Independent appraisals: why? What? Who? When?

RMA Journal, The, Feb, 2005 by Beverly J. Foster

The independent appraisal for commercial real estate was one of many hot topics presented at RMA's Annual Risk Management Conference in November. In this article, a lender, an appraiser, and a regulator explore the origin and meaning of an interagency advisory letter, Independent Appraisal and Evaluation Functions.

Commercial real estate lenders have been hearing about, talking about, and dealing with the October 28, 2003 interagency (1) advisory letter, Independent Appraisal and Evaluation Functions. The statement "clarifies and reminds banks of the existing standards for independence within the appraisal and real estate lending regulations and the Interagency Appraisal and Evaluation Guidelines." (2) It further states, "A key element of the program must be the independent selection of qualified and experienced individuals to appraise or evaluate real estate. The individuals selected also must be independent of the transaction, and not subject to external or internal influence. Finally, a qualified individual who is not involved in loan production should review the reports."

Numerous questions have come to the agencies, and at RMA's Annual Risk Management Conference, a credit risk specialist with the OCC, the manager of Union Bank of California's commercial appraisals department, and the chief appraiser for U.S. Bank came together to answer some of them.

RMA's Jim Nelson, moderator for the panel, noted that the OCC, FDIC, and the Fed have participated in RMA's chief appraiser round tables over the years, paving the way to open dialogue among chief appraisers and their institutions' regulators.

Dena Patel, credit risk specialist for the OCC, said the statement on Independent Appraisal and Evaluation Functions was created to "reinforce the standards of independence that the regulatory agencies require of banks in order to achieve certain safety and soundness standards and a division of responsibilities between the collateral evaluation function and the loan production function." She noted that numerous questions coming into the OCC since the statement was issued fell into common themes.

The Advisory Letter: Why

Patel began with why the statement was issued in October 2003 and why the subject is being stressed now. "This is not new guidance or a new layer of regulatory burden," she reminded the audience. "Appraisal regulations written in 1990 made direct mention of appraiser independence. The Interagency Appraisal and Evaluation Guidelines of 1994 provided further guidance on this subject while reinforcing the same theme of a division of duties and responsibilities between loan production and collateral valuation. The statement written and issued a year ago was intended to remind banks that this separation of duties and responsibilities is necessary."

Commercial real estate has been receiving increased attention, said Patel, as could be seen in the number of sessions devoted to or including the topic during RMA's Annual Risk Management Conference. Emphasis, too, is being placed on underwriting and all macro- and microeconomic factors that contribute to the portfolio risks that banks are encountering. Key importance is being placed on the appraisal process for the CRE projects now being aggressively underwritten and on how banks are managing their risk from a valuation perspective. Thus, she said, "the statement is a firewall to ensure an unbiased opinion in the collateral valuation process." Patel said that OCC examinations have revealed some slippage of controls in this area, which is typical in a stronger market, and a normal reaction from regulators is to remind organizations that they need to make sure that the collateral valuation function and the loan production process are indeed separate.

Who: Loan Production Staff

But who should be considered loan production staff for purposes of appraiser independence? Such questions tend to come in with very detailed descriptions of the individual organization and the titles that people hold. The questioners want to know if their setup meets the standard of independence or not. "I would encourage you to take a step back and to try to determine who is responsible for ordering and reviewing appraisals," Patel said. "If that person has any influence in the credit, any reason or incentive for revenue or loan production, then independence is not being achieved. It doesn't matter to us whether someone is called a policy person, a credit administrator, or a loan administrator if there is incentive for that person to respond favorably. Generally, loan production staff consists of individuals who are involved in origination, underwriting, presenting credit offerings for approval, and credit decisioning. However, you could have credit administration folks who also participate in a bonus pool based on revenue generation; if that's the case, you need to take another look at the independence issue."

Donald W. Damron, SVP and chief appraiser, U.S. Bank, Denver, Colorado, believes that compliance comes down to account officer training. "Everyone at U.S. Bank understands the need for independence," he said. "We circulated the OCC memorandum and advisory letter, and everyone is aware of the requirements. U.S. Bank's Real Estate Technical Services division took on the appraisal ordering function, which satisfied the independence requirement for us." Damron noted that smaller banks may not have the volume of business to warrant an independent group and also may face great pressure from their customers. "Borrowers who own their own businesses tend to be Type-A personalities who want to be involved in that part of the process," he said. "They want some control over what that valuation turns out to be, and that's precisely what the advisory letter warns against. So it comes down to educating your customer--customer management, if you will. In every presentation I give to our lenders, I stress the importance of managing customer expectations about lender involvement in the process. I tell them they can't be involved, and I provide them a copy of the advisory letter so they can understand that this is a federally regulated process."