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.

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