Following an extended period of public comment, federal regulators (The Agencies) have issued final Interagency Appraisal and Evaluation Guidelines for real estate appraisals and evaluations used in financial transactions.  The guidelines replace the 1994 version developed under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989 and the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA.) The latter required that each regulated institution adopt and maintain written real estate lending policies that are consistent with safety and soundness.

The new guidelines emphasize the importance of institutions maintaining strong internal controls to ensure reliable appraisals and evaluations. Institutions also are responsible for monitoring and periodically updating valuations of collateral for existing real estate loans and for transactions, such as modifications and workouts. The following is a summary of the guidelines.

1.  Supervisory Policy

Appraisal policies and procedures will be reviewed by regulators as part of a regular examination of real estate-related activities.  Examiners will consider the size and nature of each institution's real estate-related activities in assessing the appropriateness of its program and will review the steps taken to ensure that the persons who perform appraisals and evaluations are qualified, competent, and not subject to conflicts of interest.

2. Appraisal and Evaluation Program

An institution's board of directors (or its delegates) is responsible for developing a program that will provide for the independence of persons involved in the appraisal process, establish criteria and procedures to evaluate and monitor their performance ensure that appraisals and evaluations comply with regulations and contain sufficient information to support the credit decision.

The board must establish and maintain criteria for content and use of evaluations including timely receipt and review, assessment, and monitoring collateral values and for obtaining appraisals for transactions not otherwise covered by the Agencies' appraisal regulations.

3. Independence of the Appraisal and Evaluation Program

An institution should maintain standards of independence for collateral evaluations throughout its real estate lending activity.  Collateral evaluations must be isolated from influence by the institutions loan production staff and the institution should establish reporting lines independent of loan production for staff who administer the evaluation program.  Appraisers must be independent of loan production and collection and have no direct, indirect or prospective interest in the property or the transaction.  Policies devised to insure the independence of collateral valuation must not hinder the communication of appropriate information.

For small or rural institutions where is it not always possible or practical to separate collateral valuation from production, the institution should be able to demonstrate clearly that it has prudent safeguards to isolate the valuation process from influence or interference.  In cases where only one person is qualified to analyze collateral that person must not participate in loan approval.

The appraiser can be provided with a copy of the sales contract and the person who requests the appraisal can request that the appraiser consider additional information about the property, provide supporting information about the basis for a value, and correct factual errors.  The institution, however, may not directly or indirectly coerce, influence or otherwise encourage an appraiser or evaluator to misstate or misrepresent the value of a property or communicate a predetermined, expected or qualifying estimate of value, specify a minimum value for the property, or condition the appraisers compensation or future employment on obtaining a certain value or on consummation of the loan.

Where a second appraisal or evaluation is necessary, the institution is expected to select the most credible product rather than the one with the highest value.

4. Selection of Appraisers or Persons Who Perform Evaluations

 The institution's criteria for selection evaluating, and monitoring the performance of appraisers and evaluations should ensure that:

• The person selected possesses the requisite education, expertise and experience for the assignment;
• The work performed is periodically reviewed;
• The person is capable of rendering an unbiased opinion, is independent, and has no direct or indirect interest in the property or the transaction;
• Is appropriately licensed or certified and has expertise relevant to the particular property.  Documentation should be maintained to support these qualifications.

The institution must directly select and hire appraisers except where Agency regulations allow use of an appraisal prepared for another institution.  Independence is compromised when a borrower recommends or loan production staff selects an appraiser.

Where an institution establishes an approved appraiser list, it should have appropriate procedures for developing and administering that list including a process of initial qualification, periodic monitoring of performance and accreditations and a periodic internal review of the use of the list.  For residential work, loan production staff can use a revolving, pre-approved appraiser list as long as the development and maintenance of the list is not under their control.

5. Minimum Appraisal Standards
      
Appraisals must:

• Conform to generally accepted appraisal standards as evidenced by the USPAP of the Appraisal Standards Board of the Appraisal Foundation.Be written and contain sufficient information and analysis to support the institution's decision to undertake the transaction;
• Analyze and report appropriate deductions and discounts to proposed changes to the physical condition of the building or lease/financial terms.
• Be based upon the definition of market value set forth in the appraisal regulation.
• Be performed by state certified or licensed appraisers in accordance with the appraisal regulation.

6. Appraisal Development

Appraisals must comply with the requirements of USPAP and, consistent with the USPAP "Scope of Work Rule) provide credible assignment results including the extent to which the property is identified and inspected, the type and extent of data researched, and the analyses applied to arrive at opinions or conclusions.  The institution itself is responsible for obtaining an appraisal that contains sufficient information and analysis to support its credit decision.

7.  Appraisal Reports

Each institution can selection the appropriate USPAP report option to support its credit decisions, taking into account the risk, size, and complexity of the transaction and the collateral.

8. Transactions that require Evaluations

 An institution can obtain an evaluation in lieu of an appraisal for transactions that qualify for certain exemptions including:

• a transaction with a value equal to or less than the appraisal threshold of $250,000, a business loan with a value less than the business loan threshold of $1 million and is not dependent on the sale or rental of the property as the principal source of repayment;
• Involves an extension of existing credit at the institution provided there has been no material change in market conditions or physical aspects of the property or there is no advancement of new monies other than that necessary to cover closing costs.

Although an institution may be allowed, under the regulations, to use an evaluation, the institution should establish policies and procedures opting for an appraisal such as for higher risk transactions like atypical properties or properties outside of the institution's traditional lending market.

9.   Evaluation Development and Content

The institution should establish policies to determining appropriate collateral valuation methods for a transaction regardless of the cost or turnaround time of the evaluation.  An evaluation must provide a property's market value and sufficient information and analysis to support that value, address the property's actual physical condition and characteristics as well as economic and market conditions.  These should include, among other factors:

• The location and description of the property and its current and projected use;
• An estimate of the market value, physical condition, zoning, and limiting conditions;
• A description of the methods used to confirm the physical condition, the analysis performed, the supplemental supporting information and its source
• Information on the person conducting the evaluation.

10. Validity of Appraisals and Evaluations

Where an institution uses an existing appraisal or evaluation, it should establish criteria for assessing whether it continues to be valid.  A new appraisal or evaluation will be deemed necessary if the market value has changed due to:

• Passage of timeLocal market volatility
• Changes in terms and availability of financing;
• Natural disasters
• Availability of competing properties;
• Property improvements or deterioration;
• Changes in zoning, building materials or technology;
• Environmental contamination.

11.   Reviewing Appraisals and Evaluations

Prior to making a credit decision, the institution should review appraisals and evaluations to ensure they comply with the Agencies' appraisal regulations and the institution's internal policies.  The policies and procedures for reviewing these documents should, at a minimum:

•  Include the independence, educational and training qualifications and role of the reviewer;
• Reflect a risk-focused approach for determining the depth of the review;
• Establish a process for resolving any deficiencies in the product;
• Set forth documentation standards for the review and the resolution of deficiencies.

12.  Third Party Arrangements

An institution that engages a third party to perform collateral valuations on its behalf is responsible for understanding and managing the risks associated with the arrangement.  The institution should have internal controls for such arrangements and should compare the risks, costs and benefits of the proposed relationship with using another vendor or conducting the activity in-house and should exercise due diligence in selecting the vendor.

13.  Program Compliance

In addition to establishing internal controls to promote an effective appraisal and evaluation program the institution should have policies that address the need to understand its collateral position over the life of a credit including criteria for obtaining current valuation information.  Such criteria should address deterioration of the credit or changes in market condition.    If an institution finds it appropriate to modify a loan or engage in a workout the Agencies expect it to consider current collateral valuation information and obtain a new appraisal or evaluation if necessary.  

14.   Referrals

An institution is expected to file a complaint with the appropriate state regulatory officials when it suspects that a state certified or licensed appraiser has failed to comply with state laws or engaged in unethical or unprofessional conduct.  The institution also must file a suspicious activity report with the Department of the Treasury when suspecting fraud or identifying other transactions meeting the filing criteria.

The Dodd-Frank Wall Street Financial Reform and Consumer Protection Act of 2010 underscores the importance of sound real estate lending decisions; future revisions to the appraisal guidelines may be necessary after regulations are adopted to implement the Act.