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January 199 S






Fed Revises Guidelines for
Real Estate Appraisal Programs
Revised guidelines implementing
changes to real estate appraisal
regulations now allow choices
for appraisal scope and report
formats, and relax requirements
for reappraisals on existing
credit relationships. Many
transactions which are



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Federal Reserve Bank of St. Louis

News and Views
for the Eighth District

newly exempt from complete
appraisals, however, require
written "evaluations."

Transactions Req_uiring
Complete Appraisals
Most real estate transactions
over $250,000 are federally
related transactions and require
a "complete" appraisal, which
contains the five minimum
appraisal standards. The
appraisal must:
• conform to SPAP standards,
unless safety and soundness
concerns require compliance
with stricter standards;
• be in writing and contain
sufficient information and
analysis to support the
institution's decision to
engage in the transactions;
• analyze and report
appropriate deductions
and discounts for proposed
construction or renovation;
• be based on the definition
of market value; and
• be performed by statelicensed or certified

When "limited"
Appraisals are
The guidelines now permit
banks to accept "limited"
appraisals conducted in
accordance with the USPAP
Departure Provision. The bank
and the appraiser must agree
that the Departure Provision is
appropriate before the appraisal
is commenced. For example,
a limited appraisal may be
appropriate when a property
unique to the market, such
as a recycling facility, has no
comparable sales information
and the appraiser therefore
would not utilize the market
data approach to value. Banks
should be cautious when agreeing to limited appraisals because
these are less thorough reviews.

"Summary" or
"Restricted" Reports
Banks are no longer required
to obtain the traditional "selfcontained" appraisal report,
(continued on ne:xt page)

Revised Guidelines
(continuedfrom front page)

but may now accept shorter
reports with either "summary"
or "restricted" formats. Summary reports are condensed
versions of the self-contained
report, while restricted reports
present only conclusions and
no analysis. Bank policies
should identify the type of
report format that is acceptable
for the transaction based on an
assessment of risk factors. A
significant number of restricted
reports are not appropriate
because the supporting information and analysis are limited.
An evaluation is a less

formal written opinion of
value which may be performed
by a qualified individual who
is not an appraiser. Under the
new regulations, an evaluation
is normally required for:
1) loans secured by real estate

below a $250,000 threshold;
2) business loans below
$1 million where income
from real estate collateral
is not the primary source
of repayment; and,
3) renewal or refinancing of
an existing loan when:
(a) only closing costs are
advanced; or,
(b) new funds are advanced
as long as the institution's collateral protection is not threatened.
Evaluations should also be
obtained for other transactions
which the bank considers
necessary to ensure sound
underwriting. For example,
an evaluation would be appropriate to support the typical
home equity loan, especially
_ _ Reserve Bank of St. Louis

when higher loan-to-value
ratios are being permitted or a
concentration exists. Policies
should set standards for contents of evaluations which, at
a minimum, should contain
calculations, supporting
assumptions, and a discussion
of any comparable sales data.
Useful life of
Appraisals and

Bank policies should contain
clear guidelines for determining
when an appraisal or evaluation is no longer valid. There
is no longer a presumption
that a new appraisal is required
when advancing new funds or
altering the terms of an existing
loan, or when the loan's credit
quality has deteriorated. The
revised guidelines permit banks
to use an existing appraisal or
evaluation to support a subsequent transaction, if the bank
documents that the existing
estimate of value remains
valid. To support such a
conclusion, the bank must
assess factors relating to the
physical aspects of the property
or the market to determine
whether there could be a
material change in values.
For example, an additional
advance on an existing loan to
remodel or upgrade a property
is permitted without obtaining
a new appraisal, as long as the
quality of the property is sound
and the bank's resulting loanto-value remains satisfactory.
In this case, an evaluation
is all that is required. The
bank's programs should clearly
establish when a new appraisal
is required, and that internal
procedures provide for documentation of information

sources and analyses utilized
to determine the continuing
validity of appraisals.
Selecting the
Appraiser or

The appraiser must be directly
engaged by the bank and be a
competent individual subject
to effective professional supervision. Persons performing
evaluations need not be
appraisers, but should have
appropriate training, and
experience and knowledge
of the relevant market. Banks
should establish criteria for
selecting, evaluating and monitoring individuals performing
appraisals and evaluations.
Bank policies should
identify acceptable
appraisal report
formats based on
an assessment of
risk factors.

Banks should also develop
an internal list of approved
appraisers and evaluators
and a process for removing
substandard performers.
Appraisals and
Evaluations in the
Credit Process

Because the appraisal
and evaluation program is an
important component of credit
underwriting, it must be separate from the loan approval
function to avoid compromising
the valuation process. In a
small or rural institution, the
bank's own loan officers may
be the most qualified to conduct appraisals or evaluations.
This arrangement is permissible
as long as prudent safeguards

are established, such as recusing that loan officer from the
final credit decision.
Appraisals and evaluations
must be received and assessed
before the bank enters into a
binding commitment. Because
appraisers and evaluators often
carry heavy workloads and are
under pressure to meet tight
deadlines, the possibility of
errors and inconsistencies can
be material. Banks must have
adequate procedures to ensure
that each appraisal or evaluation receives appropriate review
and any errors are corrected
before the credit decision
is made.
Internal Controls

Effective internal controls
should be established to ensure
that the bank maintains a
satisfactory program. The bank
should designate a competent
individual to conduct compliance reviews which include
sampling of individual
appraisals and evaluations.
The compliance review must
be documented, either in
narrative form or by checklist,
and should ensure that corrective action is taken to eliminate
noted deficiencies.
Abank's board of directors
is responsible for reviewing
and adopting policies and
procedures that establish an
effective real estate appraisal
and evaluation program.
By Barkley Bailey, a Field Director at
the Federal Reserve Bank ofSt. Louis.

Regulation HPermits Public Welfare Investments
Federal Reserve Bank of St. Louis

he Fed recently
Regulation H
to permit a state
member bank
to invest up to 5 percent of its
equity capital plus loan loss
reserves in certain public
welfare ihvestments that are
permitted by state law. An
investment in any one project
is limited to 2 percent of equity
plus reserve.
If the investment fits clearly
into one of the following categories, it may be made without
prior approval:
• an investment previously
determined to be a public
welfare investment by the
Board or by the Comptroller
of the Currency; 1
• an investment in a
community development
financial institution, as
defined in the Community
Development Banking and
Financial Institutions Act
of 1994;
• an investment in low- and
moderate-income housing;

• an investment in nonresidential real estate
development in a low- or
moderate-income area that
is targeted towards low- and





moderate-income persons;
an investment relating to
small business development
in a low- or moderateincome area;
an investment relating to
job training or placement
for low- and moderateincome persons;
an investment relating to
job creation in a low- or
moderate-income area for
low- and moderate-income
persons; or
an investment relating to
technical assistance and
credit counseling to benefit
community development.
In addition, the bank must be:

• "adequately capitalized";
• rated CAMEL composite
1 or 2; and
• rated "satisfactory" for
consumer compliance
and have no outstanding
supervisory actions.

If both the financial and
investment criteria are met,
the public welfare investment

of the investment and the
identity of the entity in which
the investment was made.
Proposals that do not meet
the above requirements must
proceed by way of applications.

If financial and
investment criteria
are met, the public
welfare investment
may be made without
prior Fed approval.
The Fed also revised an
interpretation of Regulation Y,
relating to public welfare
investments by bank holding
companies, to permit companies
that have received approval
to engage in activities that
promote community welfare
to make additional investments
of the type that are permissible
for state member banks without additional Fed approval.
These additional investments
can be made if the holding
company's total public welfare
investments, when aggregated
with the public welfare investments made by its bank and

may be made without prior

thrift subsidiaries, do not

Fed approval. Within 30 days
of making the investment, the
bank _must advise the Reserve
Bank, in writing, of the amount

exceed 5percent of the holding
company's consolidated equity
capital and loan loss reserve.
If you have questions, please
call Supervisory Officer Dennis
Blase at (314) 444-8435.

Risk-Based Capital Guidelines
Incorporate New Accounting Rules
he Fed, along with
the other federal
banking agencies,
has amended the
risk-based capital
guidelines for state member
banks and bank holding companies to address the capital
treatment of new accounts
created by FAS 115, "Accounting
for Certain Investments in
Debt and Equity Securities,"
and FAS 109, "Accounting
for Income Taxes."
FAS 115 -Accounting/or
Certain Investments in Debt
and JJquity Securities. The
capital guidelines are amended
to exclude from Tier 1 and


Tier 2 capital net unrealized
gains and losses from availablefor-sale debt securities and
net unrealized gains from
marketable equity securities.
Net unrealized losses on
marketable equity securities,
however, should be deducted
from Tier 1 capital.
FAS 109 -Accountingfor
Income Taxes. The amended
capital guidelines limit the
amount of deferred tax assets
an institution may include in
Tier 1 capital to the lesser of:
1) the amount of deferred tax
assets the institution expects
to realize within one year of

the quarter-end report date,
based on its projection of
taxable income; or
2) 10 percent of Tier 1 capital.
In addition, the portion
of the allowance for loan
and lease losses established
in accordance with FAS 114,
"Accounting by Creditors for
Impairment of a Loan," should
be reported on the call report
as part of the general valuation
allowance, rather than as a
separate, specific allowance.
Thus, this portion of the
allowance will continue to
be included in Tier 2 capital,
subject to existing limits.
Regulatory nonaccrual rules
will be retained and no new
reporting items will be required
as a result of the implementation of FAS 114.
By Paul Lippold, an Examiner at
the Federal Reserve Bank ofSt. Louis.

Change for
Bank Holding
Federal Reserve Bank of St. Louis

hanges to the Annual
Report of Bank Holding
Companies (Form FR Y-6),
effective for the December 31,
1994, reporting period, revise
audit requirements and eliminate several report items.
Bank holding companies
will no longer submit audited
financial statements as part of
the FR Y-6. However, top-tier
bank holding companies with
total consolidated assets of $500
million or more must have
an annual audit of their consolidated financial statements


by an independent public
In addition, amendments
to the articles of incorporation
and confirmation of changes
in investments and activities
will no longer be reported on
the FR Y-6. Nonbank subsidiary
financial statements and insider
loan disclosures will be submitted with other required reports.
An organization chart, report
to shareholders, list of officers
and directors, list of principal
shareholders and Form 10-K
will continue to be required as

part of the report. The report is
due no later than 90 days after
the end of the company's fiscal
year. To assist those holding
companies who must file by
March 31, filing instructions
will be mailed shortly. For
questions concerning the
FR Y-6, call Cynthia A. Koch
at (314) 444-4630 or Jim
Mack at (314) 444-8599.
By Cynthia A. Koch, an Assistant
Examiner at the Federal Reserve
Bank ofSt. Louis.

Deposit Increases Fund Loan Growth
oans at Eighth
District institutions
continued to grow
vigorously in the
quarter ended
September 30, 1994. Total
loans grew by roughly $4.25
billion, an 18 percent increase,
at an annualized rate, since
June. All loan categories
contributed to the increase,
with real estate-secured loans
accounting for 60 percent and
consumer loans accounting
for 23 percent of the jump in
total loans. Robust total loan
growth pushed loans as a
percentage of total assets to a
four-year high of 59.2 percent.
The ratio had fallen as low as
54.1 percent in the fourth
quarter of 1992.
District banks used the liability
side of their balance sheets to
fund most of the loan growth.
Indeed, in the third-quarter


8th District Banks
Total Nontransaction Deposits (including MMDA)
Billions of Dollars
90 - - . - - - - - - - - - - - - - - - - ~


12/ 92

3/ 93

6/ 93


9/ 93


3/ 94



Nontransaction Accounts: Savings Accounts, MMDA' s and Time Deposits<$ 1OOM
Federal Reserve Bank of St. Louis

8th District Banks
Cumulative Quarterly Growth
Billions of Dollars
18 - - . - - - - - - - - - - - - - - - - ~

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3/ 93

6/ 93


12/ 93


6/ 94



total deposits, particularly nontransaction accounts, grew at
a 6.2 percent annualized rate.
In comparison, total deposits
grew by an anemic 2.3 percent
from the end of 1992 through
June 30, 1994. The $2.01
billion rise in total deposits
covered almost one-half of
the increase in total loans.
Increases in short-term
borrowings covered another
one-third of District loan
growth. Slightly over onehalf of the $1.41 billion rise in
short-term borrowings came
from overnight repurchase
agreements. Additionally,
district banks continued to
be a net purchaser of federal
funds, buying roughly 3.5
billion more fed funds than
they sold in the third quarter.
Loan growth also resulted in
adjustments on the asset side
of the balance sheet. Between



Securities -




June 30 and September 30,
District banks trimmed their
total securities holdings by
$1.15 billion, a figure that
represents over one-quarter of
total loan growth. The greatest
decrease came from availablefor-sale U.S. Treasury securities
($1.2 billion). In contrast,
held-to-maturity securities
showed a $0.6 billion increase.
In summary, though loans
grew briskly in the third quarter,
the growth was matched in part
by an increase in deposits, and
balances reflect more interest
rate risk. The shift toward
short-term liabilities has
not yet adversely affected net
interest margins as evidenced
by stable funding costs.
By Andrew P. Meyer, an Associate
Economist at the Federal Reserve
&nk ofSt. Louis.

Changes in Call Reports Address Derivatives
he FFIEC has announced
changes to the Call Report
effective March 31, 1995. These
changes will increase information on the extent and associated
risks of banks' involvement in
derivative activities, including
mortgage-backed securities,
off-balance-sheet contracts
and structured notes. The
new disclosures will permit
strengthened analyses of these
activities and the resulting
exposure on banks' capital.
Other revisions clarify reporting for mutual funds sales
and adjustments for reciprocal
demand balances and incorporate changes in accounting
Highlights of the changes are:


Derivatives Activities

• Schedule RC-B will be
revised to collect data on all

mortgage-backed securities,
so that overall holdings of
these instruments will be
disclosed concisely. Also,
memorandum items will
be added for "high-risk
mortgage securities" and
"structured notes," which
are potentially more volatile
instruments. In addition,
related instructions are
being clarified.
• Schedule RC-L will contain
an expanded matrix showing all off-balance-sheet
derivative contracts, both
exchange-traded and overthe-counter, categorized by
the four types of underlying
risk exposure - interest rate,
foreign exchange, equity,
and commodity/other.
Banks over $100 million
in assets will also report
the fair value of these

derivatives contracts.
• Schedule RC-R will collect
both net current credit exposure and notional principal
value of off-balance-sheet
derivative contracts, reflecting forthcoming changes
in risk-based capital rules.
• Schedule RI will contain
new items for disclosing
trading revenue from
derivatives and the related
impact on net income for
banks over $100 million
in assets.
Other Revisions

• Schedule RC-M will
collect the sales volume
ofproprietary mutual
funds and annuities.
• Schedule RC-O will show
adjustments to demand
deposits for certain reciprocal demand balances which


Post Office Box 442
St. Louis, Missouri 63166


Supervisory Issues is published
bi-monthly by the Banking Supervision and Regulation Division of
the Federal Reserve Bank of St. Louis.
Views expressed are not necessarily
official opinions of the Federal Reserve
System or the Federal Reserve Bank
of St. Louis. Questions regarding
this publication should be directed
to Sarah F. Casanova, editor,
(314) 444-4634.
Federal Reserve Bank of St. Louis

are needed for accurate
calculation of deposit
insurance assessments.
• Banks will be required
to implement FASB 114,
"Accounting by Creditors
for Impairment of a Loan,"
which principally affects
calculation of the valuation
reserve and bad debt expense.
• There will be several deletions, primarily involving
detail items for restructured
loans and risk-based capital.
Also, there are instructional
changes for extensions of
credit to insiders, refundable
loan commitment fees and
stock subscription payments.
By Frank Bufe, an Assistant Manager
in Regulatory Reporting at the Federal
Reserve Bank ofSt. Louis.