CUNA Regulatory Comment Call

December 1, 2008

EXECUTIVE SUMMARY

• The National Credit Union Administration (NCUA) and the other federal financial institution regulators (Agencies) have issued a proposed Interagency Appraisal and Evaluation Guidelines (Guidelines) that outline supervisory expectations for sound real estate appraisal and evaluation practices. This includes formal appraisals, as well as other evaluation methods that are permitted under certain circumstances.
• The Guidelines are intended to clarify and provide more details on appropriate risk management principles and internal controls for ensuring that real estate appraisals and other evaluations are reliable and support the real estate transactions.
• The Guidelines replace the 1994 Interagency Appraisal and Evaluation Guidelines and incorporate recent regulatory actions, while also reflecting other changes in industry practices, uniform appraisal standards, and available technologies. NCUA was not a party to the 1994 Guidelines.
• The Guidelines also include three appendices. One provides further clarification on real estate transactions that are exempt from the agencies’ appraisal regulations, while another addresses acceptable evaluation alternatives, including the use of automated valuation models (AVMs). The third appendix provides a glossary of terms.
• Comments on the proposed Guidelines are due by January 20, 2009. Comments are due to CUNA by January 12, 2009.

Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Senior Vice President and Deputy General Counsel Mary Dunn at mdunn@cuna.coop and to Senior Assistant General Counsel Jeff Bloch at jbloch@cuna.coop; or mail them to Mary and Jeff c/o CUNA’s Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, South Building, Suite 600, Washington, DC 20004-2601. You may contact us at 800-356-9655, ext. 6732, if you would like a copy of the interim final rule. You may also access it here.

BACKGROUND

In 1994, the federal banking agencies jointly issued the Interagency Appraisal and Evaluation Guidelines to provide banks and thrifts with guidance on prudent appraisal and evaluation policies and practices. NCUA was not a party to these 1994 guidelines, although credit unions have been subject to appraisal rules and other guidance that NCUA has issued over the years.

Since 1994, the Agencies have issued supervisory guidance in an effort to promote sound practices with regard to an institution’s appraisal and evaluation programs. Since that time, there have been advancements in collateral valuation practices, as well as other significant developments regarding appraisals.

For the above reasons, the Agencies are now issuing the proposed Guidelines to provide further clarification and details concerning the Agencies’ expectations with regard to an institution’s appraisal and evaluation program and practices.

DESCRIPTION OF THE PROPOSED GUIDELINES

The following describes the proposed Guidelines, as well as the three appendices:

Supervisory Policy
Examiners will consider the following when examining the institution’s real estate activities:

• The institution’s size and nature of its real-estate related activities.
• For individual transactions that are reviewed, whether the methods, assumptions, and valuation conclusions are reasonable.
• Whether the appraisal and evaluation complies with the appraisal regulations, supervisory guidelines, as well as the institution’s policies.
• Whether the individual performing the appraisal or review is qualified and not subject to conflicts of interest.

Appraisal and Evaluation Program
The institution’s board of directors, or designated committee, is responsible for establishing the appraisal and evaluation program, which should:

• Provide for the independence of the person who orders, performs, and reviews the appraisal or evaluation.
• Establish criteria and procedures to evaluate and monitor the person who performs the appraisal or evaluation.
• Ensure that the appraisal contains sufficient information to support the loan decision.
• Maintain criteria for content and the appropriate use of evaluations.
• Ensure that the appraisal or evaluation is received in a timely manner.
• Develop criteria to assess the validity of existing appraisals or evaluations to support future transactions.
• Implement internal controls to ensure compliance with the program.
• Establish criteria for obtaining appraisals or evaluations for transactions not otherwise covered under the appraisal rules.

Independence of the Appraisal and Evaluation Program
Those who perform appraisals and evaluations should be independent and be isolated from influence by the loan production staff. They should also have no direct or indirect interest in the property or transaction. Institutions may provide the appraiser with a copy of the property sales contract, but must not provide an estimate of the property value, the loan amount, or a target loan-to-value ratio.

For smaller institutions, it may not be practical to separate the valuation from the loan production process. In these situations, the institution should demonstrate that it has appropriate safeguards to isolate the collateral valuation program from influence from the loan production process. This may include the lending official abstaining from voting on an approval of a loan if he or she was involved in the appraisal or evaluation.

Selection of Persons Who May Perform Appraisals or Evaluations
Institutions should establish criteria to select, evaluate, and monitor the performance of those who perform appraisals or evaluations, which should ensure that:

• The selection process is unbiased. Independence is compromised when a borrower or loan production personnel recommends or selects the person who performs the appraisal or evaluation.
• The person selected has the necessary education, expertise, and competence.
• The work performed by those providing appraisals and evaluations is periodically reviewed by the institution.
• The person selected is capable of rendering an unbiased opinion and has no direct or indirect interest in the property or transaction.
• The person selected has the appropriate State certification or license.

Institutions should use written engagement letters when ordering appraisals, which should be in the permanent credit file. Appraisal or evaluation work should not begin until the institution has selected the person for the assignment.

Transactions that Require Appraisals
The appraisal regulations determine transactions in which appraisals are required. The Agencies also reserve the right to require an appraisal for other transactions to address safety and soundness concerns.

Minimum Appraisal Standards
The Guidelines provides details on the five minimum standards for appraisals, which are required under the Agencies’ appraisal regulations. Under these standards, the appraisal must:

• Conform to generally accepted appraisal standards, as outlined by the Uniform Standards of Professional Appraisal Practice (USDAP), unless safety and soundness principles require stricter standards. For example, although allowed by USDAP, the appraisal regulations prohibit an appraiser from having an interest in the property.
• Be in writing and contain sufficient information and analysis to support the loan decision. The form of the appraisal should be appropriate, based on the risk and complexity of the transaction. The level of detail should be sufficient to understand the analysis and opinion of the property’s value. The USDAP outlines three different reporting options for rendering the opinion. The appraisal report should also provide sufficient information as to the nature and extent of the inspection and research performed that verifies the property’s condition and value.
• Analyze and report appropriate deductions and discounts for proposed construction or renovation, partially leased buildings, non-market lease terms, and tract developments with unsold units. This includes the following:
  • Proposed Construction or Renovation – An institution may request a prospective market value, as completed. A sum or retail sales for a development would not be considered the market value.
  • Partially Leased Buildings – The appraiser must make appropriate deductions, which would include leasing commissions, rent losses, tenant improvements, and entrepreneurial profit.
  • Non-market Lease Terms – This refers to properties subject to leases with terms that do not reflect market conditions. Here, the appraiser must make appropriate deductions and discounts, which should be based on stabilized occupancy at prevailing market terms.
  • Tract Developments with Unsold Units – For raw land, the value must be based on its current condition and existing zoning with appropriate deductions, such as holding costs, marketing costs and entrepreneurial profit. For proposed developments of five or more residential lots, appropriate deductions should also reflect these costs and profits during the time the property is developed and sold. For single family developments of five or more homes, an appraisal for an individual unit may be used if the feasibility study or market analysis shows that all units collateralizing the loan can be built and sold within twelve months. Similar provisions apply for condominium developments.
• Be based on the definition of market value in the appraisal rules. Market value assumes the price is not affected by undue stimulus, such as favorable financing or seller concessions, and that it does not include a going concern value or special value to a specific property user. The appraisal may contain a separate opinion of these items, as long as they are clearly disclosed as such. Market value should include the property’s physical condition, use, and zoning as of the appraisal date.
• Be performed by a state-certified or licensed appraiser, in accordance with the Agency’s appraisal rules. Institutions should also consider an appraiser’s education and level of experience.

Appraisal Development
Appraisals must comply with the USDAP, which requires the appraisal to reflect an appropriate scope of work that includes the extent to which the property is identified and inspected, the type and extent of data researched, and the analysis that is used. Lower costs or speed of delivery should not influence the appraiser’s scope of work. The institution should discuss its needs and expectations with the appraiser and this should assist the appraiser in establishing the scope of work and form the basis of the engagement letter.

If applicable, the appraisal should include three approaches, which includes cost, income, and sales comparisons. These results should be reconciled to estimate the market value. The appraisal should also include an analysis of the property’s sales history and an opinion as to the highest and best use of the property. In addition, USDAP requires the appraiser to disclose if the property was inspected and whether anyone provided significant assistance to the appraiser.

Appraisal Reports
The institution is responsible for identifying the appropriate appraisal reporting option, based on the risk, size and complexity of the transaction and collateral. The USDAP outlines the various reporting options that an appraiser may use to present the information in the appraisal. These vary based on the level of detail required. Regardless of the option chosen, the appraisal should contain sufficient detail to allow the institution to understand the scope of work performed. This should include the disclosure of the research and analysis performed, as well as the research and analysis that were not performed, along with the rationale for its omission.

Qualifications of Persons Performing Evaluations
Institutions should select those who are independent of the loan production process and the transaction and who have the real-estate training, knowledge and experience to perform evaluations. Institutions should document the qualifications and experience of those selected to perform evaluations. Institutions should also have sufficient controls to confirm that the person performing the evaluation is qualified and independent. If an institution uses a third-party, it should communicate its evaluation criteria and have controls to confirm compliance with its internal policies and these Guidelines.

Evaluation Content
An evaluation should provide an estimate of the market value of the collateral. The institution should establish policies and procedures for determining the valuation methodology for the transaction, given the associated risks. These policies and procedures should address the process for selecting the most reliable evaluation method, rather than the method that renders the highest value.

These evaluations should at least:

• Identify the location of the property.
• Describe the property and its current and projected use.
• Indicate the sources of information used to value the property, including external data sources, previous sales data, photos, property assessments, comparable sales information, description of the neighborhood, and local market conditions.
• Disclose the analysis that was performed and the supporting information that was used to value the property.
• Provide an estimate of the property’s market value in its actual physical condition, use, and zoning designation.
• Indicate the preparer’s name and contact information.
• Be documented in the credit file, and the documentation should be appropriate for the methodology that was used.

The institution should establish criteria to identify the extent to which an inspection of the property is necessary to determine if it is in acceptable condition for its current or projected use. More detailed evaluations should be obtained for higher risk transactions, or as the institution’s portfolio risk increases. Higher risk transactions may include loans with combined loan-to-value ratios that exceed supervisory limits, atypical properties, properties outside the institution’s traditional lending market or those in a transitional location, and borrowers with high-risk characteristics.

Accepting an Appraisal from Another Institution
An institution may use an appraisal performed by an appraiser who was engaged by another institution, provided the user determines that the appraisal is valid and acceptable and conforms to the Agencies’ rules. This determination should be documented in the credit file and be made before the appraisal is accepted. The user should also obtain documentation that the appraiser was engaged directly by the institution transferring the appraisal and that the appraiser had no interest in the property or transaction. An institution must not accept an appraisal that has been altered with the intent to conceal the original client.

Validity of Appraisals and Evaluations
Institutions may use an existing appraisal or evaluation for a subsequent transaction. To do so, they should establish criteria for assessing whether the existing appraisal or evaluation is valid. The criteria will vary depending upon the condition of the property and marketplace, as well as the nature of the transaction. The credit file should contain documentation that provides facts and analysis to support the validity of the existing appraisal or evaluation. Factors that would lead to a new appraisal or evaluation include the passage of time, volatility of the local market, availability of financing, inventory of competing properties, improvements or lack of maintenance of the property or competing properties, changes in zoning, or environmental contamination.

Third Party Arrangements
An effective program oversight should address arrangements with third parties. Institutions should periodically assess these arrangements for compliance with program standards and with the Agencies’ guidance on third party arrangements. Any deficiencies should be addressed in a timely manner.

Reviewing Appraisals and Evaluations
An institution should assess the acceptability of the appraisal or evaluation, as well as its compliance with the appraisal rules, the Guidelines, and the institution’s own internal policies. This review should be performed prior to the final credit decision. This review procedure should address the role, independence, and qualifications of the reviewer; the techniques, timing and level of review; documentation requirements, and the appropriate resolution of deficiencies. These procedures should also address the reviewer’s responsibility to verify that the methods, assumptions, data sources, and conclusion are reasonable and appropriate for the transaction.

Reviewers of appraisals and evaluations should be independent of the transaction and possess the appropriate education, expertise, and competence to perform the review, based on the complexity of the transaction. Smaller institutions should implement safeguards for accepting appraisals and evaluations when absolute lines of independence cannot be achieved. In these situations, the review may be part of the loan officer’s credit analysis, as long as the officer does not approve or vote to approve the loan.

Institutions should implement a risk-focused approach to determine the level of review needed to ensure the appraisals and evaluations are acceptable. This will depend on the size, type, complexity, and risk of the transaction and whether the appraisal and evaluation is obtained directly or from another institution.

With approval from the primary regulator, an institution may employ techniques, such as automated tools or sampling methods, when performing pre-funding reviews of appraisals or evaluations that support lower risk single-family mortgages. With these techniques, the institution should maintain sufficient data and employ appropriate screening techniques that provide adequate quality assurance and should ensure that the appraisers and evaluators are reviewed periodically.

The institution should document the content of the review in the credit file. A checklist or narrative format may be used, as appropriate. Deficiencies noted in a review should be addressed by the person who prepared the appraisal or evaluation or by another qualified, independent person. Unreliable appraisals or evaluations should be replaced prior to the final credit decision.

An appraisal review performed by a state-certified or licensed appraiser must comply with USDAP and any changes to an appraisal’s estimate of market value is only permitted as a result of a review conducted by an appraiser with these qualifications.

Program Compliance
An institution’s appraisal and evaluation policies should establish effective internal controls that promote compliance with regulatory requirements and guidelines. This should include adequate controls, verification, and testing to ensure reliability of appraisals and evaluations. These controls should be commensurate with the risk of the institution’s overall real estate lending activities, and those responsible for compliance should be insulated from influence by the loan production staff. Appraisers and evaluators should be subject to periodic evaluation of the quality of their work, which will form the basis for deciding whether to retain the services of these individuals.

Portfolio Monitoring and Updating Collateral Evaluations
A prudent portfolio monitoring program should include criteria for determining when to obtain a new appraisal or evaluation, in accordance with the Agencies’ real estate lending standards. These criteria should be based on changes in market conditions or deterioration in the credit since origination. An institution’s policies and procedures should ensure that timely information is available to management for assessing collateral and associated risks. Examiners have the right to require an appraisal or evaluation when there are safety and soundness concerns on existing real estate loans, and examiners are expected to provide institutions a reasonable amount of time to obtain the new appraisal or evaluation.

Referrals
An institution should make referrals to state appraiser regulatory authorities if it suspects that a state-certified or licensed appraiser has failed to comply with USDAP, State laws, or otherwise engages in unethical or unprofessional conduct. Examiners who find evidence of unethical or unprofessional conduct should forward their findings and recommendations to their supervisory office

Appendix A – Appraisal Exemptions

The Guidelines discuss the following exemptions to the requirement for obtaining appraisals:

• Appraisal Threshold – Appraisals are not needed for transactions in which the value is equal to or less than the thresholds in the appraisal rules, although an evaluation is required, consistent with safe and sound banking practices. In these situations, NCUA rules specifically require a written estimate of market value, performed by a qualified and experienced person who has no interest in the property.
  
  
• Abundance of Caution – An institution may take a lien on real estate and be exempt from obtaining an appraisal if the lien is taken as an abundance of caution. This is intended to have limited application. For business loans to qualify for this exemption, the Agencies expect the loan to be well supported by the borrower’s cash flow or collateral other than the property. This exemption should not be used merely to avoid the cost of the appraisal, minimize transaction processing time, or to offer slightly better terms to the borrower. The analysis to verify the use of the exemption should be placed in the credit file, and an appraisal should be obtained if it is later determined that the property will be relied upon as a repayment source.
  
  
• Liens for Purposes Other than the Real Estate’s Value – Institutions may take liens against real estate without obtaining an appraisal in order to protect legal rights or control other collateral. In these situations, the institution should determine that the market value of the real estate as an individual asset is not necessary to support the decision to extend credit.
  
  
• Leases – Institutions are not required to obtain appraisals of leases, unless they are the economic equivalent of a purchase or sale of the leased asset.
  
  
• Renewals, Refinancing, and Other Subsequent Transactions – These types of transactions may be supported by evaluations rather than appraisals if: 1) no new funds are advanced, other than reasonable closing costs; or 2) there are no obvious and material changes in market conditions or the physical aspects of the property, such as a change in the planned future use or rezoning of the property.
  
  
• Loan Workouts or Modifications – Loan workouts, debt restructures, loan assumptions, and similar transactions involving the addition or substitution of borrowers may qualify for an exemption if they meet the requirements above for renewals, refinancing, and other subsequent transactions. The quality of the underlying collateral and the validity of the existing appraisal or evaluation should also be taken under consideration. As indicated in the above exemption, an institution may advance funds beyond closing costs and not require an appraisal or evaluation if there are no material changes in the physical aspects of the property that threaten the collateral. The Agencies interprets this to apply in situations in which funds are advanced to protect the collateral, such as repairing damaged property.


An appraisal or evaluation may be prudent if the loan workout involves modification of the loan, such as a change in the collateral. An appraisal or evaluation would not be needed if the modification does not involve new advances of funds, material changes in the borrower’s creditworthiness, changes to the borrower’s or guarantor’s obligations, or changes to the collateral pool or deterioration in collateral protection. Examples that may meet these criteria include changes in the rate, short-term extensions, or changes in the repayment terms.


• Transactions Involving Real Estate Notes – This exemption applies to the purchase, sale, investment in, exchange of, or extension of credit secured by a loan or interest in a loan, or pooled loans, including mortgage-backed securities. Institutions should use audit procedures and review a sampling of the appraisals of the underlying transactions.
  
  
• Transactions Insured or Guaranteed by a U.S. Government Agency or U.S. Government- sponsored Agency – Although these transactions are exempt from the appraisal and evaluation requirements, it is expected that these transactions will meet all of the underwriting requirements of the federal insurer or guarantor, which may include its own appraisal requirements.
  
  
• Transactions that Qualify for Sale to, or Meet the Appraisal Standards of, a U.S. Government Agency or U.S. Government-sponsored Agency – This applies, for example, to loans in which the appraisal conforms to Fannie Mae or Freddie Mac appraisal standards. In these situations, a separate appraisal conforming to the Agencies’ appraisal rules would not be required. The institution should maintain adequate documentation that the transaction qualifies for this exemption.>
  
  
• Appraisals Not Necessary to Protect Federal Financial and Public Policy Interests or Safety and Soundness of Financial Institutions – This is intended to apply to individual transactions, as opposed to broad categories, and institutions need to seek a waiver from their supervisory federal agency.

Appendix B – Evaluation Alternatives

If the appraisal rules allow for an evaluation instead of an appraisal, institutions should maintain policies and procedures for determining whether an evaluation alternative is appropriate for a given transaction, based on the associated risk. These procedures should address risk criteria, such as transaction size and purpose, borrower creditworthiness, and the loan-to-value.

The institution should demonstrate that the evaluation alternative, such as an AVM or tax assessment valuation, provides a reliable estimate of the collateral as of a stated date prior to the decision to enter into a transaction. The institution should also establish criteria for determining the extent in which an inspection of the collateral is necessary to determine that the property is in acceptable condition for its current or projected use. The method used for valuation should not be selected solely on the basis that it will result in the highest value. Below outlines more specific guidance for AVMs and tax assessment valuations.

AVM – AVMs may be used, as permitted by the Agencies’ appraisal rules. For credit unions, AVMs may be used to meet the requirement to provide an evaluation of value, as long as there is also a review by a loan officer or person with knowledge, training and experience in the real estate market in which the loan is being made. An institution should conduct testing to ensure that the AVM provides credible values and related information. In selecting a specific AVM to use, the institution should perform due diligence to:

• Obtain relevant information about the data the model provides. The institution should know the source and types of data used, the frequency of updates, the quality control that is performed, and how the data is obtained in States in which real estate sales data is not disclosed.
• Understand the modeling techniques used, including the strengths and weaknesses of different models and how these models perform for different properties.
• Evaluate the model provider’s confidence score when assessing the model’s reliability in determining market values for different properties.
• Ascertain which models provide the most credible values for the institution’s lending activities.

An institution should establish appropriate practices for the use of AVMs and should indicate its AVM performance criteria. In establishing these practices, the institution should:

• Address the qualifications and responsibilities of those designated to select, validate, and administer the models.
• Establish standards and procedures for model validation testing and monitoring.
• Maintain AVM performance criteria for reliability and suitability based on the institution’s risk tolerance.
• Establish procedures for selecting a different valuation method if AVM performance criteria are not met.
• Adopt criteria that establish standards and procedures for validation testing when using multiple AVMs to ensure that results are credible.

Determining AVM Use – Institutions may consider the following in determining whether an AVM is appropriate for a specific transaction:

• Whether the property is homogeneous in a typical neighborhood for its market and if the address is recognized by the model.
• Whether the property is in a market with strong sales activity and in a location that is typical or average for its market.
• Whether there is sufficient information to assess if the property is in average or above-average condition and if the area is free of known adverse conditions.
• Whether the property’s initial estimated value is within the average price range for its market.
• Whether the property is in an area that appears to have minimal fraud, if the frequency of sales of the property does not otherwise suggest flipping or fraud, and if the property is owner-occupied.

Validating AVM Results – Institutions should establish procedures for independently validating an AVMs results on a periodic basis. The depth and extent of the validation should be consistent with the materiality and complexity of the risks. An independent model validation process should at least specify the expectations for an appropriate sample size, level of geographic analysis, testing frequency and criteria for re-testing, standards of performance measures, and range of acceptable results. AVM values should be compared to data from sales transactions prior to being recorded in public records. Institutions should document the validation testing and audit findings and use them to analyze and update their practices regarding AVM use.

Tax Assessment Valuation (TAV) – Institutions may use data provided by local tax authorities as the basis for estimating the value of the collateral. The institution should document how the tax jurisdiction calculates the TAV and how frequently revaluations occur. The institution should also analyze the relationship between the TAV and the market value within a tax jurisdiction for each property type and price tier. This correlation between the TAV and the market value should be tested and documented and institutions may then use TAVs if a reliable correlation can be established.

Appendix C – Glossary

Appendix C provides an extensive glossary of terms that are used in the Guidelines.

Other comments?

---

---

---

---

---

Eric Richard • General Counsel • (202) 508-6742 • erichard@cuna.com Mary Mitchell Dunn • SVP & Deputy General Counsel • (202) 508-6736 • mdunn@cuna.com Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 • jbloch@cuna.com Lilly Thomas • Assistant General Counsel • (202) 508-6733 • lthomas@cuna.com Luke Martone • Senior Regulatory Counsel • (202) 508-6743 • lmartone@cuna.com

Copyright © 2009 - Credit Union National Association, Inc.