Acquisition and review of a professionally-prepared appraisal is fundamental to the sound underwriting of real estate loans. Title XI of the Financial Institutions Reform and Recovery and Enforcement Act (FIRREA) of 1989 requires that federal financial and public policy interests in real estate-related transactions be protected by requiring real estate appraisals utilized in connection with federally-related transactions to be performed in writing, in accordance with uniform standards, by individuals whose competency has been demonstrated.1
FIRREA also promulgated that each federal banking agency prescribe appropriate standards for the performance of real estate appraisals in connection with federally-related transactions. Since the enactment of FIRREA, the federal banking agencies (the agencies) have been working to ensure that banks develop effective, independent real estate appraisal programs.
This article will provide an overview of current supervisory guidance pertaining to real estate appraisals. In addition, since FIRREA recognizes the Appraisal Standards Board's (ASB) Uniform Standards of Professional Appraisal Practice (USPAP) as the generally accepted appraisal standard, recent revisions to the USPAP and its implication for banks will also be discussed.
Overview of Interagency Appraisal Guidelines
In September 1992, the agencies issued interagency guidance to address supervisory matters related to real estate appraisals and to clarify the development of prudent appraisal programs. In June 1994, that guidance was superseded by new interagency guidance,2 which addressed amendments to the agencies' real estate appraisal regulations.3 The new guidance, which provides more detail for each of the points listed below, notes that an effective real estate appraisal program should:
Additional guidance was provided in a second interagency statement issued on October 28, 2003, which served as a reminder to financial institutions to develop effective, independent real estate appraisal programs for all of their lending functions.4 This guidance included all real estate-related financial transactions originated or purchased by a financial institution for its own portfolio or to be held for sale.
The 2003 interagency statement also reinforced the need for appraiser independence (with limited exceptions for banks that do not directly engage an appraiser). The statement focused on ensuring independence by safeguarding against internal influence or interference and by fostering effective internal controls so that no single person has sole authority to render credit decisions for loans on which they ordered or reviewed the appraisal.
Regulatory Guidance on 2006 USPAP and the ASB
On June 22, 2006, the agencies put forth an interagency statement to inform financial institutions that significant revisions were made to the USPAP. The 2006 USPAP, effective July 1, 2006, included a new Scope of Work Rule and deleted the Departure Rule and associated terminology. Consequently, financial institutions must ensure that appraisals supporting federally-related transactions adhere to the new USPAP standards and meet the other minimum standards contained in appraisal regulations.
For state member banks, the Board of Governors issued SR Letter 06-9, which incorporated two attachments.5 The attachments contain the interagency statement and a Q&A document prepared by the ASB to highlight some of the most common questions about the recent changes.
How Has USPAP Changed?
In adopting the 2006 revisions, the ASB has indicated that the appraisal process has not changed and that the concepts in the Scope of Work Rule are not new to USPAP.6 Nevertheless, there is greater emphasis on the appraiser's process of problem identification and development of an appropriate scope of work. In essence, the new Scope of Work Rule serves to clarify the standards for the type and extent of research and analysis performed by the appraiser in the appraisal assignment. Since the Scope of Work Rule is now required, the 2006 USPAP deletes the Departure Rule and associated terminology, such as "binding" and "specific" requirements and "complete" and "limited" appraisals.
What Effect Does This Have on Financial Institutions?
As detailed in the June 2006 interagency guidance, while an appraiser is responsible for establishing the scope of work under the 2006 USPAP, financial institutions are responsible for complying with the agencies' appraisal regulations. Besides conforming to USPAP, the agencies' appraisal regulations require that appraisals supporting federally-related transactions must:
From the appraiser's perspective, these regulatory appraisal requirements are "supplemental standards" to USPAP. If an appraiser knowingly fails to comply with supplemental standards, the appraiser is in violation of the USPAP Ethics Rule.
When ordering appraisals, a financial institution should convey to an appraiser that these supplemental standards remain applicable. The agencies also continue to encourage financial institutions to use engagement letters when ordering appraisals to facilitate communications with the appraiser and to document the expectations of each party to the appraisal assignment. To determine an appraisal's acceptability, a financial institution should review the report to assess the adequacy of the appraiser's scope of work, given the intended use of the appraisal. In accepting an appraisal report, financial institutions must determine that the appraisal report contains sufficient information and analysis to support the credit decision.
Financial institutions are reminded to consider an appraiser's competency for a given appraisal assignment. Furthermore, institutions should not allow lower cost or reduced delivery time to compromise the determination of an appropriate scope of work for appraisals supporting federally-related transactions.
Responsibility, Independence, and the Examiners
The board of directors is ultimately responsible for reviewing and adopting policies and procedures that establish and maintain an effective, independent real estate appraisal program. To that end, management is responsible for ensuring that the policies are effectively implemented and adequate procedures are employed.
The key word above is independent, which is a crucial element in developing an effective appraisal function. Improperly-prepared appraisals or undue influence by the lending function on the appraisal process could undermine the integrity of the credit underwriting process. Consequently, bankers can be assured that examiners seek to verify that proper segregation has been established between the appraisal process (ordering, preparation, and review of appraisals) and the various lending functions (underwriting, administration, etc.).
Examiners are expected to analyze individual transactions and the related appraisal to determine whether the methods, assumptions, and findings are reasonable and in compliance with the appraisal regulations, supervisory guidelines, and the institution's policies. Examiners will also review the steps taken by an institution to ensure that the individuals who perform appraisals (whether in-house or outsourced) are qualified and not subject to conflicts of interest. Institutions that do not maintain a sound appraisal program or fail to comply with appraisal regulations, supervisory guidance, or policies will be cited in examination reports and may be criticized for unsafe and unsound banking practices. Any deficiencies found will require corrective action.
If you have any questions on issues related to appraisal guidance in general or questions related to the recent revisions to the USPAP, please contact your primary regulatory agency. For those financial institutions that are supervised by the Federal Reserve Bank of Philadelphia, please contact either David F. Fomunyam (email@example.com) at (215) 574-4128 or James W. Corkery (firstname.lastname@example.org) at (215) 574-6416.
The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.