NOTE TO READERS: Regulatory compliance is top of mind for financial institutions in this era of strict oversight, and all types of bank underwriting are affected, including the appraisal function. To help you do everything you can to prepare for the scrutiny of examiners, EDR Insight is fortunate to have Mitch Kreeger, MAI SRA MBA, as a guest author for this two-part series on surviving an appraisal compliance audit. Kreeger is an appraisal, environmental and seismic risk consultant and reviewer who has worked extensively with lenders and independently for over 25 years. Part 1 of our series was published in January, and focused on the specific things that bank examiners are looking for in an appraisal compliance audit. Below is Part 2 in which Kreeger provides specific best practices for banks to include in their appraisal policies to protect them from themselves when markets heat up.
Recall from Part 1 in this series, regulators used to be considered the “Bad Cop” going after the “Bad Bank”; however, times have improved and regulatory examiners are emerging as a “Good Cop” encouraging lenders to seek them out for advice or interpretation of regulatory guidance in realizing “Good Bank” status.
In Part 2 of this series, I offer a few “best practices” and survival tips for lenders faced with appraisal compliance audits or exams. It is based on numerous discussions and interviews with regulators and industry peers, as well as my 25-plus years of experience inside and as outside consultant for various large and small lending institutions.
BEST PRACTICES TIPS
Below is my advice on things you can (and should) do at every step of the process: prior to the audit, during the audit and after the audit.
Prior to the Audit:
• Retain a 3rd party or independent in-house auditor to conduct a pre-exam evaluation of loan and appraisal files, identifying weaknesses or deficiencies to be improved prior to the arrival of examiners.
• Have processes, policies and data at the ready to demonstrate that the institution follows sound risk management principles.
• Be organized and consistent. File management platforms (e.g., RIMS, FNC, ATS, etc.) can assist in this area. Be able to show:
o Encrypted secured transmission of Non-Public Personal Information (NPPI).
o Offsite backup systems and archives for minimal downtime or data loss.
o Vendor file management (licenses, E&O, SME niche, geo coverage, performance ratings, contact information, vendor approval process with demonstrated compliance, etc.).
• Maintain good NOTES TO FILE for each assignment. Document, Document, Document:
o Why you selected a specific vendor.
o Why you varied from policy or procedure.
o Appraisal deficiencies found and how resolved, corrected, or deemed to have a nominal impact on value or compliance.
o Copies of supporting comments and correspondence to backup actions.
o Time, date and details on verbal discussions – follow-up calls with email summary.
o If asked why you took a particular action, the Notes to File audit trail can demonstrate that you: a) recognized the issues, b) acted correctly, and c) documented the facts.
During the Audit:
• Always tell the truth.
• If you do not know or are unsure of an answer, say “I do not know” or “I cannot recall”; then be quiet. If requested by examiners, later seek out more information and provide the answer back both timely and concisely.
• Regulators (“Good Cop”) advise that you should discuss potential deficiencies addressed in the audit with the examiner along with possible remedial actions (“Good Bank”).
• If deficiencies are discovered, take remedial action in a timely manner. Repeated deficiency findings in subsequent audits (“Bad Bank”) often lead to increased penalties and enforcement.
In response to adverse exam findings, regulators want the institution to develop a corrective action plan and demonstrate factual, tangible steps taken to address findings and concerns.
Do not merely focus on regulatory compliance (or the appearance of regulatory compliance). It is wiser to focus on leveraging these functions to improve earnings reliability, reduce losses, and reduce loss severity. Focus on long-term sustainable earnings and capital strength rather than short-term fee income or shareholder quarterly earnings reporting.
Appraisal Independence – it’s the law.
Using unqualified or under-qualified people to detect risks harms the institution and its stakeholders. Paying more to obtain higher qualified talent to review appraisals has statistically proven to be cost-justifiable over time. Competent appraisal and review programs are the best defense in mitigating valuation-related loan loss and civil litigation risk exposures.
Risk management processes should consider the complexity of each assignment in vendor selection. Document vendor relationships with respect to:
• Compliance with applicable regulations.
• Consistency with supervisory guidance.
• Job performance standards.
• Vendor’s competency, license status and areas of expertise.
• Attempts to validate the vendor’s diversity, confidentiality, legal practices (Know Your Vendor).
POLICIES: Create a system to ensure that valuation tools provide credible market values. Create IA&EG and USPAP compliant policies aligned with FFIRA Guidance. Remember that the Institution’s appraisal function must be independent from loan production.
PROCEDURES: State your valuation production and review processes. Develop processes to assure vendor competency. Vendor selection should consider prior experience of, and with, the vendor. Procedures should address the institution’s internal controls in recognizing, reporting and repairing deficiencies in a timely manner.
AVOID PRACTICES INCONSISTENT WITH POLICIES AND PROCEDURES. If unavoidable or inconsistencies are justifiable on a one-off basis, clearly document how and why you varied from policy or procedure. Loan Committee or Board Approval, on record, is a good checks-and-balances function for all policy exceptions. NOTE: Multiple or regular policy or procedure exceptions become de facto policy and will raise a red flag to regulators.
After the Audit:
It may be practical to not dispute with regulators. Doing so may inflame the situation, give appearance the institution is in denial, or might trigger “Bad Cop”. That said, one senior managing regulator whom I interviewed confidentially noted: “I expect bankers to challenge examiners if they think their process is okay. Just be professional.”
– Appraisal Institute
– Interagency Appraisal and Evaluation Guidelines (IA&EG, 2010)
– GAO Website
– FDIC Office of the Inspector General Report to Congress: Comprehensive Study on the Impact of the Failure of Insured Depository Institutions Report, January 2013
ABOUT THE AUTHOR
Since 1980, Mitch Kreeger provides real estate appraisal and review services on residential and commercial valuation assignments, environmental and seismic risk management services for lenders, plus consulting services related to policies and procedures, regulatory compliance, and appraisal / environmental risk in-house or outsource function design. Professional services also have included apartment acquisition investment DCFs, budget analysis, construction lending inspections and analysis, and real estate market trend analysis. Mitch’s client base ranges from very small to very large lending institutions, corporate and individual property owners, investors and syndicates, municipalities and redevelopment agencies, and legal services; however, most of his career has been as internal appraisal management or staff with various institutional lenders. Mitch is considered a Subject Matter Expert (SME) on various valuation, environmental and seismic risk, and regulatory compliance topics by peers nationwide, and volunteers or is sponsored as guest speaker, panelist, author, and network blogger. Mitch is currently Chief Appraiser and Principal Consultant at Kreeger Consulting, a private appraisal / environmental / seismic risk consulting services firm that offers commercial appraisal reviews, outsourced Chief Appraiser duties, and advisory services to lenders on regulatory compliance, efficient appraisal / environmental risk functions, and effective policy updates.
Mitch Kreeger, MAl SRA MBA
Principal Consultant, Kreeger Consulting: Appraisal Review, Environmental & Seismic Risk Policy Manager
Mitch’s LinkedIn Profile
“Appraisal Leader for Tomorrow’s Environment”