Mortgage Fraud: Basic Categories

QUESTION 

We are reviewing our branch and home office procedures for identifying mortgage fraud. As the Compliance Officer, I receive all allegations of mortgage fraud for review. However, I can't be at all the branches all the time, and I want to be able to categorize some basic areas related to mortgage fraud. 

Each branch has a Branch Manager who works with a senior underwriter to identify potential mortgage fraud. The senior underwriter conducts a second review, and the Branch Manager provides oversight. Even with the training we do, there is no standardization for a categorical approach. What I am looking for is a list of the most likely areas of mortgage fraud. We would like to distribute the list so that it can be used throughout the company. It will help us to set basic standards. 

What are some of the basic categories of mortgage fraud? 

COMPLIANCE SOLUTION 

QC Tune-up® 

Forensic Mortgage Audit®

RESPONSE 

Mortgage fraud prevention is an area in which we have extensive expertise. Indeed, we invented the Forensic Mortgage Audit®, which uses loan-level reviews to detect mortgage fraud. I've provided expert witness representation and given testimony in cases related to mortgage fraud. Our clients regularly discuss potential cases of it with us. We've written policies and procedures to prevent it. I've spoken about it at conferences and written extensively on the topic, for instance, here. 

Here's my published article, with linked sections, entitled Mortgage Fraud Challenges: How to Catch a Crook. 

And I can tell you, based on my experience, crooks continue to find new ways to commit mortgage fraud all the time. To identify the means and methods of these crooks requires staying one step ahead of them – and, even then, they devise new plans to scam, deceive, rip off, con, double-deal, cheat, and skunk their way toward new contrivances of chicanery. 

For instance, request information about our Identity Theft Prevention Program – a program which, by the way, is a statutory requirement. Our policy provides an extensive list of the various nefarious methods by which thieves commit mortgage fraud. 

If you are a subscriber to our newsletters, we will be happy to provide our checklist of Common Red Flags for Mortgage Fraud. Just request it here! 

BASIC CATEGORIES

The basic features of mortgage fraud revolve around intentional deception or misrepresentation to obtain a mortgage loan or to profit from the lending process. 

If you're looking for a basic set of mortgage fraud categories, it is possible to group them into a few areas, with the proviso that this construct is a very high-level outline. The outline should not be taken as comprehensive. But if you want to offer it to the affected personnel, it might help to streamline the review process. 

I think you should still be notified that a mortgage fraud review is taking place, even if the second review clears it. Be aware of potential false positives! 

In my opinion, mortgage fraud can be categorized into fraud for housing, fraud against homeowners, and fraud for profit. Unfortunately, industry professionals are often involved in mortgage fraud activities in pursuit of profits. 

So, let's outline these categories. 

Fraud for Housing 

This illicit activity happens when a borrower provides false information to acquire or maintain ownership of a home. A borrower commits this type of fraud to obtain or maintain ownership of a home in an illegal manner. They may misrepresent their financial standing to qualify for a loan they would not otherwise be able to get. 

Categories of Fraud For Housing 

Income and Employment Fraud 

Falsifying or inflating income, fabricating employment history, or creating forged documents like W-2s, tax returns, and bank statements to qualify for a larger loan or a better interest rate.

Appraisal and Evaluation Program

QUESTION 

Our state banking department requested that we update our independent appraisal policy. They want us to update the "Appraisal and Evaluation Program." And they want us to provide information about its independence. We bought the policy from a company that sells mortgage policies, but the examiner says the policy is "defective." 

We went back to the mortgage policy company, and they said there was nothing wrong with their policy. Obviously, there's something wrong if an examiner has a problem with it! We told the examiner that the mortgage manuals company is well known, but she didn't care and told us to update the policy. 

We don't know what to put into the policy to satisfy the examiner. We need some pointers. 

What is an appraisal and evaluation program? 

What is independence in relation to an appraisal and evaluation program? 

ANSWER 

The term "Appraisal and Evaluation Program" is found in variations throughout various regulatory frameworks. An institution's board of directors or its designated committee is responsible for adopting and reviewing policies and procedures that establish an effective real estate appraisal and evaluation program. 

We believe there are certain features of an appraisal and evaluation program. The program should: 

·       Provide for the independence of the persons ordering, performing, and reviewing appraisals or evaluations. 

·       Establish selection criteria and procedures to evaluate and monitor the ongoing performance of appraisers and persons who perform evaluations. 

·       Ensure that appraisals comply with the agencies' appraisal regulations and are consistent with supervisory guidance. 

·       Ensure that appraisals and evaluations contain sufficient information to support the credit decision. 

·       Maintain criteria for the content and appropriate use of evaluations consistent with safe and sound banking practices. 

·       Provide for prompt receipt and review of the appraisal or evaluation report to facilitate the credit decision. 

·       Develop criteria to assess whether an existing appraisal or evaluation may be used to support a subsequent transaction. 

·       Implement internal controls that promote compliance with these program standards, including those related to monitoring third party arrangements. 

·       Establish criteria for monitoring collateral values. 

·       Establish criteria for obtaining appraisals or evaluations for transactions that are not otherwise covered by the appraisal requirements of the appraisal regulations. 

Regarding the independence of the appraisal and evaluation program, for both appraisal and evaluation functions, an institution should maintain standards of independence as part of an effective collateral valuation program for all of its real estate lending activity. 

The collateral valuation program is an integral component of the credit underwriting process and, therefore, should be isolated from influence by the institution's loan production staff. We also recommend that an institution establish reporting lines independent of loan production for staff who administers the institution's collateral valuation program, including the ordering, reviewing, and acceptance of appraisals and evaluations. 

Appraisers must be independent of the loan production and collection processes and have no direct, indirect, or prospective interest, financial or otherwise, in the property or transaction.[i] These standards of independence also should apply to persons who perform evaluations. 

For a small or rural institution or branch, it may not always be possible or practical to separate the collateral valuation program from the loan production process. If absolute lines of independence cannot be achieved, an institution should be able to demonstrate clearly that it has prudent safeguards to isolate its collateral valuation program from influence or interference from the loan production process. In such cases, another loan officer, other officer, or company director may be the only person qualified to analyze the real estate collateral. However, to ensure their independence, such lending officials, officers, or directors must abstain from any vote or approval involving loans on which they ordered, performed, or reviewed the appraisal or evaluation.[ii] 

Communication between the institution's collateral valuation staff and an appraiser or person performing an evaluation is essential for exchanging appropriate information relative to the valuation assignment. An institution's policies and procedures should specify communication methods that ensure independence in the collateral valuation function. These policies and procedures should foster timely and appropriate communications regarding the assignment and establish a process for responding to questions from the appraiser or person performing an evaluation. 

We are often asked if an institution may exchange information with appraisers and persons who perform evaluations. The short answer is Yes, with restrictions; for example, you may provide a copy of the sales contract[iii] for a purchase transaction. However, an institution should not directly or indirectly coerce, influence, or otherwise encourage an appraiser or a person who performs an evaluation to misstate or misrepresent the property's value. 

Consistent with its policies and procedures, an institution also may request the appraiser or person who performs an evaluation to: 

·       Consider additional information about the subject property or comparable properties. 

·       Provide additional supporting information about the basis for a valuation. 

·       Correct factual errors in an appraisal. 

Furthermore, an institution's policies and procedures should ensure that it avoids inappropriate independence of the collateral valuation function, including: 

·       Communicating a predetermined, expected, or qualifying estimate of value, or a loan amount or target loan-to-value ratio to an appraiser or person performing an evaluation; 

·       Specifying a minimum value requirement for the property that is needed to approve the loan or as a condition of ordering the valuation; 

·       Conditioning a person's compensation on loan consummation; 

·       Failing to compensate a person because a property is not valued at a certain amount;[iv] 

·       Implying that current or future retention of a person's services depends on the amount at which the appraiser or person performing an evaluation values a property; and 

·       Excluding a person from consideration for future engagement because a property's reported market value does not meet a specified threshold. 

After obtaining an appraisal or evaluation, or as part of its business practice, a institution may find it necessary to obtain another appraisal or evaluation of a property. You would be expected to adhere to a policy of selecting the most credible appraisal or evaluation rather than the appraisal or evaluation that states the highest value. 

Further, an institution's reporting of a person suspected of non-compliance with the Uniform Standards of Professional Appraisal Practice (USPAP) and applicable federal or state laws or regulations or otherwise engaged in other unethical or unprofessional conduct to the appropriate authorities would not be viewed by governmental agencies as coercion or undue influence. Indeed, an institution should not use the threat of reporting a false allegation to influence or coerce an appraiser or a person who performs an evaluation.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[i] The Agencies’ appraisal regulations set forth specific appraiser independence requirements that exceed those set forth in the Uniform Standards of Professional Appraisal Practice (USPAP). Institutions also should be aware of separate requirements on conflicts of interest under Regulation Z (Truth in Lending Act), see 12 CFR 1026.42(d).

[ii] For instance, the NCUA has recognized that it may be necessary for credit union loan officers or other officials to participate in the appraisal or evaluation function although it may be sound business practice to ensure no single person has the sole authority to make credit decisions involving loans on which the person ordered or reviewed the appraisal or evaluation. 55 FR 5614, 5618 (February 16, 1990), 55 FR 30193, 30206 (July 25, 1990).

[iii] Refer to USPAP Standards Rule 1-5(a) and the Ethics Rule.

[iv] This provision does not preclude an institution from withholding compensation from an appraiser or person who provided an evaluation based on a breach of contract or substandard performance of services under a contractual provision.

Reconsideration of Value and Appraisal Independence

QUESTION 

We are a large wholesale lender. I am a senior underwriter. Every week, we get requests from our broker partners to have properties reappraised. When the appraisal comes back below what they need, they complain to the Account Executives, who then request that we ask for an appraisal re-evaluation.   

Whether we use an AMC or a staff appraiser, we go through a set of procedures to request a second appraisal review to get a valuation closer to the broker’s expectations. It doesn’t always work out, but sometimes we find deficiencies in the original appraisal report, which, if adjusted for, can change the valuation. 

We have a Reconsideration of Value policy and procedure for this process. Our problem is that the new compliance officer is taking the position that this process interferes with appraisal independence. I would like to know if appraisal independence is compromised by requesting a re-evaluation. 

Does Reconsideration of Value compromise appraisal independence? 

Are there procedures we can implement to avoid compromising appraisal independence? 

ANSWER 

There are risks associated with deficient residential real estate valuations. However, financial institutions may incorporate Reconsideration of Value (“ROV”) processes and controls into established risk management functions.[i] The risk occurs not only in collateral valuation models but also in the risk of discrimination impacting residential real estate valuations. 

One problem in providing guidance to you is that no existing requirements are specific to ROV processes. For purposes of this article, I will define an ROV as a request from the financial institution to the appraiser or other preparer of the valuation report to re-assess the report based upon potential deficiencies or other information that may affect the value conclusion. There is some uncertainty in the industry on how ROVs intersect with appraisal independence requirements and compliance with Federal consumer protection laws, including those related to nondiscrimination. 

Collateral valuations may be deficient due to prohibited discrimination; errors or omissions; or valuation methods, assumptions, data sources, or conclusions that are otherwise unreasonable, unsupported, unrealistic, or inappropriate. The concern is that deficient collateral valuations can keep individuals, families, and neighborhoods from building wealth through homeownership by potentially preventing homeowners from accessing accumulated equity, preventing prospective buyers from purchasing homes, thereby making it harder for homeowners to sell or refinance their homes, and increasing the risk of default. 

Up front, it should be understood that valuations that are not credible may pose risks to a financial institution's financial condition and operations. Such risks may include loan losses, violations of law, fines, civil monetary penalties, payment of damages, and civil litigation. 

Regulatory Framework

There are several regulatory frameworks that, taken together, form the basis for ROV activities. For instance, the Equal Credit Opportunity Act (ECOA), and its implementing regulation, Regulation B, prohibit discrimination in any aspect of a credit transaction. The Fair Housing Act (FH Act) and its implementing regulation prohibit discrimination in all aspects of residential real estate-related transactions. ECOA and the FH Act prohibit discrimination based on race and certain other characteristics in residential real estate-related transactions, including in real estate valuations. 

In addition, section 5 of the Federal Trade Commission Act prohibits unfair or deceptive acts or practices, and the Consumer Financial Protection Act prohibits any covered person or service provider of a covered person from engaging in any unfair, deceptive, or abusive act or practice. 

The Truth in Lending Act (TILA) and its implementing regulation, Regulation Z, establish certain federal appraisal independence requirements. Specifically, TILA and Regulation Z prohibit compensation, coercion, extortion, bribery, or other efforts that may impede the appraiser’s independent valuation in connection with any covered transaction. However, Regulation Z also explicitly clarifies that it is permissible for covered persons to, among other things, request the valuation preparer to consider additional, appropriate property information, including information about comparable properties, or to correct errors in the valuation. 

The appraisal regulations implementing Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 require all appraisals conducted in connection with federally related transactions to conform with the Uniform Standards of Professional Appraisal Practice (USPAP), which requires compliance with all applicable laws and regulations including nondiscrimination requirements. 

Applicable appraisal regulations also require appraisals to be subject to appropriate review for compliance with USPAP. Financial institutions generally conduct an independent review prior to providing the consumer a copy of the appraisal or evaluation; however, an additional review may be warranted if the consumer provides information that could affect the value conclusion or if deficiencies are identified in the original appraisal. 

An appraisal does not comply with USPAP if it relies on a prohibited basis set forth in either the ECOA or the FH Act or contains material errors, including errors of omission or commission. If a financial institution determines through the appraisal review process, or after consideration of information later provided by the consumer, that the appraisal does not meet the minimum standards outlined in the appraisal regulations and if the deficiencies remain uncorrected, the appraisal cannot be used as part of the credit decision. 

Interagency Guidance

The Federal Reserve Board, FDIC, NCUA, and OCC have issued interagency guidance describing actions that financial institutions may take to resolve valuation deficiencies. These actions include the following:

• resolving the deficiencies with the appraiser or preparer of the valuation report; 
• requesting a valuation review by an independent, qualified, and competent state-certified or licensed appraiser; or
• obtaining a second appraisal or evaluation. 

Deficiencies may be identified through the financial institution’s valuation review or consumer-provided information. The regulatory framework does permit financial institutions to implement ROV policies, procedures, and control systems that allow consumers to provide and the financial institution to review relevant information that may not have been considered during the appraisal or evaluation process.

Appraisers and Third Parties 

You mentioned the use of AMCs. You must know that a financial institution’s use of third parties in the valuation review process does not diminish its responsibility to comply with applicable laws and regulations. Moreover, whether valuation review activities and resolving deficiencies are performed internally or via a third party, financial institutions supervised by the Board, FDIC, NCUA, and the OCC are required to operate safely and soundly and in compliance with applicable laws and regulations, including those designed to protect consumers. 

In addition, the CFPB expects financial institutions to oversee their business relationships with service providers in a manner that ensures compliance with Federal consumer protection laws, which are designed to protect the interests of consumers and avoid consumer harm. A financial institution’s risk management practices include managing the risks arising from its third-party valuations and valuation review functions. 

Now to turn to Reconsideration of Value itself in the loan flow process. 

Reconsideration of Value

An ROV request by the financial institution to the appraiser or other preparer of the valuation report encompasses a request to reassess the appraisal report based on deficiencies or information that may affect the value conclusion. A financial institution may initiate a request for an ROV because of the financial institution’s valuation review activities or after consideration of information received from a consumer through a complaint or appeal to the loan officer or other lender representative. 

A consumer inquiry or complaint regarding a valuation would generally occur after the financial institution has conducted its initial appraisal or evaluation review and resolved any issues identified. Given this timing, a consumer may provide specific and verifiable information that may not have been available or considered when the initial valuation and review were performed. Regardless of how the request for an ROV is initiated, a request could be resolved through a financial institution’s independent valuation review or other processes to ensure credible appraisals and evaluations. 

An ROV request may include consideration of comparable properties not previously identified, property characteristics, or other information about the property that may have been incorrectly reported or not previously considered, which may affect the value conclusion. To resolve deficiencies, including those related to potential discrimination, financial institutions can communicate relevant information to the original valuation preparer and, when appropriate, request an ROV. 

Complaint Resolution

At the core of the complaint that triggers the ROV request is the complaint resolution process. Financial institutions can capture consumer feedback regarding potential valuation deficiencies through existing complaint resolution processes. The complaint resolution process may capture complaints and inquiries about the financial institution’s products and services offered across all lines of business, including those provided by third parties, as well as complaints from various channels (such as letters, phone calls, in-person, transmittal from regulators, third-party valuation service providers, emails, and social media). 

Depending on the nature and volume, appraisal and other valuation-based complaints and inquiries can be important indicators of potential risks and risk management weaknesses. Appropriate policies, procedures, and control systems can adequately address the monitoring, escalating, and resolving of complaints, including determining the merits of the complaint and whether a financial institution should initiate an ROV.

Policies and Procedures

With respect to procedures you can implement to avoid compromising appraisal independence, there are several policies, procedures, and control systems that should be considered. I will offer a brief outline of such systemic activities that should be installed in the loan flow process.

Appraiser Selection and Independence

QUESTION 

We had a problem recently with one of our appraisers. Long story short, he had a criminal background that we did not know about. We found out about it when he got caught falsifying his evaluations by getting bribed by a loan officer. 

Both the appraiser and the loan officer were fired. As the one and only compliance manager in our company, it is up to me to revise our appraiser independence policy. I need to know how to select appraisers and how to manage our appraiser list. 

What criteria should I use to select appraisers? 

How do I manage the appraiser list? 

ANSWER 

Don't be too hard on yourself. You might have a decent appraiser independence policy; however, people who are set on committing crimes will tend to ignore your standards and do whatever they can to defeat your protective systems. 

This is why it is not sufficient just to have a good appraiser independence policy. You must monitor it and conduct risk assessments. We offer the AIR Tune-up to give you the feedback you need about Appraiser Independence Requirements. Contact us and we'll send you information about it. 

An institution's collateral valuation program should establish criteria to select, evaluate, and monitor the performance of appraisers and persons who perform evaluations. 

The criteria should ensure that: 

·     The person selected possesses the requisite education, expertise, and experience to complete the assignment competently; 

·     The institution periodically reviews the work performed by appraisers and persons providing evaluation services; 

·     The person selected is capable of rendering an unbiased opinion; and 

·     The person selected is independent and has no direct, indirect, or prospective interest, financial or otherwise, in the property or the transaction. 

The appraiser selected to perform an appraisal must hold the appropriate state certification or license at the time of the assignment. 

Importantly, persons who perform evaluations should possess the appropriate appraisal or collateral valuation education, expertise, and experience relevant to the type of property being valued. Such persons may include appraisers, real estate lending professionals, agricultural extension agents, or foresters.[i] 

An institution or its agent must directly select and engage appraisers. The only exception to this requirement is that the Agencies' appraisal regulations allow an institution to use an appraisal prepared for another financial services institution, provided certain conditions are met. 

An institution or its agents also should directly select and engage persons who perform evaluations. Independence is compromised when a borrower recommends an appraiser or a person to perform an evaluation. 

Independence is also compromised when loan production staff selects a person to perform an appraisal or evaluation for a specific transaction. For certain transactions, an institution also must comply with the provisions addressing valuation independence in Regulation Z (Truth in Lending Act).[ii] 

An institution's selection process should also ensure that a qualified, competent, and independent person is selected for a valuation assignment. An institution should maintain documentation to demonstrate that the appraiser or person performing an evaluation is competent, independent, and has the relevant experience and knowledge for the market, location, and type of real property being valued. 

Furthermore, the person who selects or oversees the selection of appraisers or persons providing evaluation services should be independent from the loan production area. 

Your institution should prohibit the use of borrower-ordered or borrower-provided appraisals, as this would violate the Agencies' appraisal regulations. However, a borrower can inform an institution that a current appraisal exists, and the institution may request it directly from the other financial services institution. 

With respect to managing the approved appraiser list, if an institution establishes an approved appraiser list for selecting an appraiser for a particular assignment, it should have appropriate procedures for the development and administration of the list. 

These procedures should include a process for qualifying an appraiser for initial placement on the list and periodic monitoring of the appraiser's performance and credentials to assess whether to retain the appraiser on the list. 

There should be periodic internal reviews of the approved appraiser list to confirm that appropriate procedures and controls exist to ensure independence in the list's development, administration, and maintenance. 

For residential transactions, loan production staff can use a revolving, pre-approved appraiser list, provided the development and maintenance of the list are not under their control. 

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[i] Although not required, an institution may use state certified or licensed appraisers to perform evaluations. Institutions should refer to USPAP Advisory Opinion 13 for guidance on appraisers performing evaluations of real property collateral

[ii] See 12 CFR § 1026.42

Appraisal Compliance – Required Procedures

QUESTION 

We revised our appraisal management policy. Our banking department told us it should include both required and Best Practices. We do not know much about the Best Practices involved in appraisal management. 

Last year we got approved by Fannie Mae, and yesterday we received their MORA letter to come here and do an audit. I think we're unprepared for the appraisal management policies and procedures. 

Our main concern involves the required procedures. We appreciate your response. Thank you! 

What are some required appraisal management procedures for an appraisal management policy? 

ANSWER 

Your Appraisal Management policy and its references to Appraiser Independence Requirements (AIR) should contain a checklist to support your self-assessment. I will provide a responsive but not necessarily comprehensive reply because these aspects of appraisal compliance are somewhat vast. You can contact me here to discuss your concerns or retain us to review your Appraisal Management policy. 

Indeed, it is the case that many state banking departments and the GSEs expect companies to conduct self-assessments. If you've been following my articles, hopefully, you have noted my descriptions of the importance of these self-assessments. 

There are many required self-assessment criteria relating to appraisal compliance. When we conduct an Appraiser Tune-up®, we consider these criteria. We also consider many recommended or Best Practices criteria in our evaluation. Required assessments and Best Practices should be part of your Appraisal Management and AIR initiatives. 

I am offering an outline below; however, depending on a financial institution's size, complexity, and risk profile, the list may need to contain many more processes. 

Required Review Criteria for Appraisal Compliance 

·      Qualified appraisers and appraisal management companies (AMC) should be selected according to GSE guidelines – essentially, the industry standard. 

·      Sales and loan production employees should be restricted from the appraisal process (i.e., ordering appraisals and communicating with the appraiser). 

·      Be sure to have "firewalls" in place to ensure no employee, director, agent of your company, or any third party acting on behalf of your company influences the ordering, development, reporting, result, or review of an appraisal through coercion, extortion, collusion, compensation, inducement, intimidation, bribery, or in any other manner. Review these actions with counsel if unsure of what legally constitutes them. Include examples, as needed. 

·      If you are a wholesale lender, implement controls to prevent the mortgage broker from selecting from an approved appraiser AMC list. 

·      At least annually, AMC and appraiser lists should be reviewed for credentials and licensing. 

·      Include a process flow regarding AIR to manage appraisal assignment distribution properly. 

·      Be sure there is a systemic means to provide a copy of the appraisal to borrower(s). Alternatively, make sure there is a systemic means to get a signed waiver at least three days before closing. And, be sure there is a systemic means to ordering transferred conventional appraisals in adherence to AIR. 

·      Before ordering the appraisal, be sure that the assigned appraiser has the active credentials and appropriate license level to complete appraisal assignments based on the complexity and transaction amount, among other things. 

·      Appraisers should evince sound reasoning and provide evidence to support the methodology chosen to develop the value opinion; therefore, there should be a procedure to ensure such oversight, particularly in cases not explicitly covered by GSE guidelines. 

·      Before the loan delivery, priority procedures should be established for appraisals to be successfully submitted to the GSE portals (i.e., to Fannie Mae through the Uniform Collateral Data Portal (UCDP)). 

·      Continually evaluate the appraiser's work through the quality control process. 

·      A dedicated staff should be designated to be responsible for appraisal quality. 

·      If you use an AMC, an oversight process must be implemented to monitor the outcomes of the work produced. All defects should be noted and cured. 

·      Compare potential new appraisers to an in-house exclusionary list, other investor exclusionary lists, and, for instance, Fannie Mae’s Appraiser Quality Monitoring (AQM) list. (The AQM list  includes appraisers whose work is subject to 100% post-acquisition review or is no longer accepted by Fannie Mae.) If you encounter appraiser misconduct, you should refer the matter to the applicable state appraiser certifying and licensing agency or other relevant regulatory bodies. 

·      Report fraudulent appraisal practices to the Mortgage Asset Research Institute (MARI), the GSEs, The Appraisal Foundation, and state and/or local regulatory authorities. 

·      If you use Desktop Underwriter (DU), validate that the property condition has not materially changed in areas identified as disaster areas, and procedures should provide the requirements to resubmit loan case files to DU. 

·      Pay attention to high risk scores, escalating through a process to review appraisals with high Collateral Underwriter (CU) risk scores (viz., 4 or 5 on a scale of 1 to 5, with 5 being the riskiest)

Note: You must establish policies and procedures to ensure that loans - whether or not your financial institution originated them - are not secured by properties encumbered with a private transfer fee.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
Lenders Compliance Group

AVMs and the “Fifth Factor”

QUESTION

We have a question that involves appraisals and AVMs. Our concern is about the new proposals coming out of the CFPB about computer models influencing home valuations. As we understand it, their view is that these models could cause fair lending violations. 

We’ve read whatever we could about this proposal. However, it still is a bit confusing because computer models are simply not something that we know anything about. It makes us feel that this is a potential blind spot that could expose us to fair lending risk. 

It would be great if you’d explain the CFPB’s proposal in layman’s terms. 

How does the CFPB’s proposal about AVMs and computer models potentially cause fair lending violations? 

ANSWER

I know how you feel. Sometimes it seems like you have to be a computer wiz to stay current with the latest and greatest digital improvements used to originate loans. I’ll explain the CFPB’s proposal. Hopefully, it will give you a better understanding. 

The proposal involves potential requirements to prevent “algorithmic” bias in home valuations. The word “algorithmic” just means a set of concise rules that must be followed, for instance, in doing calculations. It has come to be associated with computer science, but it’s actually a term used in many disciplines. 

Let’s refer, then, to the proposal as involving “Algorithmic Bias,” which, in fact, is the CFPB’s terminology. The Bureau's proposal is entitled Consumer Financial Protection Bureau Outlines Options to Prevent Algorithmic Bias in Home Valuations.[i] 

Categorically, the proposal involves compliance management, ECOA (Regulation B), fair Lending, Fintech (Financial Technology), and Real Estate Appraisals. You can comment on the proposal at the CFPB. All potentially affected entities will have the opportunity to comment once these new AVM rules are proposed. 

In essence, the CFPB announced an initiative to ensure that computer models used to help determine home valuations are accurate and fair. Thus, the Bureau outlined the options it is considering in connection with future rulemaking on quality control standards for automated valuation models (AVMs). 

First, some background and then an explication of where this all goes. 

According to the CFPB,[ii] 

“When underwriting a mortgage, lenders typically require an appraisal, which is an estimate of the home’s value. While traditional appraisals are conducted in person, many lenders also employ algorithmic computer models. These models use massive amounts of data drawn from many sources to value homes. The technical term for these models is automated valuation models. Both in-person and algorithmic appraisals appear to be susceptible to bias and inaccuracy, absent appropriate safeguards.” 

The CFPB claims that 

“AVMs can pose fair lending risks to homebuyers and homeowners. [It] is particularly concerned that without proper safeguards, flawed versions of these models could digitally redline certain neighborhoods and further embed and perpetuate historical lending, wealth, and home value disparities.” 

This claim leads the CFPB to conclude that “computer models and algorithms…[used in] AVMs can pose fair lending risks to homebuyers and homeowners.” 

The CFPB’s oversight of these computer models is multifold, including: 

·       Ensuring a high level of confidence in the estimates produced by automated valuation  models;

·       Protecting against the manipulation of data;

·       Seeking to avoid conflicts of interest;

·       Requiring random sample testing and reviews; and

·       Accounting for any other such factor that the agencies determine to be appropriate. 

Where is this all going? 

It is going to the Fifth Factor. 

The CFPB is considering including an AVM nondiscrimination quality control factor, referred to as the “Fifth Factor.” Under this option, entities would be required to adopt policies and procedures specifically designed to mitigate fair lending risk in the use of AVMs. This would be an obligation independent of the preexisting obligation to comply with federal nondiscrimination requirements. 

There are two alternative compliance approaches the CFPB is considering. 

Under the first approach, entities would have the flexibility to design the relevant, fair lending policies, practices, and control systems in a manner that is tailored to their business models and commensurate with the institution’s risk exposures, size, and business activities. 

Under the second approach, the CFPB is considering whether compliance with applicable nondiscrimination laws for AVMs is already encompassed within the first Four Factors; specifically, the factors requiring: 

Factor 1: A high level of confidence in the estimates produced by AVMs; 

Factor 2: Protection against the manipulation of data;

Factor 3: Avoidance of conflicts of interest; and 

Factor 4: Random sample testing and reviews.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[i] Consumer Financial Protection Bureau Outlines Options to Prevent Algorithmic Bias in Home Valuations, Consumer Financial Protection Bureau, Newsroom, February 23, 2022 https://www.consumerfinance.gov/about-us/newsroom/cfpb-outlines-options-to-prevent-algorithmic-bias-in-home-valuations

[ii] Idem, this and following quotes.

Appraiser Coercion

QUESTION

We are a small lender in the southeast. We originate only conventional loans. We are currently licensed in three states. 

Last fall, we had a state banking examination which didn’t go well. The examiner found several problems but the biggest involved how we deal with appraisers. 

The banking department sent us their report, which showed a few instances of “appraiser coercion.” I have to say, this really caught us off guard because we thought that our procedures prevented that from happening. However, now we are facing the potential for serious administrative actions. 

What guidance can you provide on how we could avoid a charge that we coerce appraisers? 

ANSWER

Many companies do not tend to have a comprehensive understanding of appraiser independence. They think of it as a compliance issue, meaning a regulatory matter. But it is much more. There is a view that adopting policies and procedures is a sufficient resolution, but there is hardly much implementation monitoring. 

Appraiser independence, when done correctly, can prevent appraiser coercion. 

You should be monitoring appraiser independence – whether appraisers are staffed, individually retained, or in an Appraisal Management Company (AMC). If you were to have been doing such monitoring, you might have caught the appraiser coercion issues and corrected them. You could have conducted the review internally or used our firm to provide the Appraiser Tune-up. Either way, the decision not to monitor was irresponsible. 

Keep this in mind: appraiser independence covers a broad range of appraisal rules, such as the ECOA appraisal rule. There are many dimensions to ensuring that appraiser coercion is avoided. I will provide a brief list that should help you prepare appropriate procedures. But, remember, without monitoring, your procedures are no more than useless pontifications. 

Notwithstanding the prohibitions that I will outline, a lender may ask an appraiser to consider additional information about a dwelling or comparable properties. A lender may ask an appraiser to provide additional information about the basis for a valuation or correct factual errors in a valuation. And, a lender may withhold compensation for breach of contract or substandard performance as provided by contract. 

Here are some prohibitions that I have compiled. The list is certainly not meant to be comprehensive. 

A lender must not imply to an appraiser that the current or future retention of the appraiser depends on the amount at which the appraiser values a dwelling. Indeed, you must not exclude an appraiser from consideration for future engagement because the appraiser reports a value that does not meet or exceed a minimum threshold. 

Along the same lines, you must not withhold or threaten to withhold payment or partial payment for an appraisal report because the appraiser does not value a dwelling at or above a certain amount; and you must not condition an appraiser’s compensation on loan consummation. 

Trying to influence the appraiser leads into the appraiser coercion ditch quickly. Thus, you shouldn’t attempt to influence an appraiser by withholding or threatening to withhold future business for an appraiser, or demoting or terminating or threatening to demote or terminate an appraiser. Moreover, a lender must not attempt to influence an appraiser by expressly or impliedly promising future business, promotions, or increased compensation for an appraiser. Avoid the quid pro quo debacle, where a lender attempts to influence an appraiser by conditioning the ordering of an appraisal report or the payment of an appraisal fee or salary or bonus on the opinion, conclusion, or valuation to be reached or on a preliminary estimate requested from an appraiser. 

One violation we encounter much too often is where a lender attempts to influence an appraiser by asking the appraiser to provide an estimated, predetermined, or desired valuation in an appraisal report before completion of the appraisal report or requesting the appraiser to provide estimated values or comparable values or comparable sales at any time prior to the appraiser’s completion of an appraisal report. Furthermore, you must not attempt to influence an appraiser by providing a minimum reported, anticipated, estimated, encouraged, or desired value for a subject property or a proposed or target amount to be loaned to the borrower, other than a copy of the sales contract for a purchase transaction. 

Any form of bribing the appraiser lead straight to administrative action. Put bluntly, a lender must not attempt to influence an appraiser by providing stock or other financial or non-financial benefits to an appraiser, appraisal company, appraisal management company, or any entity or person related to the appraiser, appraisal company, or appraisal management company. 

Another coercive tactic is where a lender allows the removal of an appraiser from a list of qualified appraisers without prior notice to the appraiser, including written evidence of the appraiser’s illegal conduct, a violation of the Uniform Standards of Professional Appraisal Practice (USPAP), or state licensing standards, substandard performance, improper or unprofessional behavior or other substantive reason for removal. This prohibition does not preclude the management of appraiser lists for bona fide administrative reasons based on written management-approved policies. 

An adverse finding that comes up in our monitoring reviews occurs where a lender orders, obtains, uses, or pays for a second or subsequent appraisal or automated valuation model in connection with a mortgage loan, unless, of course, the lender has a reasonable basis to believe that the initial appraisal was flawed or tainted. With respect to a reasonable basis in believing an appraisal to be flawed or tainted, that view should be clearly and appropriately noted in the loan file. The appraisal or automated valuation model may be done pursuant to written, pre-established, bona fide, pre-funding or post-closing appraisal review or quality control process (or underwriting guidelines), in which case the lender should adhere to a policy of selecting the most reliable appraisal rather than the appraisal that states the highest value. 

A lender must not ask an appraiser to remove details about the material condition of the property to avoid problems in qualifying certain types of mortgage loans. 

Finally, do not threaten to place an appraiser on a “blacklist” (i.e., an exclusionary list), which is sometimes used to blackball appraisers for refusing to hit a predetermined value.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

Unduly Influencing an Appraiser

QUESTION
We have been assessed with an administrative action for unduly influencing our appraisers. Our state regulator is meeting with our lawyer to work out a plan to remediate this situation.

Recently, we also received a letter from another state banking department requesting documents and procedures relating to our appraiser independence. We are licensed in many states and, needless to say, we’re concerned that many other states will be examining us on appraiser independence. 

We have an appraiser independence policy and procedures, but that is not satisfying the regulator. They believe it is “boilerplate,” and we are not following our own plan, which, they also say, is deficient. On top of that, they picked out several areas that show we are unduly influencing our appraisers. 

We would like to get some guidance on how to prevent this from happening to us again. 

What are some of the pitfalls to watch for to avoid unduly influencing our appraisers?

ANSWER
Policies and procedures don’t mean much if you’re not implementing them. You’re just wastefully pontificating if you do not take them seriously. And what do I mean by that? 

First of all, you must have comprehensive policies that meet regulatory scrutiny. Don’t try to hand a “boilerplate” policy to a regulator with the hope that it is sufficient. Stay away from “manual mills” and cheap policies offered by firms in return for getting you on a long-term retainer for legal or regulatory compliance support. Some of these manual mills pump out policies that are “customizable.” But, often, the purchaser does not know how to customize a policy based on current regulatory rules and laws. So, what’s the point? 

And, many regulators see the same policies from company to company, and these regulators know when you’re trying to snow them with the exact same policy they’ve seen elsewhere. Stay away from one-size-fits-all policies. Make sure the document fully reflects the way you do business. 

Secondly, practice what you preach! Monitor and periodically test your policies and procedures. How do you know they are being implemented if you are not monitoring and testing? Don’t assume anything. Over time, procedures often get bent out of shape. Your monitoring should include defects, remedies, and re-testing plans. An untested appraiser independence policy leads to why the policy doesn’t cut it with regulators.

We offer the Appraiser Tune-up if you need an objective review! 

Management should be hands-on with appraisal independence. Accurate and unbiased evaluation of the collateral is foundational to the mortgage banking edifice. Ultimately, it is management’s responsibility to select, evaluate, and monitor the individuals performing appraisals, pursuant to the selection process set forth in the subject policy. 

In accordance with the policy guidelines, for staff and fee appraisers given an assignment, the basis for choosing them should ensure that the appraiser is independent of the transaction, possesses the requisite expertise, and holds the proper state certification or license, if applicable. 

In promulgating the policy, management should set forth important process issues. It is critical that management certify the procedures for when to obtain appraisals and when to obtain a re-appraisal, including frequency and scope. It is critical that appraisal and evaluation compliance procedures determine that appraisals comply with appraisal regulations and supervisory guidelines, where appropriate. For instance, there must be written (and monitored) appraisal review procedures to ensure that, where appropriate, a lender’s appraisals are consistent with the standards of Uniform Standards of Professional Appraisal Practice (USPAP), appraisal regulations, and supervisory guidelines. 

And, importantly, management has the responsibility, at least on an annual basis, to review the company’s appraiser independence policy and procedures to ensure that they meet the needs of the lender’s mortgage lending activity. 

You ask, what are some of the pitfalls to watch for in compromising appraiser independence? 

There are so many such pitfalls, I would be remiss to endeavor to offer a full slate of them. However, surely, the following list will get you started. You should check the Home Valuation Code of Conduct and Regulation Z for further details. However, the following suggestions are usually in the regulators’ purview to ferret an undue influence on an appraiser. 

Unduly Influencing an Appraiser – Some Pitfalls 

A residential mortgage lender or originator must not: 

- Imply to an appraiser that current or future retention of the appraiser depends on the amount at which the appraiser values a dwelling. 

- Exclude an appraiser from consideration for future engagement because the appraiser reports a value that does not meet or exceed a minimum threshold. 

- Withhold or threaten to withhold payment or partial payment for an appraisal report because the appraiser does not value a dwelling at or above a certain amount. 

- Condition an appraiser’s compensation on loan consummation. 

- Attempt to influence an appraiser by withholding or threatening to withhold future business for an appraiser, or demoting or terminating or threatening to demote or terminate an appraiser. 

- Attempt to influence an appraiser by expressly or impliedly promising future business, promotions, or increased compensation for an appraiser. 

- Attempt to influence an appraiser by conditioning the ordering of an appraisal report or the payment of an appraisal fee or salary or bonus on the opinion, conclusion or valuation to be reached, or on a preliminary estimate requested from an appraiser. 

- Attempt to influence an appraiser by asking the appraiser to provide an estimated, predetermined or desired valuation in an appraisal report before completion of the appraisal report, or requesting the appraiser to provide estimated values or comparable values or comparable sales at any time prior to the appraiser’s completion of an appraisal report. 

- Attempt to influence an appraiser by providing a minimum reported, anticipated, estimated, encouraged, or desired value for a subject property or a proposed or target amount to be loaned to the borrower, other than a copy of the sales contract for a purchase transaction. 

- Attempt to influence an appraiser by providing stock or other financial or non-financial benefits to an appraiser, appraisal company, appraisal management company, or any entity or person related to the appraiser, appraisal company, or appraisal management company. 

- Allow the removal of an appraiser from a list of qualified appraisers without prior notice to the appraiser, including written evidence of the appraiser’s illegal conduct, a violation of the USPAP or state licensing standards, substandard performance, improper or unprofessional behavior, or other substantive reason for removal. This prohibition does not preclude the management of appraiser lists for bona fide administrative reasons based on written management-approved policies. 

- Order, obtain, use or pay for a second or subsequent appraisal or automated valuation model in connection with a mortgage loan unless the lender has a reasonable basis to believe that the initial appraisal was flawed or tainted and that basis is clearly and appropriately noted in the loan file or unless the appraisal or automated valuation model is done pursuant to written, pre-established bona fide pre- or post-funding appraisal review or quality control process or underwriting guidelines, and the lender adheres to a policy of selecting the most reliable appraisal rather than the appraisal that states the highest value. 

Concerning the Home Valuation Code of Conduct, be advised that it is not a complete list of prohibited activities. Other practices are not specifically listed but are also considered an attempt to compromise appraiser independence. For instance, these should also be prohibited:

- Asking an appraiser to remove details about the material condition of the property, to avoid problems in qualifying certain types of mortgage loans, or

- Threatening to place an appraiser on a “blacklist” (i.e., an exclusionary list), sometimes used to blackball appraisers, for refusal to hit a predetermined value. 

Notwithstanding the above prohibitions, you may ask an appraiser to consider additional information about a dwelling or comparable properties. A lender may ask an appraiser to provide additional information about the basis for a valuation or correct factual errors in a valuation. On a case-by-case basis, a lender may also withhold compensation for breach of contract or substandard performance as provided by contract.

Jonathan Foxx, Ph.D., MBA

Chairman & Managing Director

Lenders Compliance Group