REQUIRED READING: While the mortgage lending market works its way through current economic challenges, lenders face rapidly changing and more complex governmental regulatory supervision and controls. As outlined in the final December 2010 interagency appraisal and evaluation guidelines, federal financial institution regulators challenged lenders to identify and utilize valuation products that are more relevant and reliable in the post-financial crisis era.
Up to this point, innovative and more reliable analysis outside of traditional valuation products remains elusive. Meanwhile, regulators are offering lenders the opportunity to use potentially less expensive valuation products that may better protect the lender, servicer and investor, assuming they can identify and utilize the products properly. Regardless of explanations, perceptions and rationale, the guidelines are having a significant impact on servicers in this market environment. As a result, the search for new valuation products to address the impact has begun.
Regulators will know the right valuation products when they see them, but to definitively describe them in advance seems nearly impossible. In an effort to clarify this matter, it is essential to first consider the full range of valuation products, their capabilities and their limitations as defined by the guidelines.
Though the guidelines include clarification on the use of appraisals, evaluations, broker price opinions (BPOs) and automated valuation models (AVMs), the discussion surrounding evaluations is noticeably lacking specifics. The discussion on appraisals was limited and largely deferred to the Uniform Standards of Professional Appraisal Practice (USPAP), as offered and governed through the Appraisal Foundation.Â
Appraisals are understood by lenders as a definitive source in the cascade of valuation products. This cascade generally runs from the least expensive and automated statistical products, through professional judgment products, including BPOs and appraisals. The attributes of an AVM, BPO and appraisal are generally appreciated and agreed upon. However, the ‘evaluation’ has been misunderstood, relatively undefined, and under-utilized, at least up to this point.
Although authoritative, few specifics on the development and use of evaluations were offered in the guidelines. Alternatively, clarity concerning the use of BPOs and AVMs as contributions to an evaluation report were clearly outlined. It was noted that BPOs could not be considered as an evaluation because they provide an opinion of market ‘price’ rather than market value. Nonetheless, the guidelines declared a BPO ‘may provide useful information in developing an appraisal or evaluation.’Â
The valued perspective offered by a professional real estate broker or agent was recognized, and current users of BPOs are familiar with this valuation methodology. Lenders are still relying upon neighborhood-specific perspectives offered by this property and corresponding mortgage due-diligence product.Â
Although AVMs are clearly insightful and meaningful in markets where statistically significant data is available, they are also unable to be utilized as an evaluation because verification of the current property use and condition is not a part of the automated process. However, augmented by a specified physical property inspection, an AVM can be effectively used as an evaluation product in some lending due-diligence scenarios. AVMs also provide validation of market activity and velocity, or lack thereof.
The guidelines offered the use of evaluations to lenders, but provided little direction as to the required products, components or other analysis needed to be considered within an evaluation report. They also broadly defined the use of the evaluation product within the risk definition of a ‘federally related transaction,’ ultimately leaving its application up to the credit policies established by each lender or servicer. But they did ‘reaffirm that valuation methods used to develop an evaluation must be consistent with safe and sound banking practices’ and produce a credible market value conclusion.
Some lenders have sought to utilize BPOs or variations of BPOs in this space, in spite of contrary guideline direction. Others, fearful of regulatory sanctions and a public relations backlash, have decided to ‘bite the bullet’ and order traditional appraisal products, regardless of the cost to their balance sheet and the consumer.
Each portion of the mortgage origination process may be able to justify the resulting higher valuation due-diligence costs by passing them on to the consumer. However, default servicers are unable to generate revenue and can therefore only contribute to the profitability through cost-savings exercises, falling deeper into the economic-loss hole.Â
Our industry is becoming increasingly challenged to financially justify traditional appraisal services in a default servicing environment characterized by expanding regulatory influence. As we attempt to mitigate the fear of additional regulatory oversight and sanctions, many of us are led to policy and implementation conclusions based on vague information. An acceptable and financially prudent valuation solution is the challenge currently facing those of us in mortgage banking, capital markets and mortgage servicing.
Today's market requires a valuation product that provides us with safety and security from regulatory scrutiny, cost-effectiveness and the development of a superior market value estimate that is more supportable, defendable and credible. A valuation tool that provides multiple perspectives on market value and effectively meets the diverse due-diligence challenges we face is long overdue.Â
We are now in an environment that requires unique valuation products that can bring together the judgment-based insight of an appraiser and a licensed broker or agent, along with acceptable statistical and automated valuation processes to better define the risk and value associated with a specific property. Although some valuation providers have attempted to offer a valuation product with multiple perspectives, our industry today requires multiple independent perspectives that effectively integrate into a user-friendly format with multi-dimensional, high-definition and reviewable analyses for those requiring well-reasoned, defensible, and reviewable market value opinions in the decision-making.Â
An evaluation product that is both an appraisal, as outlined in USPAP and an evaluation, as defined by the 2010 guidelines, should be a goal for our industry. Such a product would end the debate over what valuation methodology and analysis can be used to meet the ‘evaluation’ requirements contained in the guidelines.
The multi-perspective approach of such a valuation tool can provide a defendable, completely reviewable, and credible market value estimate as the basis for safe and sound lending practices. The exacting standards of in-house compliance and valuation officers could also be confidently achieved by these types of solutions, and staffing efficiencies could be realized within valuation due-diligence processes.Â Â
It costs how much?
With the cost-absorption issues surrounding appraisal consumption in the second mortgage, default servicing and portfolio management processes (including capital markets), the right evaluation products would provide significantly lower pricing when compared to traditional appraisal products. The savings realized by replacing the use of a Fannie Mae Form 2055 (exterior-only ‘drive-by’) appraisal with a suitable evaluation report could result in a $40 or more per-report savings. A high-quality evaluation with an interior broker or agent inspection would cost around $215 per report.Â
When comparing this type of evaluation cost to that of a Fannie Mae Form 1004 (uniform residential appraisal report) appraisal, it results in more than $150 in savings per report. For example, assuming a lender is managing 1,000 loans per month, the annual cost savings realized by a consumer of valuation reports using this type of product in place of a 2055 appraisal report is almost $500,000 per year. Using the same example, a savings of over $2.5 million per year can be achieved when a suitable evaluation product replaces the 1004 appraisal report. The only question remaining is the credibility of the analysis.
When it is time to establish market value, the perspective and depth of the analysis to provide clarity, validity and credible results are most important in the due-diligence process. Individually, the single-dimension perspective of traditional valuation products provides meaningful information, but gives less than a full understanding of the property considered as mortgage collateral.Â
This single-dimensional view of residential real estate market value leaves us stuck in valuation mediocrity, with unsatisfactory short- and long-term results. High-quality evaluation products can paint the picture of a property in vivid color and multiple dimensions resulting in a high-definition understanding of the asset, along with its relationship to the neighborhood and the overall market. Safe and increasingly sound lending decisions could be achieved through the use of valuation products that consider more than one dimension.
An evaluation report should consider the use of AVM components to provide statistical market value indications, reflecting the value of the subject property, including distressed-use assumptions. Statistical analysis could provide information on the viability of a specific real estate market and neighborhood. Even by knowing there is little data to compare to a specific subject property, a mortgage underwriter or manager can understand additional risks associated with that specific property in the decision-making process.
A complete BPO should also be a part of the evaluation product our industry needs to meet the requirements of today's valuation landscape. The unique perspective offered by a licensed broker or agent is vital to the validity and credibility of a strong evaluation report.
This traditional judgment-driven opinion of the subject property's market price would provide us with property descriptions, including characteristics and condition, which stand as the basis for all judgment-driven analysis. This analysis would be performed by a licensed broker or agent who actively lists, negotiates transactions, and sells properties in the subject neighborhood. This broker or agent is also familiar with neighborhood nuances, trends and perspectives that add support to the other included indications of value.Â
The overriding perspective within a truly useful evaluation report would be provided by a certified appraiser who has the training, experience and analytical skill to review and reconcile the previously described indications of price and value, augmented by additional data and analysis deemed relevant, to arrive at an overall market value estimate.Â
The resulting report would provide a clear, concise and easy-to-review market value analysis meeting regulatory and USPAP guidelines and standards in a way our industry requires to navigate the market of today.
Michael H. Christensen is director of strategic relations for CoreLogic Valuation Services, located in Salt Lake City. He can be reached at (866) 308-4713.