Vendor oversight and management is certainly not new to financial institutions, but recent enforcement actions by the Office of the Comptroller of the Currency are heightening the need for banks to have demonstrated processes in place. As summarized by the Federal Deposit Insurance Corp. (FDIC) in FIL-44-2008, “An institution’s board of directors and senior management are ultimately responsible for managing activities conducted through third-party relationships, and identifying and controlling the risks arising from such relationships, to the same extent as if the activity were handled within the institution.” Financial institutions using outside firms for appraisals and environmental due diligence are ramping up their oversight of outside firms and for some, the data management burden is not insignificant. As noted recently by one lender, “We essentially have to manage our consultants as diligently as if they were bank employees.” Another referenced a shorter approved vendor list due to what he called “the sheep dog effect,” noting that “a dog can only watch so many sheep so if we’re forced to watch them more diligently, we have to limit the number we use.” To help lenders effectively manage the vendor management responsibility for outside appraisers and environmental consultants, EDR Insight is fortunate to have Mitch Kreeger, MAI SRA MBA, as a guest author for this three-part monthly series.
VENDOR MANAGEMENT: Advice for Lenders in Using Appraisers and Environmental Professionals (Part I of III)
I hear these all the time:
- “Lending clients demand that we save money and time so we use the fastest, lowest bidder to be competitive.”
- “Appraisers are either residential or commercial, right?”
- “Environmental engineers can handle any environmental or seismic risk assignment, right?”
- “Appraisers simply call brokers for the three recent sales; the subject’s value is mid-range. Anyone can do that. Overpaid. Take too long.”
- “Do vendors actually need to be ‘managed’?”
This is Part One in a three-part exploration of key issues in appraisal and environmental vendor management. First, I will lay the groundwork of relevant regulatory guidance and the basics of setting up appraisal and environmental risk functions. Then, in Part Two, I will offer advice in finding the right vendor for the job, “knowing your vendor” and managing your vendors. Last, Part Three will offer advanced tips on optimizing vendor relationships for a win-win-win (i.e., lender-vendor-customer) program.
Regulators require banks to manage their risks, but how do smaller and newer banks develop policies, lending functions, and find competent vendors for the first time?
My past articles addressed appraisal policy development. This series tackles staffing appraisal and environmental risk functions, and the “why and how” of managing outsourced vendor relationships. Seismic risk, a regional concern with its own specialty vendors, depends on each institution’s risk tolerance level – but don’t get caught with your pants down when “The Big One” comes.
Some lenders see “faster, cheaper” as opportunity to gain market share when competing for customers who do not know or care about regulations or lender capitalization. Stakeholder demands for quarterly profits may be a mandate to reduce costs or increase volume. Some lenders see appraisers and environmental professionals as indistinguishable commodities, a “one size fits all,” overpaid for what they do, imprecise, and necessary evils created by obstructive, excessive banking laws. These are ALL misperceptions.
Why do we need to manage vendors? Aren’t they all essentially the same?
Why? Because regulator guidance says so, and because it serves long-range stakeholder risk management and survival. Vendors are NOT created equal. Most are very professional, but some are less scrupulous with profits and repeat business being primary motives. Under OCC guidance, it is the responsibility of board members and senior management to ensure that contracted activities fall in line with regulatory guidance to uphold safety and soundness at lending institutions (For a list of relevant guidance, see the FOR MORE INFORMATION section at the end of this brief.)
Effective vendor risk management is a lifecycle relationship that generally follows this order:
- Due diligence and 3rd-Party selection;
- Contract negotiation;
- Ongoing monitoring (with independent reviews); and
When should we hire a Chief Appraiser and staff this function? What about environmental risk?
It is prudent when an institution sees steady, stable volume of collateral valuation tasks (e.g., 10 to 20 jobs per month) or upon reaching an asset size of $1 billion or more with a real estate lending focus (when it becomes too big a task or beyond the competency of current multi-tasking staff members) to recognize that the appraisal function may be ready for dedicated in-house and/or outsourced Subject Matter Expert representation.
What about environmental risk management? When and how should that function be brought in-house? That topic is briefly touched upon here, but is a strategic growth concept to be considered early on.
Common findings at many bank failures include “insufficient bank resources to manage, oversee appraisal function” (Source: AI Material Loss Reports, Regulatory Impact on Consumers and Business, 2012) and “failure to obtain appraiser with required independence or competency” (Source: FDIC OIG, Comprehensive Study on the Impact of the Failure of Insured Depository Institutions Report EVAL-13-002, 2013).
Supervisory guidance reflects a highly regulated appraisal function, yet less regulated environmental risk management. That said, these present long-range risk mitigation opportunities toward avoiding potential consequences and losses (e.g., financial, functional, regulatory, legal, reputational, etc.) compared to using inadequate or under-qualified personnel for appraisal, environmental, and review functions.
Below I offer an informal guide to functional progression for consideration. The progression reflects that, as an institution grows, these functions expand:
Part Two in this series will be published in May 2015, and includes advice on how best to get started in establishing an effective vendor management program.
FOR MORE INFORMATION
Source documents for vendor risk management guidance include:
- FDIC Guidance for Managing 3rd Party Risk (2008)
- OCC 3rd Party Relationships Guidance (2013)
- FRB Managing Outsourcing Risks (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”