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FOR RELEASE ON DELIVERY
10:00 AM (EDT)
September 16, 1992
Testimony by
John P. LaWare
Member, Board of Governors of the
Federal Reserve System
before the
Subcommittee on General Oversight and Investigations
of the
Committee on Banking, Finance and Urban Affairs
United States House of Representatives
September 16, 1992
I am pleased to appear before you this morning to
discuss the implementation and effectiveness of the real estate
appraisal requirements contained in Title XI of the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989
("FIRREA"). Title XI contemplates a dual state and federal role
in fulfilling its goal which, as indicated in its statement of
purpose, is to provide "that federal financial and public policy
interests in real estate-related transactions will be protected
by requiring that real estate appraisals utilized in connection
with federally related transactions are performed in writing, in
accordance with uniform standards, by individuals whose
competency has been demonstrated and whose professional conduct
will be subject to effective supervision."
At the federal level, Title XI required the federal
financial institutions regulatory agencies to issue regulations
prescribing appropriate appraisal standards for those real
estate-related transactions that would require the services of a
licensed or certified appraiser under the statute and, therefore,
are federally related.
The agencies were also required to
distinguish between those transactions that require the services
of a state certified appraiser (the senior designation) and those
requiring a state licensed appraiser (the junior designation).
The states also play a vital role under the statute.
Title XI contemplates that the states will establish appraiser
certification and licensing agencies, as well as set minimum
requirements for individuals who are qualified to perform
appraisals in connection with federally related transactions.
2
After December 31, 1992, state certified or licensed appraisers
must be used for all federally related transactions, unless a
temporary waiver is granted in accordance with provisions
contained in Title XI.
At the outset I should make clear that the Board shares
Congress' desire to ensure that banks establish sound loan
underwriting and administrative procedures.
An integral part of
such procedures, of course, is a prudent and effective appraisal
program.
Indeed, the loss experience of depository institutions
in recent years has demonstrated the critical importance of
sound underwriting standards in promoting the safety of financial
institutions and protecting the interests of depositors.
The Committee's letter of invitation provides that this
hearing generally will examine the implementation and
effectiveness of Title XI, and, as well, requests that the Board
address a number of specific questions.
The individual questions
are addressed in an attachment to this testimony.
However, given
the interest that has been expressed on the issue of a threshold
above which appraisals are required, I will address that issue
later in my statement.
Since the enactment of FIRREA on August 9, 1989, the
Federal Reserve has been working extensively with the other
federal financial institutions regulatory agencies to implement
the requirements of Title XI.
These efforts fall into several
categories, as required by Title XI.
One set of initiatives is
the establishment of the Appraisal Subcommittee of the Federal
3
Financial Institutions Examination Council and our continued
representation on that Subcommittee.
Regarding the activities of
the Appraisal Subcommittee, I will defer to the statement of the
Appraisal Subcommittee Chairman, Fred Finke, to the Subcommittee
today.
A second area in which each of the agencies has
expended considerable effort is prescribing appropriate standards
for the performance of real estate appraisals.
In developing the
regulation, the Board has attempted to comply with both the
letter and the spirit of Title XI, while at the same time
remaining sensitive to the potential costs and burdens that the
regulation could impose, particularly on consumers and small
businesses seeking real estate loans.
Title XI required the
Board to adopt appraisal standards in its regulation that
incorporated the appraisal standards in the Uniform Standards of
Professional Appraisal Practice ("USPAP"). Moreover, the Board
was also permitted by Title XI to require compliance with
additional standards, if necessary, to properly carry out its
statutory responsibilities.
At the time the Board sought public comment on adopting
its appraisal regulation, the USPAP was in the process of being
revised, and the Board, as well as the other financial
institutions regulatory agencies, were uncertain whether the
substance of the final version would fully satisfy the purposes
and the requirements of Title XI.
As a result, to ensure that
the requirements of Title XI were met, the Board, along with the
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other regulatory agencies, adopted its own set of appraisal
standards that were substantially similar to those proposed in
the USPAP.
In June 1990, the Board adopted the appraisal
regulation containing the agencies' additional appraisal
standards, and, at the same time, the USPAP revisions were
finalized.
Our experience with appraisals since the adoption of
the revised USPAP standards appears to indicate that these
standards adequately address the concerns expressed in the
legislative history of FIRREA regarding the sufficiency of
appraisal standards.
Accordingly, the Board and the other
regulatory agencies are considering the deletion of the portion
of their appraisal regulations containing standards that are
substantially similar to the revised USPAP standards.
Given
reports that some appraisers maintain that the standards
specified in the agencies' regulations constitute an additional
set of standards requiring separate analysis, deferring more
fully to the USPAP should reduce regulatory burden and the
commensurate costs to the public and depository institutions.
During the course of its consideration of its real
estate appraisal regulation, the Board remained sensitive to the
need for minimizing potential costs and burdens that the
regulation could impose while, at the same time, not jeopardizing
safety and soundness considerations and the purposes of Title XI.
In that light, the Board promulgated its final regulation with a
$100,000 threshold above which appraisals would be required for
5
federally related transactions.
After considerable comment, the
Board subsequently issued a proposed rule to reconsider the level
of the threshold.
Before making a final determination on this
issue, the Board will review the results of the recently
completed OMB study mandated by FDICIA and a pending 6A0 study,
both related to the appraisal threshold issue, as well as over
2,800 comment letters received in response to the Board's own
proposal.
Clearly this is a controversial issue and one in which
some members of Congress have expressed considerable interest.
The Board initially prescribed the $100,000 threshold
because in its view transactions below the threshold did not
appear to implicate the federal financial and public policy
interests addressed by Title XI, nor did they pose a significant
risk of loss to institutions covered under the statute.
In the
Board's experience with its regulated institutions, credit losses
arising from inadequate appraisals of l-to-4 family residential
loans, which comprise the vast majority of real estate-related
transactions falling below the threshold, have not been a
significant cause of failures of commercial banking
organizations.
Further, the threshold lessens the potential
costs and burdens that the regulation could have on small
businesses and individuals seeking real estate loans.
The Board's supervisory experience also suggests that
employees of community banks have made reasonable assessments in
the past of real estate collateral values for residential loans.
Moreover, the majority of all l-to-4 family residential loans are
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originated for potential sale to the secondary mortgage market.
In this regard, the Board understands that FHA, VA, FNMA and
FHLMC as well as many private mortgage insurers will require
appraisals performed by licensed or certified appraisers for
residential loans insured or guaranteed by them.
We are not unconcerned about problems stemming from
relatively small- or medium-size loans which, of course, can and
do result in some losses to banks.
It is for this reason that
our supervisory appraisal and evaluation policies cover loans of
all sizes.
Nevertheless, our experience with commercial banking
organizations has suggested that losses on residential loans have
not contributed significantly to bank failures; and, in any case,
that significant losses to banks on l-to-4 family residential
loans less than the $100,000 threshold have not resulted from
faulty appraisals.
Moreover, we believe that the prudential standards
contained in our supervisory appraisal guidelines, together with
annual on-site examinations, have helped to mitigate the risks
associated with transactions below the threshold.
Further,
discussions with state agency representatives and public comments
suggest that an employee of a community bank in a rural area,
where it may be difficult to obtain the experience required by
many state licensing authorities, is likely to be at least as
knowledgeable about the value of local properties as an out-of
area appraiser.
In contrast, it has primarily been loans collateralized
7
by larger commercial buildings, condominiums, shopping centers,
and agricultural and other commercial properties that have caused
major credit losses and, in some cases, failures within the
commercial banking system.
As an indication of the loss
experience of insured banks and savings banks on l-to-4 family
residential loans, compared to typically larger commercial real
estate loans, I note that for 1991 the nonperforming loan and
loan charge-off ratios for l-to-4 family loans were 1.65 percent
and 0.20 percent, respectively, compared to 5.81 percent and 1.24
percent for commercial real estate loans.
In this regard, the
Board believes that Title XI is particularly helpful in
standardizing and strengthening appraisal procedures for large
real estate loans that historically have been a major source of
problems for some banking institutions.
Accordingly, the Federal
Reserve's regulation requires the use of certified appraisers for
all commercial transactions exceeding $250,000 in value.
In sum, I believe that the approach we have adopted in
our regulation represents a reasonable attempt to implement the
purposes of Title XI, while remaining sensitive to the concerns
of smaller institutions, the possible impact on the cost of
appraisals, „"id the potential burden associated with additional
regulation.
In developing the regulation, Board staff has worked
closely with representatives of the other bank regulatory
agencies to establish a consistent approach for commercial
banking organizations.
Hr. Chairman, your invitation letter states that one
8
purpose of this hearing is to examine the effectiveness of Title
XI.
As I have already noted, the Board believes that Title XI
has contributed to strengthening appraisal procedures within
depository institutions.
Having said that, I must also caution
that the Board believes that the appraisal process is not an
exact science nor should it be the sole focus of an examiner's
review of a commercial real estate loan.
Work still must be done
on refining the appraisal process to avoid the use of dubious
assumptions that can contribute to exaggerated valuations in both
the upside and downside phases of the real estate cycle.
Further, as the agencies indicated in their November 7, 1991,
guidance to examiners, the focus of an examiner's review of a
commercial real estate loan must be an assessment of the
borrower's ability to repay the loan in an orderly and timely
manner.
The principal factors that bear on this assessment are
the income-producing potential of the underlying collateral and
the borrower's willingness and capacity to repay under the
existing loan terms and from the borrower's other resources, if
necessary.
As we proceed in implementing Title XI, I want to
assure you that we will monitor the effectiveness and impact of
the Board's appraisal regulation.
As is true of any new
regulation, we recognize that adjustments may have to be made in
order to accomplish desired objectives.
In this regard, the
Federal Reserve will not hesitate, in coordination with the other
Federal agencies, to consider, and, if appropriate, adopt changes
9
or refinements that are deemed to be necessary to strengthen our
implementation of Title XI or to assure the safety and soundness
of our nation's depository institutions.
10
Federal Reserve Board's
Responses to Questions Submitted by
Congressman Hubbard
for the September 16, 1992 Hearing
on the Implementation and Effectiveness of Title XI
1.
The current status of implementation of state agencies and
the effects this has on federal regulations requiring
appraisals.
While FDICIA extended the federal effective date for the
requirement to use the services of licensed or certified
appraisers in a federally related transaction to January 1,
1993, individual states have the latitude to set an earlier
effective date for licensed and certified appraisers for
purposes of state law. In fact, many states have already
implemented their state appraisal regulatory programs.
This difference has caused some confusion among regulated
financial institutions as to what is required of them. The
Board has provided guidance to our examiners and regulated
institutions that institutions are expected to adhere to any
state law requirements, including an earlier implementation
date, for a particular state appraisal regulatory scheme.
2.
The impact of requiring a professionally prepared appraisal
on all real estate related transactions regardless of the
amount, compared to requiring appraisals only on the real
«state related transactions above $50,000 and $100,000.
Since the majority of such transactions are l-to-4 family
residential loans, the impact of a change in the appraisal
threshold would for the most part affect the cost and
closing time for residential mortgages. Considering the
relatively low loss experience on residential mortgages,
financial institutions believe that the appraisal costs far
exceed the benefits. Rather, loss experience is more
readily attributed to underwriting mortgage loans with high
loan-to-value ratios which are then highly susceptible to
problems arising from deteriorating market conditions or the
borrower's personal financial difficulties.
In that regard, the majority of comments on the Board's
appraisal regulation received from financial institutions
reported minimal historical losses on l-to-4 family
residential loans of amounts between $50,000 and $100,000.
Data on charge-offs also indicate that l-to-4 family
residential loans have had comparatively low loss experience
and significantly better experience than other types of real
estate loans.
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3.
The effect on the safety and soundness of financial
institutions if real estate transactions under $100,000 are
exempt from an appraisal.
While the Board does not require an appraisal by a state
certified or licensed appraiser for a transaction below
$100,000, the Board requires an appropriate evaluation of
the real estate collateral as outlined in supervisory
guidelines. These supervisory guidelines underscore the
responsibility of bank boards of directors to ensure that
their institutions have well-defined and effective programs
for appraising and evaluating real estate in support of
their lending activities.
Our Reserve Banks report that there have been no bank
failures or significant problems or losses because of
inadequate evaluations and appraisals on loans under
$100,000. In the past four years, the Reserve Banks
reported only 24 corrective actions that cited appraisal
deficiencies or problems, and most of these cases dealt with
the appraisals on transactions over $100,000.
4.
The likelihood of a significant shortage of appraisers,
other than localized anomalies, after January 1, 1993.
Please include your estimate of how many licensed and
certified appraisers are necessary to meet current and
expected demand.
The issue of the availability of licensed and certified
appraisers has been one of the major issues cited by banks,
particularly rural community bankers, as affecting the
implementation of Title XI. The question of whether there
is a shortage of appraisers may be influenced by an uneven
distribution of appraisers between metropolitan areas and
rural communities, with fewer appraisers in rural areas of
the country.
Since all states have not implemented their licensing and
certification programs, there is insufficient data, at this
time, to determine whether there is an adequate number of
certified and licensed appraisers. Further, the general
slowdown in most real estate markets has also reduced the
demand for appraisal services. Regulated institutions have
expressed concern that when the market does pick up that a
shortage will develop. Indeed, in certain areas of the
country, financial institutions are experiencing significant
delays in receiving appraisals. This is especially true for
residential appraisals because of the significant volume of
refinancings due to lower interest rates.
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Institutions have commented to our Reserve Banks that
currently it is taking 2 to 4 weeks to receive an appraisal
once a request for an appraisal is made when, in the past,
it would take 7 to 10 days. Information is not available to
isolate the effect on appraisal costs and delivery time of
the increased volume of residential refinancings versus the
newly enacted state requirements for qualified appraisers.
Institutions also commented that part of the availability
problem is a shortage of qualified appraisers for complex
and specialized projects.
In some of the Federal Reserve districts, banks located in
rural and remote areas have reported experiencing
significant delays. The consequence is that a delay in the
appraisal delays the loan closing. Some smaller
institutions have commented that the burden caused by the
appraisal regulation may force them out of real estate
lending.
In its April 1991 study on the appraisal threshold, the
Appraisal Institute, a professional appraisal organization,
estimated that 32,800 appraisers would be needed to handle
the annual volume of residential appraisals. This was based
on the assumptions that there would be 8.2 million
residential appraisals per year and that an appraiser could
conduct 250 such appraisals annually. The Institute's
estimate of the number of such transactions was based on
doubling the number of the existing and new home sales
reported by the National Association of Realtors in 1989.
The Appraisal Institute concluded that there would be a
sufficient pool of appraisers given their membership of
approximately 60,000 appraisers.
The conclusion to be drawn from the Institute's analysis is
limited, however, insofar as it did not address the fact
that the location and availability of appraisers does not
necessarily match the transactions' geographic and seasonal
distribution. Further, there was no estimate given on the
impact on commercial real estate appraisals, which require a
greater level of expertise and time to prepare.
5.
How many real estate appraisers are currently licensed and
certified pursuant to FIRREA requirements and how many more
are in the process of becoming licensed and certified?
A recent estimate of the Appraisal Subcommittee places the
number of state certified and licensed appraisers at 58,000.
The Appraisal Subcommittee estimates that there will be
between 60,000 to 70,000 state certified or licensed
appraisers by January 1, 1993.
With appraisals currently being required for virtually all
real estate loan transactions, is the requirement that
appraisers be held accountable through a state-sanctioned,
licensing program an additional burden?
A major intent of Title XI was to ensure that professionals
conducting appraisals for federally related transactions
would be subject to effective supervision. By holding
appraisers accountable to a code of professional conduct and
to standards of performance, there is now a remedy for users
of appraisal services to bring action against dishonest and
incompetent appraisers.
Please discuss the proper and required criteria for
selection of an appraiser for federally related
transactions.
The Board's supervisory guidelines require financial
institutions to have proper procedures for the selection of
appraisers and monitoring of appraisers' work. An
institution may either use its own staff or engage fee
appraisers, as circumstances warrant. When the services of
a fee appraiser are used, an institution or its agent is
required to directly engage the appraiser.
In selecting an appraiser, a financial institution should
consider whether the individual's experience and educational
background adequately demonstrate the ability to appraise
the particular real estate. The level of training,
experience and knowledge should be commensurate with the
type and complexity of the property to be valued. The fact
that an individual is licensed or certified is not the sole
qualifying factor.
The selected appraiser is prohibited from having a direct or
indirect interest, financial or otherwise, in the property
or transaction. Disclosure of a potential conflict of
interest does not eliminate the conflict. This applies to
both in-house staff of the bank or fee appraisers engaged by
the bank to perform appraisals.
Are the standards of the industry, the Uniform Standards of
Professional Appraisal Practice (USPAP), a significant step
in the evolution of professionalism within the appraisal
community; and if so, why? Are these standards sufficient?
At the time the Board sought public comment on adopting its
appraisal regulation, the USPAP was in the process of being
revised, and the Board was uncertain whether the substance
of the final version would fully satisfy the purposes and
14
the requirements of Title XI. Therefore, the Board and the
other financial institutions regulatory agencies adopted
their own set of appraisal standards that were substantially
similar to those proposed in the USPAP. Since that time,
Board staff's experience with the appraisal regulation and
the revised USPAP standards indicate that these new USPAP
standards address the concerns expressed in the legislative
history of FIRREA.
Board staff believes that the USPAP improved the quality and
thoroughness of the appraisal report in that appraisers must
fully disclose in writing the analysis and assumptions
behind the opinion of value. However, it should be
recognized that the appraisal process is not an exact
science nor should it be the sole focus of an examiner's
review of a real estate loan. The appraisal process needs
to be refined to ensure that appraisers avoid using dubious
assumptions which contribute to exaggerated valuations in
both the upside and downside phases of the real estate
cycle.
9.
How much validity is there to the argument that, with a high
threshold for the use of a professionally prepared
appraisal, many low- and moderate-income borrowers will not
be given the same opportunity to have their choice of home
appraised by a competent, accountable professional as
borrowers of greater financial means?
The Federal Reserve's experience relating to financial
institutions' assessing collateral value for residential
loans, especially loans under the $100,000 threshold, has
been that institutions historically have performed adequate
assessments of the collateral value. This is supported by
the fact that current and historical data show that loss
experience for residential loans is minimal.
Requiring the use of licensed appraisers on transactions
below $100,000 would increase closing costs for low- and
moderate-income borrowers seeking credit for residential
loans, but not necessarily provide an assessment of the
collateral's worth that is more precise than an evaluation
prepared by the bank. However, the Board's appraisal
regulation does not prohibit a borrower from requesting an
appraisal performed by a certified or licensed appraiser.
Of course, in most cases, the additional cost of the
appraisal would be borne by the borrower.
@FedFRASER