Evaluating the Evaluation Bank Evaluation Programs Doug Potts, MAI, VP Commerce Bank
A Few Questions True/False? – Most loan transactions require appraisals. True/False? – Evaluations are killing the appraisal profession. True/False? – Reg B will eventually create more business for appraisers. True/False? – Reg B will - in time - increase available consumer credit.
A Primer on Bank Lending Major Purposes New Loans (new collateral) Subsequent Transactions (existing collateral) Problem Loan Management (“exiting” collateral) Major Loan Categories Consumer purpose lending (GSE / HELOC) Commercial business lending (C & I) Commercial investment lending (CRE) Unclassified lending – the “junk drawer”
Bank Portfolios--Risks & Rewards Where does most of a bank’s workload sit? Do renewals generate new $ for added cost? New loans generate growth in profits 80/20 rule with a vengeance Loan profitability sits in the 20% But the workload sits in the 80% Renewed loans generate $0 added profit But comprises the bulk of a bank portfolio
The Point Is …. When you combine the 80/20 rule with the $0 profit rule …… You need a cost-effective solution to meet Underwriting need Regulatory requirements The key is “adequacy”
The Purpose of Evaluations Regulations require every loan get a value Only some deals require an appraisal. But they also provide for cost effectiveness Spread thin but broadly Load balance tool Balance risk & reward Risk sensitized For loan size (e.g. <$250M de minimis) For repayment reliance (CRE v C&I v Consumer) For portfolio concentration & workload (new v renewal)
Program Basics External Vendor Procured Proliferating Options Growing array of vendors Growing array of evaluation styles & products Coverage & Fulfillment Internally Developed Licensed or Unlicensed Team Members Qualifications & Training Data Sourcing & Inspections QA / QC Controls
Evaluation – Scope of Work Interagency Appraisal & Evaluation Guidelines Flexibility v rigidness When & where to use Defining the problem Creating the solution What will your regulator permit?
2010 IAG Requirements Should contain sufficient information Details analysis, assumptions, conclusions Should be documented in the credit file or reproducible. Identify the location of the property. Provide a description of the property and its current and projected use. Provide an estimate of the property’s market value in its actual physical condition, use and zoning designation as of the effective date of the evaluation (that is, the date that the analysis was completed), with any limiting conditions. Describe the method(s) the institution used to confirm the property’s actual physical condition and the extent to which an inspection was performed.
2010 IAG Requirements #2 Describe the analysis that was performed and the supporting information that was used in valuing the property. Describe the supplemental information that was considered when using an analytical method or technological tool. Indicate all source(s) of information used in the analysis, as applicable, to value the property, including: – External data sources (such as market sales databases and public tax and land records); – Property-specific data (such as previous sales data for the subject property, tax assessment data, and comparable sales information); – Evidence of a property inspection; – Photos of the property; – Description of the neighborhood; or – Local market conditions.
2010 IAG Requirements #3 Include information on the preparer when an evaluation is performed by a person, such as the name and contact information, and signature (electronic or other legally permissible signature) of the preparer.
Let’s Re-Arrange the IAG Ideas Evaluations have 5 major elements Define the problem to be solved Get needed research elements Make needed inspections as appropriate Selecting the right data Doing the math & calculations
Evaluation Scope - Defining the Problem Research & Descriptions Research & Descriptions Inspection & Descriptions Selecting Appriorate Data Calculating an Answer
Eval Content - Preliminaries Defining the Problem Complexity Effective date(s) – what is this? Limiting conditions Can the premise be prospective? Can the zoning be prospective? Basic research & descriptions - Property specific records Neighborhood & market trends Current & projected use Current zoning designation
Eval Content – Inspection Elements Methods to confirm physical condition Describe extent of inspection Evidence of inspection Descriptions inspection details - granularity Property photos
More on Inspections “Methods to confirm physical condition” “Describe extent of inspection” What about? Out of territory property Borrower or lender representation? Shelf life of the representation/inspection? Origination v Renewal? Flexible standard? Credit Quality? Pass v non-pass?
Eval Content –Selecting Data “As applicable” data External sales databases etc. Local market conditions Comparable sales
Eval Content – Calculate an Answer Provide value in actual physical condition Is that the only condition allowed? Describe analysis performed Describe supporting information Data sourcing & selection What valuation technique? What methods? Analytical method or technological tool Analysis performed & supporting information Supplemental information
Eval Content - Fingerprints “When performed by a person” Name / contact info Actual signature Electronic signature Is the evaluator qualified? What about state restrictions?
Evaluation Scope - Defining the Problem Research & Descriptions Inspection & Descriptions Selecting Appriorate Data Calculating an Answer
Limitations Shelf life of evaluations Tailoring for loan-specific issues LTV adequacy Lease structures Environmental impacts & offsets As-is value v prospective value
Evaluation Options & Risk What program to develop and use? “You get to pick your problems, you don’t get to pick no problems….” Internal Program External Vendor Program Appraisal Only – “no evaluations” Hybrid? What about BPO?
The Nexus -- Risk v Regulation Triangulating competing elements Accuracy Adequacy Efficiency Cost effectiveness Does an evaluation need to be accurate? Is accuracy always cost effective? Is precision always necessary? What about low LTV transactions? Using a shotgun to shoot a fly…
External v Internal Eval Programs Consider the business model -- Collateral class – conventional v oddball Market coverage – urban v tract suburb v rural External Model Consistency & uniform product – predictable Within its limits – highly reliable system Fulfillment failure risk Internal Model Flexibility & adaptability Precision subordinated to practicality of business Disclosure Risks
External Products Appraiser-centric or broker-centric Available options How to compare them? How to review them? Fulfillment issues E & O dynamics
Vendor List Product type – residential v commercial Geographic coverage National Urban coverage Rural coverage Appraiser- v broker-centric Branch from national appraisal firm Local vendor based approach
Some Options NameTypeCoverage Best Concentration Performed by BoxwoodCommlNatlUrban/SuburbAppraiser MountainseedCommlNatlUrban/SuburbAppraiser Clear CapitalComml & ResNatlUrb/Sub/RuralBroker Collateral AnalyticsRes 1-4NatlUrban/SuburbAVM CorelogicComml & ResNatlUrb/Sub/RuralAppr Brkr AVM DataQuickRes 1-4NatlUrban/SuburbAppr Brkr AVM First AmericanComml & ResNatlUrban/SuburbAppr Brkr AVM Inside ValuationComml & ResNatlUrban/SuburbBroker ProTeckRes 1-4NatlUrb/Sub/RuralAppr Brkr AVM ValligentRes 1-4NatlUrban/SuburbAppr ValueNetRes 1-4NatlUrban/SuburbAppr AVM VerosRes 1-4NatlAVM
Evaluation Review Needs General v specific Checklist only? Part of the purpose is speed/efficiency Drags on velocity Secondary data confirmations Secondary corroborating data Secondary inspections
Evaluation Review Questions 1.Adequately identifies the collateral property (e.g. legal description, tax number, street address, etc.)? 2.Adequately describes the collateral’s current and (if applicable) projected use? 3.Provides an estimate of the collateral’s market value in “As is” condition & use & (if applicable) zoning as of the effective date of the Alternate Valuation? 4.Indicates all source(s) used in the analysis, as applicable, to value the property (e.g. external data sources, property specific data, photos, neighborhood description, description of local market conditions)? 5.Describes the analysis that was performed and the supporting information that was used in valuing the property? 6.Evidence of a sufficient property inspection (e.g. photographs, comments)? 7.Includes all other relevant information (described as needed in Comments below)? 8.Report includes preparer name and signature?
Here’s an Interesting Wrinkle This review intends to fulfill Regulation B requirements for Residential 1- to 4-unit dwellings. Transactions secured by 1- to 4-unit dwellings that qualify for an evalution by law may be valued for xxxx by outside providers. The valuation document under review may be labeled “Appraisal;” but because of its limited content, it is reviewed under “evaluation” content standards outlined in the Interagency Appraisal & Evaluation Guidelines (effective Dec-2010).
Vendor Management Fulfilling possibilities List of serviced counties How many active vendors How many jobs by county last year Avg fee by county How many fulfillment failures by county Contracts – NDAs - Processing The follow-up process What changes can be incorporated to improve? Portals & ownership
To AMC or Not to AMC Geographic coverage Panel control Customary & Reasonable Fees Waterfall process - upgrades Portals Invoicing Compliance challenges Would it just be cheaper to bring it in house?
Automated Valuation Modeling Products & Options Hit Rates Confidence Intervals & FSD AVM Cascades & Selection Tables Program Benefits Speed – returns in moments Cost effective – even in a cascade/waterfall
AVM Validation - Challenges Regulatory compliance – modelling policy Sample spread Sample size Sample cost Sample frequency Validations methods applied to each event Who owns the validation process?
Trends in Vendor Mgmt Fed management requirements are heavy And getting heavier Escalating compliance costs Many banks are considering moving to in- house programs More product control Compliance is no worse than vendor management Cost is ≤ to vendor management
Internal Evaluation Risks Adequacy of Facts Sufficient documentation Potential inaccuracies Adequacy of Opinions Recognize all needed elements? Disregard elements? Value precision? Does adequate alone = misleading? Misleading to whom? Potential inaccuracies acceptable – big picture Risk is internal business decision
Disclosure Risks Does it matter if an opinion is not disclosed? Can a consumer recognize the difference between an evaluation and appraisal? Consumer wounded ego. What about credit denial? Consumer uses a disclosed eval in unintended ways Eval walks to another bank – portability Divorce litigation or tax appeal Price representations & negotiations Personal financial statement Estate planning or donation
What About Fed/State Compliance The enforcement referral The court subpoena The patchwork quilt of state regulators Mandatory v non-mandatory states Scope of practice Issues State enforcement risk to an internal program Built-in exemptions Fed requirements for qualified evaluators What about AI Ethics/Standards?
Comparing possible programs Outside vendor appraisal Appraisal-centric eval Internal team eval – non licensed Internal team eval –licensed
Can BPOs Help? Shifting risks from in-house to ….. Out-house? The importance of broker/agent skill Local knowledge & customary thinking Can BPOs function as in-lieu evaluations? The IAG restriction? Work arounds? State brokers regulatory prohibitions NAR lobbying in the States
What is NAR Up To? Challenges from Zillow’s sometimes misleading zestimates RealtyAlliance v Local MLSs The RET server: – Who owns the MLS data? What level of access? RPR – the NAR AVM – 600 MLS servers feed it. – Not making money. Trying to grow New NAR rules allow broker developed AVMs in all markets Issuing rules to keep MLS data from being proprietary by local MLS systems NAR pursuing inroads to allow brokers to prepare evaluations for financial institutions without a potential listing.
Dodd Frank & Reg B / ECOA Key New Definitions Borrower Transaction Collateral – what is a dwelling? Notification v disclosure Consumer purpose or Secured by 1-4 Unit Dwelling The Dwelling Trump Card Mission creep from law to rule-making
Reg B Notice & Disclosure LOAN PURPOSE V COLLATERAL CLASS PROBLEM COLLATERAL CLASS LOAN PURPOSE ConsumerBusiness Reg B Mandated 1-4u dwelling Notice & DisclosureNo Notice & Disclosure Reg B Exempt Everything else Notice / No disclosureNo Notice / No disclosure
Reg B Impacts Community Banks Increases financing & liability risk Forces disclosure of potentially inaccurate but otherwise adequate analysis Requires deal restructure – financing unsecured to avoid documentation of value Potentially inaccurate but otherwise adequate can be misconstrued or misused by borrower Alternative is to order more vendor product to deflect risk Limits credit access to community borrowers Inflexible rules don’t sync with the physical collateral world Added cost of vendor product Added delay of vendor product
Reg B Impacts Consumers Increases confusion Blurs distinctions from consumer to biz deals Treats all “valuations” equally for disclosure Increases cost Vendor products more costly than internal products Prioritizes precision over adequacy Increases delay Vendor products take additional time Risk of fulfillment failure
Homebuilder Impacts Reg B intended to give each of thousands of individual consumers an individual appraisal. but instead …. Reg B requires a handful of homebuilders to receive thousands of appraisals
Hybrid Product – the BPO Eval Can it “shift the risk” ? How to qualify the valuation elements? Opine price or value -- both? IAG limitations Review based qualification of BPO opinion? Separate opinion using BPO elements only? Convert into bank-issued estimate of value Who inks it? Qualification v state compliance risk Wiggle words - disclaimers E & O need?
Appraisers Re-enter the Eval Space USPAP & state restrictions Economics E & O coverage
Techtonic Shifts AI Standards v USPAP FRTs v RET? Where do evaluations fit? Should we cage USPAP into FRT only? HR 5148 (Leutkemeyer TILA High Risk Mortgage Bill) Federal pre-emption – supremacy clause See Gibbons v Ogden 22 US 1 (1824) See Gade v National Solid Wastes Mgmt Assoc 505 US 88.98 (1992) See Florida Lime v Avocado Growers Inc v Paul 373 US 132, 142-43 (1962)
The Pre-Flight Evaluation The good-housekeeping seal of approval Post-eval changes to loan – Impact on eval reliability Ordering a subsequent appraisal – Valuation priority of place
Foreclosure Evaluations What is allowed – de minimis rules. Risks v benefits of use Can you manage the inspection? How to manage accounting needs Fair Value Liquidation / Distress Value Pre-foreclosure requirements Post-foreclosure surprises
The Forensic Evaluation Multiple evaluations over time Same asset Allows a measure of market change Retrospective analysis to test an appraisal Showing editorial selection process What comps were uncovered but not used
Evaluation in Portfolio Monitoring The Nexus of Accuracy v Adequacy Existing collateral & the subsequent transaction Transaction cost v flat profitability shift Floor values on file as adequacy filter Against current balance? Increasing balance? Declining value? Physical deterioration? Methods? Owner occupied class Investment class Special cases