Interagency Appraisal and Evaluation Guidelines

December 9, 2010 at 4:21 pm Leave a comment

On December 2, 2010, the federal financial institution regulatory agencies issued joint guidance relating to real estate appraisals and evaluations used to support real estate-related financial transactions (the “Guidance“).  The Guidance supplements, and in some cases replaces, previously issued guidance dealing with appraisals and evaluations.

WHY IS THE GUIDANCE IMPORTANT TO YOUR BANK?

All federally regulated financial institutions are required to prepare and maintain appropriate real estate and appraisal evaluation programs.  Those programs will be reviewed as part of the examination of the bank’s overall real estate lending activities.  Examiners are increasingly citing banks for maintaining unsafe and unsound appraisal and evaluation programs.  This newly issued Guidance will assist you in preparing and updating your program so that you may avoid any negative citations in your examination report and to help ensure the overall safety and soundness of your institution’s lending activities.

WHEN IS AN APPRAISAL REQUIRED?

Any real estate related financial transaction requires an appraisal unless it is specifically exempt from the appraisal requirement.   Generally, a “real estate related financial transaction” is any transaction involving (i) the use of real property or interests in real property as security for a loan, (ii) the refinancing of real property, or (iii) the sale, lease, purchase, investment in or exchange of real property, or financing thereof.  Here is a non-exclusive list of common exemptions from the appraisal requirement and a brief discussion of when those exemptions apply:

1.   Appraisal Threshold.  Transactions with a value equal to or less than $250,000.00 are exempt from the appraisal requirement.  If a particular piece of real property has a value less than that amount, an appraisal is not needed.  However, an evaluation consistent with safe and sound banking practices is required.

2.   Abundance of Caution.  With respect to business loans, this exemption applies when the loan is “well supported by the borrower’s cash flow or collateral other than real property.”  The abundance of caution exemption is not available when the credit analysis shows that the loan would not be adequately secured by sources of repayment other than real estate, “even if the contributory value of the real estate collateral is low relative to the entire collateral pool and other repayment sources.”  Banks should document and retain in the credit file the analysis performed to verify that the exemption was properly applied. Finally, if the performance or financial condition of the borrower deteriorates and the lender determines that the real estate will be relied upon as a repayment source, an appraisal should be obtained unless another exemption applies.

3.   Real Estate Secured Business Loans.  This exemption applies to business loans with a transaction value of $1 million or less when the primary source of repayment of the loan is operating cash flow from the business rather than rental income or the sale of real estate.  The Guidance warns that “[t]his exemption will not apply to transactions in which the lender has taken a security interest in real estate, but the primary source of repayment is provided by cash flow or sale of real estate in which the lender has no security interest.”  

4.   Renewals, Refinancings and Other Subsequent Transactions.  Renewals, refinancings, and other subsequent transactions, including loan workouts and restructurings, may be supported by evaluations rather than appraisals when either (i) there has been no obvious and material change in the property or market conditions that threatens the adequacy of the institution’s collateral protection, even with the advancement of new money, or (ii) no new money (i.e. increase in principal amount of the loan) is advanced other than funds to cover reasonable closing costs.  “If a loan workout involves acceptance of new real estate collateral that facilitates the orderly collection of the credit, or reduces the institution’s risk of loss, an appraisal or evaluation of the existing and new collateral may be prudent, even if it is obtained after the workout occurs and the institution perfects its security interest.” 

WHEN IS AN EVALUATION REQUIRED?

In short, evaluations are required in connection with transactions that are exempt from the appraisal requirement under one of the exemptions listed in items 1, 3 and 4 above.  Although the appraisal regulations allow an institution to use an evaluation in some circumstances, the Guidance encourages institutions to establish policies and procedures for determining when to obtain an appraisal for those transactions.  For example, appraisals should be considered as the bank’s portfolio risk increases or for higher risk real estate loans.

IS MY EXISTING APPRAISAL STILL VALID?

Institutions should establish criteria for determining whether an existing appraisal or evaluation “continues to reflect the market value of the property.”  The facts and analysis used to determine whether an appraisal or evaluation remains valid should be documented in the credit file.  Relevant factors include:

  • passage of time
  • volatility of local market
  • changes in terms and availability of financing
  • improvement of property
  • changes in zoning

The Guidance covers a number of other important topics that are not discussed in this summary.  Those topics include:

  • the need for independence in the appraisal and evaluation functions of your bank
  • selection of appraisers
  • minimum appraisal standards
  • how to choose the appropriate type of appraisal report
  • evaluation content
  • reviewing appraisals and evaluations for compliance with regulations and guidance

 You should familiarize yourself with each of the topics discussed in the Guidance in order to maintain a safe and sound appraisal and evaluation policy.

A full copy of the Guidance may be found here.

Entry filed under: Uncategorized.

FDIC Implementation Actions Re: Dodd-Frank Act Federal Reserve Release: Expansion of Consumer Protection Regulations

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