RISMEDIA, June 23, 2011—Several months following the release of new Interagency Appraisal and Evaluation Guidelines, a great deal of confusion still exists in the marketplace regarding federal regulators expectations around the use of Automated Valuation Models (AVMs). In an effort to provide greater clarity, the Collateral Assessment Technologies Committee (CATC), a committee of the Real Estate Information Professionals Association, met with numerous lenders, investors, developers, appraisers and other industry stakeholders regarding the compliant use of AVMs under the new guidelines.
The new Interagency Guidelines resulted in a list of common questions and concerns being asked by lenders regarding the compliant use of AVMs in lending practices as outlined in the said guidelines. In addition to specific queries about compliant use, CATC was concerned about misleading published opinions that are often authored by parties that could benefit from marketing alternative products amidst any confusion.
The primary areas of concern included the following topics:
• Intended goals of the Guidelines surrounding use and application of AVMs,
• The distinction between a “valuation” and an “evaluation”,
• Language surrounding “inspection” under the “evaluation” section of the guidelines (Section XIII. Evaluation Content),
• AVM validation,
• Independence and the use of third-parties,
• Unique scrutiny on AVMs.
Intended Goals of the Guidelines
It is clear that the Guidelines are principles-based and not to be viewed as prescriptive in nature. They are also intended to provide a framework of language that will lead a lender to make valuation policy decisions in a prudent and compliant manner. It remains uncertain whether the agencies responsible for the Guidelines will be publishing any further communication regarding the subject in the near future. For each institution subject to the guidelines, individual
examiners and regulators will determine whether an institution’s program is consistent with the guidelines based on the size and nature of their real estate lending activities and the risk within their business footprint. We urge lenders to seek out their regulator with any questions for clarification.
‘Valuation’ vs. ‘Evaluation’
In summary, the guidelines establish two categories of valuation in federally regulated transactions—appraisals and evaluations. An AVM, by itself, is one of many valuation tools. When used in scenarios such as portfolio valuations, part of the appraisal review process and mark-to-market an AVM is an acceptable valuation tool in and of itself. When used as the only source of collateral valuation in conjunction with identified federally regulated transactions (e.g. a purchase lien where an appraisal is not required), it can become part of an “evaluation”, and is subject to the Guidelines as stated in Section XIII of the Guidelines. Although CATC would certainly disagree with the conclusions and would be interested in reviewing any supporting data relied upon, the Guidelines do appear to make clear that an AVM by itself does not rise to the level of an evaluation.
‘Inspection’ as Applied Under Appendix B of the Guidelines
This is an area where much of the confusion and to a degree, misinformation seems to be propagating. The intention of requiring the inspection is to gain a clear indication of a property’s condition and marketability as it pertains to value.
Again, the reference is to the language in Section XIII and Appendix B of the guidelines as they apply specifically to an evaluation. Several criteria are enumerated in this section, with “property inspection” being only one, and again, this is not prescriptive, but “principles-based.”
A process will need to be established to meet the following expectations:
A lender needs to be sure that the individual performing the inspection of the property is qualified to perform the inspection, including but not limited to knowledge of the property type. It is not a requirement that the inspector be a licensed appraiser or licensed real estate agent.
Further, the person performing the inspection needs to determine the condition of the property but not review the information pertaining to value or market conditions.
In the Evaluation Content section of the guidelines it is clear that the evaluation may be comprised of discrete parts, developed by the financial institution to complete the evaluation process in a safe and sound manner. These discrete elements may be comprised of an AVM, inspection, market data, etc. as the institutions credit risk and valuation policy dictates for the particular transaction being evaluated.
An evaluation is a compiled document composed of several elements, each addressing different suggested aspects outlined in the Guidelines. The person compiling the evaluation for the financial institution is stating that the elements of the evaluation support its conclusions. The final evaluation should include information on the preparer (the person that compiled the document) such as name, contact information and signature. Sources of each element should be documented as well.
It is critical for institutions to determine the AVM criteria and performance thresholds prior to, and independent of, the selection of an AVM for use in loan origination circumstances. It is simply not good enough to test AVMs and use the one that performs the best since the best performing AVM might not be sufficient to manage the risk.
Independence and the Use of Third-Parties
The guideline strongly reiterates the point that it is a financial institution’s direct responsibility, which may not be delegated, to manage collateral risk, and that the guidelines are not to be treated as a checklist for passing regulatory examinations. Regulated institutions must have clearly defined credit and risk policies, controls and processes in place and a focus on building and maintaining a relationship with their individual regulators.
Unique Scrutiny on AVMs
Despite a tremendous amount of data demonstrating superior loan performance on AVM-backed loans, AVMs have always been subject to an inordinate amount of scrutiny compared to any other valuation alternative. Part of the explanation may certainly be that, relatively speaking, AVMs are the new kids on the block and ultimately performed by computers. Anything new makes people uneasy or suspect despite what the data may indicate to the contrary. Nevertheless, AVMs are in a unique position by the very nature of their design.