A SOLUTION TO BAD MORTGAGE LENDING AND UNDUE APPRAISAL PRESSURE


Since the 1930s, when the F.D.I.C. first started requiring insured banks to secure independent appraisals to confirm the value of a property they planned to secure with a mortgage, the problem of “undue influence” being exerted on appraisers to “make the number” has existed. During periods of economic decline, increased mortgage defaults and foreclosures, loan officers most often blame mortgage losses on “bad” appraisals with overstated values.

The original concept of requiring an appraisal was good as all lenders “held” their loans “on book” as the loans were typically located in their local market and there was no secondary market. The requirement was designed to protect lenders and ultimately the F.D.I.C. against potential losses due to foreclosures. With the advent and explosion of the secondary market (RMBS/CMBS) lenders, and especially mortgage company/conduit lenders made loans outside their local markets and sold most of them before or shortly after loan closing. The process pushed the importance of a good appraisal to the background making only the “right number” to properly margin the loan as its sole importance to enable the loan to be sold or put into a pool for sale in the public debt markets. It is time to change that and bring the appraisal back to the foreground as one of the most important pieces of the mortgage loan underwriting process.

Until the late 1970s, when some national real estate firms established national appraisal divisions, the appraisal industry was totally a “cottage” industry comprised of numerous small and regional appraisal firms. Many appraisals were performed by realtors. Today, the industry is still substantially comprised of numerous small appraisal shops. Most strictly perform residential appraisals. The larger firms are usually commercial appraisal oriented and there are far more residential appraisers than commercial.

For many years, a number of professional appraisal societies have existed. For membership purposes they imposed the only educational, experience requirements and codes of ethics that existed. Prior to late 1980s there were no national appraisal standards or licensing for appraisers. Any licensing or experience requirements were decided by individual states with many requiring no licensure.

The majority of appraisals performed in the U. S. are for financing purposes. For years appraisers have complained about undue pressure from lenders and mortgage brokers to “make the number” or lose business from the institution or broker. Accordingly, there have been many attempts at creating solutions to avoid appraisers providing appraisals that (principally) overstated the property’s value or (occasionally) understated the property’s value due to undue pressure.

A major step occurred toward the end of the 1980s. With the on set of the Savings and Loan crisis, and knowing, as in the past, that appraisers would be blamed for the massive losses of the S & Ls, 9 major appraisal societies acted collectively to “tighten up” their industry, to avoid drastic federal government action. In 1986 they formed an “ad hoc” committee to create the first Uniform Standards of Professional Appraisal Practice (aka U.S.P.A.P.- generically- Use-pap) to provide standards for appraisal preparation and appraisal practice, nationwide. In 1987 they formally established The Appraisal Foundation and its subsidiaries, The Appraisal Standards Board and the Appraisal Qualifications Board. The first version of U.S.P.A.P. was copyrighted in April of 1987. Its purpose is to promote and maintain a high level of public trust in appraisals. It was formally adopted by the Appraisal Standards Board in January of 1989. It has been revised numerous times. Also in 1989, the federal government adopted the Financial Institutions Reform, Recovery and Enforcement Act (AKA FIRREA – generically- Fire-re-ah) that required appraisals for federally related transactions to conform with U.S.P.A.P.

Many states subsequently adopted U.S.P.A.P. as the standards they require appraisers to conform with. Virtually all went on to form certification or licensing acts that required appraisers to pass examinations for certification and to take continuing education classes. Two classes of certification or licensure were created; a strictly residential certification and a more expansive “general” certification. The latter allows such certified appraisers to appraise both commercial and residential properties.. Once certified appraisers are subject to reprimand, censure, state board/judicial review, fine, loss of certification and similar.

The current “credit crisis” wave of foreclosures has fingers again being pointed at the appraisal industry with the industry again complaining loudly about undue pressure from lenders and mortgage brokers to “make the number”.

It is important to remember that appraiser’s typically rely on recent market sales, rents and histories to arrive at their opinions of value. Prior to U.S.P.A.P.(which requires appraisers to factually support their conclusions), appraiser’s could render opinions based on their knowledge of the market that may not have been supported by tangible evidence. While that was a problem as it allowed for some truly unsupportable value opinions and lawsuits, when a market is on the precipice of rapid incline or decline, absent recent sales (which can take as long as 90-120 days to formally close and be recorded) to evidence the changes, an appraiser can’t help but over or under state value due to U.S.P.A.P. constraints even though they are aware of the substantial market change occurring.

The two most recent attempts to try to eliminate undue appraiser pressure are the development and use of “Appraisal Management Firms” (AMFs) and the most recent creation of the Home Valuation Code of Conduct or H.V.C.C. In my opinion, both are weak attempts at assuring appraiser independence and reducing undue pressure.

AMFs are really “middlemen” between their lender clients and the appraisers they hire. While the use of AMFs might reduce undue influence, their use has increased the cost to the consumer while simultaneously reducing the fees paid to individual appraisers. The difference goes to the AMF. Reducing the fees to residential appraisers has already reduced the number of appraisers willing to perform residential appraisals for AMFs and reduced overall appraisal quality.

Does anyone seriously think that the use of a middleman will really reduce undue influence? If an AMF delivers too many appraisals that don’t “make the number” they will no longer be used by that lending institution. When an AMF approved appraiser fails to “make the number” on too many appraisals they will be removed from the AMF’s list. Does the industry really believe that the AMFs and individual appraisers haven’t recognized that? All they have done by requiring an institution to use and AMF is to remove the direct contact between the lender or the originating mortgage broker and the appraiser. The process has been lengthened but not changed.

The H.V.C.C is really only a code of conduct designed to restrict lenders and brokers from directly ordering appraisals and having some control over the appraiser. It is not truly a code of ethics. Ethical appraisers already abide by the codes of conducts of the societies to which they belong.

It’s time to make a bold and significant change to the process because here’s what is amazing;

Appraisers, realtors, attorneys and numerous other professionals must be certified or licensed and must take continuing education but…

THERE ARE NO SUCH REQUIREMENTS FOR LENDERS OR LOAN OFFICERS AT BANKS, WALL STREET FIRMS, CREDIT UNIONS AND SIMILAR.

While bankers can argue that they are examined by “regulators” every year, and some actually have in house appraisers that formally review appraisals, that system obviously has not prevented the problem of bad lending, bad appraisals or undue appraisal influence. There is no direct recourse. Think about it. If someone was actually responsible for formally accepting responsibility for approving an appraisal do you think that many “made the number” appraisals would get accepted and worse, passed along to the secondary market?

Under the current structure, a lender still does not need to grant a mortgage even if the appraisal “comes in at the number” but if they do, ultimately foreclose and take a loss on the property they generally blame the appraiser I submit that the loan process is now broken. Time to put the true responsibility where it belongs, on the loan officer or underwriter

In my opinion, the best way to now fix it and to virtually eliminate undue pressure on appraisers to “make the number” is to now also make loan officers (like appraisers, attorneys, realtors and other professionals) at banks, credit unions and especially at Wall Street Brokerage Firms be educated, take and pass an examination to demonstrate a level of knowledge to be licensed or certified and take continuing education to maintain their licensure or certification. Their education would include basic appraisal knowledge. One of the semi-annual CE courses would need to be an appraisal class. All mortgage loans would then require that a certified loan officer formally sign off and approve the appraisal they have accepted for purposes of the loan they have approved. Loans sold in pools would require the pool buyer/Wall Street Underwriter to also have a licensed/certified loan officer sign off on each appraisal and so on.

When you think about it, how can a loan underwriter truly structure a loan based on appraised value (and all real estate mortgages are) if they don’t have a good understanding of what constitutes a good appraisal and it’s not just “the number”.

Armed with better knowledge of what is and is not a good appraisal, if they still accept a bad appraisal (either because they still wanted to make the loan or because they were incompetent or worse) they would then be subject to the same type of censure, fine and/or loss of certification or license (and job) that applies to appraisers and other professionals. It would substantially put an end to loan officers applying undue pressure on appraisers to make the number and then hiding behind the appraiser’s value when a loan goes bad. It would bring back the importance of having and knowing what a good appraisal is as part of the underwriting process.

Structured properly and perhaps with a new entity (similar to the Appraisal Foundation), formed by the F.D.I.C and S.E.C or other appropriate agencies, that would establish national education and certification guidelines, the F.D.I.C and S.E.C would more oversight and power to address bad loan officers. If we all agree that bringing back the secondary market is very desirable and if we all agree that confidence in the system needs to be restore to re-attract both American and foreign investors, this would be a major and visible step in that direction.

This seems like a logical solution to me. Opponents will argue that the cost or timing issues make this impractical and those are not supported by history. Appraisers have been forced to do all of this, absorb the costs and lost time and have not been able to pass those costs along to the consumer. When one acts in haste one often regrets their action at their leisure. Slowing down the loan process a little can help avoid the financing fiasco we just came through that brought our economy to its knees.

Time for a bold new change. If you agree, contact your Congressman, the President, the Chairman of the S.E.C. the head of the F.D.I.C and all others in positions of power and question why loan officers are not certified, licensed and required to take continuing education and insist that they be certified.

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