that require the services of a state-certified appraiser (the senior designation) and those that require the services of a state-licensed appraiser (the junior designation).

The states also play a vital role under the statute. Title XI contemplates that the states will establish appraiser certification and licensing agencies, as well as set minimum requirements for individuals who are qualified to perform appraisals in connection with federally related transactions. After December 31, 1992, state-certified or licensed appraisers must be used for all federally related transactions, unless a temporary waiver is granted in accordance with the provisions contained in Title XI.

At the outset I should make clear that the Federal Reserve Board shares the desire of the Congress to ensure that banks establish sound loan underwriting and administrative procedures. An integral part of such procedures is, of course, a prudent and effective appraisal program. Indeed, the loss experience of depository institutions in recent years has demonstrated the critical importance of sound underwriting standards in promoting the safety of financial institutions and in protecting the interests of depositors.

The committee's letter of invitation provides that this hearing will generally examine the implementation and effectiveness of Title XI and requests, as well, that the Federal Reserve Board address several specific questions. The individual questions are addressed in an attachment to this testimony.(1) However, because of the interest that has been expressed on the topic, I will, later in my statement, address the issue of a threshold above which appraisals are required.

Since the enactment of FIRREA on August 9, 1989, the Federal Reserve Board has been working extensively with the other federal financial institutions regulatory agencies to implement the requirements of Title XI. These efforts fall into several categories, as required by Title XI. One set of initiatives is the establishment of the appraisal subcommittee of the Federal Financial Institutions Examination Council and our continued representation on that subcommittee. Regarding the activities of the Appraisal Subcommittee, I will defer to the statement of the Appraisal Subcommittee Chairman, Fred Finke.

A second area in which each of the agencies has expended considerable effort is that of prescribing appropriate standards for the performance of real estate appraisals. In developing the regulation, the Board has attempted to comply with both the letter and the spirit of Title XI, while at the same time remaining sensitive to the potential costs and burdens that the regulation could impose, particularly on consumers and small businesses seeking real estate loans. Title XI required that the Federal Reserve Board adopt appraisal standards in its regulation that incorporated the appraisal standards in the Uniform Standards of Professional Appraisal Practice (USPAP). Moreover, the Board was also permitted by Title XI to require compliance with additional standards, if necessary, to properly carry out its statutory responsibilities.

At the time the Federal Reserve Board sought public comment on adopting its appraisal regulation, the USPAP was in the process of being revised, and the Board, as well as the other financial institutions regulatory agencies, was uncertain whether the substance of the final version would fully satisfy the purposes and the requirements of Title XI. As a result, to ensure that the requirements of Title XI were met, the Board, along with the other regulatory agencies, adopted its own set of appraisal standards that were substantially similar to those proposed in the USPAP.

In June 1990 the Federal Reserve Board adopted the appraisal regulation containing the additional appraisal standards of the agencies, and, at the same time, the USPAP revisions were finalized. Our experience with appraisals since the adoption of the revised USPAP standards appears to indicate that these standards adequately address the concerns expressed in the legislative history of FIRREA regarding the sufficiency of appraisal standards. Accordingly, the Board and the other regulatory agencies are considering the deletion of the portion of their appraisal regulations containing standards that are substantially similar to the revised USPAP standards. Because of reports that some appraisers maintain that the standards specified in the agencies' regulations constitute an additional set of standards requiring separate analysis, deferring more fully to the USPAP should reduce regulatory burden and the commensurate costs to the public and to depository institutions.

During the course of its consideration of its real estate appraisal regulation, the Federal Reserve Board remained sensitive to the need for minimizing potential costs and burdens that the regulation could impose while, at the same time, not jeopardizing safety and soundness considerations and the purposes of Title XI. In that light, the Board promulgated its final regulation with a $100,000 threshold above which appraisals would be required for federally related transactions. After considerable comment, the Board subsequently issued a proposed rule to reconsider the level of the threshold. Before making a final determination on this issue, the Board will review the results of the recently completed Office of Management and Budget study mandated by the Federal Deposit Insurance Corporation Improvements Act and a pending General Accounting Office study, both related to the appraisal threshold issue, as well as more than 2,800 comment letters received in response to the Board's own proposal. Clearly this issue is controversial and one in which some members of the Congress have expressed considerable interest.

The Federal Reserve Board initially prescribed the $100,000 threshold because, in its view, transactions below the threshold did not appear to implicate the federal financial and public policy interests addressed by Title XI, nor did they pose a significant risk of loss to institutions covered under the statute. In the Board's experience with its regulated institutions, credit losses arising from inadequate appraisals of one to four-family residential loans, which constitute the vast majority of real estate-related transactions falling below the threshold, have not been a significant cause of failures of commercial banking organizations. Further, the threshold lessens the potential costs and burdens that the regulation could have on small businesses and individuals seeking real estate loans.

The Board's supervisory experience also suggests that employees of community banks have made reasonable assessments in the past of real estate collateral values for residential loans. Moreover, the majority of all one- to four-family residential loans are originated for potential sale to the secondary mortgage market. In this regard, the Board understands that the Federal Housing Administration, the Veterans Administration, the Federal National Mortgage Association, and the Federal Home Loan Mortgage Corporation, as well as many private mortgage insurers, will require appraisals that are performed by licensed or certified appraisers for residential loans and insured or guaranteed by them.

We are not unconcerned about problems stemming from relatively small- or medium-size loans, which, of course, can, and do, result in some losses to banks. It is for this reason that our supervisory appraisal and evaluation policies cover loans of all sizes. Nevertheless, our experience with commercial banking organizations has suggested that losses on residential loans have not contributed significantly to bank failures; and, in any case, that significant losses to banks on one- to four-family residential loans below the $100,000 threshold have not resulted from faulty appraisals.

Moreover, we believe that the prudential standards contained in our supervisory appraisal guidelines, together with annual on-site examinations, have helped to mitigate the risks associated with transactions below the threshold. Further, discussions with state agency representatives and comments by the public suggest that an employee of a community bank in a rural area, where it may be difficult to obtain the experience required by many state licensing authorities, is likely to be at least as knowledgeable about the value of local properties as an out-of-area appraiser.

In contrast, it has primarily been loans collateralized by larger commercial buildings, condominiums, shopping centers, and agricultural and other commercial properties that have caused major credit losses and, in some cases, failures within the commercial banking system. As an indication of the loss experience of insured banks and savings banks on one- to four-family residential loans, compared with typically larger commercial real estate loans, I note that for 1991 the nonperforming loan and loan charge-off ratios for one- to four-family loans were 1.65 percent and 0.20 percent respectively, compared with 5.81 percent and 1.24 percent for commercial real estate loans. In this regard, the Board believes that Title XI is particularly helpful in standardizing and strengthening appraisal procedures for large real estate loans that historically have been a major source of problems for some banking institutions. Accordingly, the Federal Reserve Board's regulation requires the use of certified appraisers for all commercial transactions that exceed $250,000 in value.

In summary, I believe that the approach we have adopted in our regulation represents a reasonable attempt to implement the purposes of Title XI, while remaining sensitive to the concerns of smaller institutions, the possible impact on the cost of appraisals, and the potential burden associated with additional regulation. In developing the regulation, Board staff members have worked closely with representatives of the other bank regulatory agencies to establish a consistent approach for commercial banking organizations.

One purpose of this hearing is to examine the effectiveness of Title XI. As I have already noted, the Board believes that Title XI has contributed to strengthening appraisal procedures within depository institutions. Having said that, I must also caution that the Board believes that the appraisal process is not an exact science, nor should it be the sole focus of an examiner's review of a commercial real estate loan. Work must still be done to refine the appraisal process and to avoid the use of dubious assumptions that can contribute to exaggerated valuations in both the upside and downside phases of the real estate cycle. Further, as the agencies indicated in their November 7, 1991, guidance to examiners, the focus of an examiner's review of a commercial real estate loan must be an assessment of the borrower's ability to repay the loan in an orderly and timely manner. The principal factors that bear on this assessment are the income-producing potential of the underlying collateral and the borrower's willingness and capacity to repay under the existing loan terms and from the borrower's other resources if necessary.

As we proceed to implement Title XI, I want to assure you that we will monitor the effectiveness and impact of the Board's appraisal regulation. As is true of any new regulation, we recognize that adjustments may have to be made to accomplish desired objectives. In this regard, the Federal Reserve Board will not hesitate, in coordination with the other federal agencies, to consider and, if appropriate, to adopt changes or refinements that are deemed necessary to strengthen our implementation of Title XI or to assure the safety and soundness of our nation's depository institutions. (1.) The attachment to this statement is available from Publications Services, Board of Governors of the Federal Reserve System, Washington, DC 20551.
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Publication:Federal Reserve Bulletin
Date:Nov 1, 1992
Words:2007
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