Congress Hears Different Views on Appraisal Regulation

Among those testifying at a hearing of the House Committee on Financial Oversight’s subcommittee on
Insurance, Housing, and Community Opportunity were William B.
, director, Financial Markets and Community Investment, Government
Accountability Office (GAO) and Sara
W. Stephens, president of the Appraisal Institute.  Shear restated GAO’s earlier recommendations
that federal regulators set minimum standards for registering Appraisal
Management Companies (AMC)
before a hearing on
Thursday while Stephens countered
that non-congressionally mandated regulations are threatening to hamstring and jeopardize the real estate appraisal
profession altogether.

Shear presented results of a GAO
study on appraisal oversight which confirmed that appraisals remain the most
popular form of property valuation used by Freddie Mac, Fannie Mae (the GSEs) and
major lenders.  While other valuation
methods such as broker opinions and automatic valuation models (AVM) are
quicker and less expensive, they are also considered less reliable and are not
generally used for loan originations.   While GAO did not capture data on the
prevalence of approaches used to perform appraisals, the sales comparison
approach is required by the GSEs and FHA and is reportedly used in nearly all

Charges of conflict of interest have
changed the ways in which appraisers are selected and raised concerns about the
oversight of AMCs which often manage appraisals for lenders, GAO said.  The Dodd-Frank Act reinforced earlier
requirements and guidance about selecting appraisers and prohibiting coercion
and this has encouraged more lenders to turn to AMCs.  This in turn has raised questions about the
oversight of these firms and their impact on appraisal quality.

Federal regulators and the
enterprises said they hold lenders responsible for ensuring that AMCs’ policies
and practices meet their requirements but that they generally do not directly
examine AMCs’ operations.  Some industry
participants voiced concerns that some AMCs may prioritize low costs and speed
over quality and competence. The Dodd-Frank Act requires state appraiser
licensing boards to supervise AMCs and requires other federal regulators to
establish minimum standards for states to apply in registering them. Setting
minimum standards that address key functions AMCs perform on behalf of lenders
could provide greater assurance of the quality of the appraisals those AMCs
provide GAO said, but as of June 2012, federal regulators had not completed
rulemaking for such standards.

The Appraisal Subcommittee (ASC)
established in 1989 by the Title XI of the Financial Institutions Reform,
Recover, and Enforcement Act (FIRREA) has been monitoring the appraisal function
but its effectiveness has been limited by several weaknesses which include failing
to both define the criteria it uses to assess state compliance with Title XI and
the scope of its role in monitoring the appraisal requirements of federal
banking regulators.

ASC also lacks specific policies for
determining whether activities of the Appraisal Foundation (a private nonprofit
organization that sets criteria for appraisals and appraisers) that are funded
by ASC grants are Title XI-related. Not having appropriate policies and
procedures is inconsistent with federal internal control standards that are
designed to promote the effectiveness and efficiency of federal activities.

Appraisals and other types of real
estate valuations have come under increased scrutiny following the mortgage
and Dodd-Frank codified several requirements for the independence of
appraisers and expanded the role of ASC. 
It also directed GAO to conduct two studies which were the source of Shear’s
testimony before the committee.

GAO recommends that federal
regulators consider key AMC functions in rulemaking to set minimum standards
for registering AMCs, that ASC clarify the criteria it uses to assess states’
compliance with Title XI of FIRREA and develop specific policies and procedures
for monitoring the federal banking regulators and the Appraisal Foundation.  ASC and regulators are either taking steps to
implement these recommendations or considering doing so.

Although she was not speaking directly
to the GAO report, Stephens in a written statement told committee members that,
although appraising is the most heavily regulated activity within the mortgage
and real estate sectors
, regulatory agencies are planning to enact further
changes that would threaten to tie the hands of appraisers, curtail innovation
and increase regulatory burdens on appraisers and financial institutions.

Stephens was testifying directly
against The Appraisal Foundation’s creation of a new Appraisal Practices Board
delving into appraisal practice matters without Congressional authorization.
The Foundation does not have authority to codify appraisal methods and
techniques, she said, and called it a dangerous and unjustified move.  “The regulatory burden for appraisers is on
the cusp of being expanded exponentially.”

“Appraisal methods and techniques
require judgment by the appraiser. It is assumed that the appraiser has
been thoroughly trained to judge appropriate situations. The choice of methods
and techniques are the responsibility of the appraiser in the development of
his/her scope of work” she said. For instance, whether to use reproduction cost
or replacement cost or when and how to adjust for sales concessions are
dependent on the actions of the marketplace and should not be mandated by a
body such as the Appraisal Practices Board. Hard “rules of thumb” do not work
within valuation because there always is an exception to the rule, she said.

The Appraisal Institute offered a
long list of recommendations
to Congress including that they:

  • realign the appraisal regulatory
    structure with those of other industries in the real estate and mortgage
  • Protect the independence of the
    appraisal standards-setting process and require that standards for federally
    related transactions be issued by an entity that does not develop or offer
    education for appraisers.
  • Establish limitations around the
    Appraisal Practices Board specifying that no tax dollars be used to fund the
    venture, voluntary guidance be truly voluntary, and meaningful oversight over
    the de facto regulatory action of the Foundation be established.
  • Reiterate that the Foundation does
    not have legislative authorization in the area of “methods and techniques” and
    “appraiser education.”
  • Authorize the GSEs and other agencies
    to halt purchase or guarantees of loans in states that maintain deficient
    appraiser regulatory regimes and ensure that ongoing federal support for the
    GSEs or any replacement maintains consistent appraisal rules.

The Institute said states should be restricted from
codifying voluntary guidance into state law or regulation and the Appraisal
Standards Board prohibited from specifically
referencing its works within the Uniform Standards of Professional Appraisal
Practice and laws should be established to empower state boards to investigate
and prosecute complaints involving appraisers.

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The 30-Minute Interview: The 30-Minute Interview: Kelly Kennedy Mack

Ms. Mack, 38, is the president of the Corcoran Sunshine Marketing Group, which specializes in the marketing, sales and planning of luxury residential developments.

FHA Expected to Announce New Bulk Sales Agenda

The Federal Housing Finance Agency (FHA)
is expected to announce before the close of business today a new bulk sale
to liquidate some of the reported 700,000 delinquent loans they
.  According to The Wall Street Journal, the agency may
be planning on selling as many as 5,000 distressed loans each quarter over an
unspecified period of time.

Bulk sales were used on a large scale by
the Resolution Trust Corporation and the Federal Deposit Insurance Corporation
during the savings and loan and banking crises of the 80s and 90s and FDIC
continues to use this mechanism to clear the assets of failed banks.  Lenders and guarantors such as Freddie Mac
and Fannie Mae generally shy away from these sales because of the deep
discounts needed to move the loans.  Even
the “good” loans such as are sold by the FDIC because they are too costly and time
consuming for the institution to manage are discounted substantially; seriously
delinquent loans go for pennies on the dollar. 

The Journal
states that FHA is considering bulk sales in an effort to reduce its growing
portfolio of distressed loans
and to avoid the costly process of foreclosure,
but also because its own rules limit ways in which the mortgages can be
modified, leaving little room for aggressive loan modifications like those done
by Freddie Mac, Fannie Mae, and proprietary lenders.  Once sold these strictures disappear and the
investor can take more drastic steps to bring the loans back on line.

Bulk sales can be hugely profitable for
investors, but in this case the sales may also allow some homeowners to stave
off foreclosure by cutting better deals than would have been possible with FHA.  The Journal
quotes FHA’s acting commissioner Carol Galante as saying “There will be an incentive for a modification that isn’t able
to be done under the current system. It will be cost-effective for the
FHA….It will be better for the communities.”

also face some restrictions that work for the benefit of homeowners and the
marketplace.  They can’t foreclose for
six months after buying the loans and must agree to hold back from sale at
least 50 percent of the homes backing the loans for at least three years.

told the Journal that FHA was trying to minimize the impact of any vulture
investors who buy hoping for a quick foreclosure, eviction, and resale.  “We are trying to change, frankly, the
behavior of who’s interested in buying these notes,” she said.

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Community Lenders want Smaller GSEs Retained in Secondary Market Role

The Community Mortgage Lenders of
(CMLA) is urging policy makers to consider retaining the positive aspects
of Fannie Mae and Freddie Mac
in any future secondary market design.  CMLA is asking that a smaller Fannie and
Freddie be configured to serve 30-35 percent of the overall secondary mortgage
market while being barred from securitizing or investing in anything but plain “vanilla”

The trade association stated its
preferences in a letter to the secretaries of Housing and Urban Development
(HUD), Treasury, and the Acting Director of the Federal Housing Finance Agency
(FHFA) as well as the chairs and ranking members of two congressional
committees which will be involved in the future definition of the market.    

CML said
the two government sponsored enterprises (GSEs) have benefited from the strong
oversight and leadership they have received from FHFA and that has been
reflected in the housing market where credit has remained available primarily
because of their presence.  While the
housing industry, Congress, Treasury, HUD, and the FHFA are seeking clarity on
how the GSEs should perform going forward, CMLA “believes that the housing
industry and the public at large are best served through a sensible and calculated
reformation of the GSEs that reduces their footprint in the industry while at
the same time allowing them to serve their historically critical functions.”

The CMLA endorses a future whereby Fannie and
Freddie shrink to serve 30-35 percent of the overall secondary mortgage market,
and are barred from securitizing or investing in anything but plain
“vanilla” mortgages.

While the FHFA’s October 2011 projections shows
that the balance sheets of the GSE’s are improving, FHFA has also expressed
doubt that they will ever be able to repay the government its investment during
the crisis.  CMLA believes that the
taxpayer can be repaid through creative and thoughtful planning and through
tailoring an increase in guarantee fees to more accurately price risk. 

There are a number of principles that should
inform creation of a fair and effective secondary mortgage market according to

Standardization reduces

Liquidity is needed

Conventional lending
should be protected

Loss mitigation
procedures should be retained and further enhanced

Risk must be made

Market concentration
should be reduced

Portfolio flexibility
should be increased

Proper use of
Guarantee Fees must be required

Reform must include
standards for the non-GSE Secondary Market.

The letter states that a sensible and calculated
reformation of the GSEs will result in continued liquidity and stability
without an unnecessary disruption
to the secondary market, “or worse, a
concentration of the secondary market within a limited number of large
banks/servicers.”  CMLA sets out the
following steps for the GSEs to complete within a transition time and
recognizing market realities.

  • Pay an explicit
    backstop fee to the federal government;
  • Be prevented by
    statute from securitizing or investing risky mortgages as defined by the
    Qualified Residential Mortgage Rule;
  • Be shrunk and
    normalized to sustain roughly 30 to 35 percent of the secondary market
  • Continue to be required
    to serve lenders of all sizes and to nurture smaller markets in areas of market
  • Continue to provide
    standardization of origination documentation, servicing practices,
    securitization terms and modification/foreclosure strategies as a policy of
    consumer protection;
  • Reduce and maintain
    portfolios over time, but only as transitional market pricing reduces the
    portfolios. Given that the portfolios
    provide a stabilizing influence of mortgage pricing and that the FHFA has said
    the portfolios will only cause 9 percent of overall losses “any forced downsizing
    seems politically motivated to benefit large banks and Wall Street.”
  • Establish a governing
    board to maintain and set a competitive guarantee fee following the public
    utility model with funds generated to be retained in the housing industry for
    the benefit of taxpayers;
  • Regulate
    post-conservatorship executive compensation through a governing board to
    prevent excessive risk-taking.

CMLA says it is the first trade group to call for
the GSEs to remain intact.  Mark
McDougald, Chairman of the organization said, “Our plan is forward-looking
and will result in distinct changes in the secondary market. However, we call
on Washington to move expeditiously and to avoid
drastic, politically-driven changes that will harm small lenders and the small
communities in which they serve,”

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DeMarco Discusses the Future of FHLBanks

Edward J. DeMarco, Acting Director of the Federal Housing Finance Agency (FHFA) told Federal Home Loan Bank (FHLBank) directors yesterday that their Banks’ proven ability to access global markets could play a large role in their future.  DeMarco spoke to the directors as they met in conference in Washington, DC.

DeMarco said that most FHLBanks had emerged from the recent crisis in relatively good condition and all 12 were profitable last year.  Retained earnings have increased dramatically in the past five years and now top $9 billion and should continue to increase as a result of the capital plan provisions adopted last year to set aside 20 percent of income in restricted retained earnings.  The quality of assets held by the Banks has also improved as holding of private label mortgage-backed securities (MBS) have declined.  Credit-related other than temporary impairment charges on those securities also dropped in each of the last three quarters.  “In a reversal from just a few years ago, the market value of equity exceeds the par value of capital stock at most FHLBanks,” Demarco said.

The banks still face headwinds, the largest being the decline in the volume of advances, “and the outlook for advances growth is not promising in the short-term as members remain flush with cash and loan demand remains slack.”  Expenses have not contracted as fast as assets and advances and persistent low interest rates have reduced the return on invested capital, both contributing to weakened earnings.

Growth of membership over the past year has been concentrated among insurance companies.  Their collateral arrangements with the FHLBanks differ in some critical ways from those with insured depository institutions and, DeMarco said, these arrangements bear watching as does market risk, especially at Banks with large holdings of mortgages and MBS relative to assets.

In the current climate housing finance reform is a critical concern and, while the futures of Fannie Mae and Freddie Mac are central to that discussion, the FHLBanks should be part of it as well.  The Banks, DeMarco said, have long been a conduit to global capital markets and have enhanced the liquidity and funding of mortgages for decades.  “Expanding, maintaining, or refining that role will be the focus of the conversation as it pertains to the FHLBanks.”

There are more than $10 trillion in single-family mortgage loans in the nation, there are not enough deposits in the country to fund them all, and the risk management challenges for domestic financial institutions to manage all the associated risks in the portfolio are substantial.  The U.S. Housing market of the future, like the market today, needs access to global capital markets.

“A critical question for policy makers is how to build or rebuild the plumbing necessary to connect global market investors with individual families seeking a mortgage to buy a home,” he said.   FHLBanks have already demonstrated their scalability and their ability to access the markets, even during the height of the liquidity crisis.  By issuing debt into global markets the FHLBanks raise funds that support housing through funding advances for mortgages going into members’ portfolios.  The ready availability of advances also makes those mortgages more liquid than they would otherwise be, thereby reducing the liquidity risk in members’ mortgage portfolios.  This also allows the FHLBanks to issue market-worth letters of credit which, in turn, allows members to attract their own funds for use in housing finance.  “Furthermore, as market intermediaries, the FHLBanks now serve as facilitators in the securitization process, collecting mortgage loans from members for sale in the secondary market.”

The FHLBanks already have strong relationships, including a cooperative ownership structure, to their nearly 8,000 front-line local lenders and these relationships give the Banks an important role as market intermediaries.  This makes them well suited to be part of an evolving housing market.

DeMarco laid out three ways in the Banks might be affected by moves to rebuild the housing finance infrastructure.  Congress could choose to expand the FHLBanks’ permissible business activities and such expansion might also require a review of the System’s capital structure and requirements and its approach to risk management.  Congress could choose to add some limits or restrictions on the Banks, essentially requiring some degree of contraction such as suggested in the Administration’s finance reform white paper by way of adding restrictions on the access of larger members to advances.  Or Congress could decide that the System is working well and leave it largely unchanged from where it is today.

If the decision is to stay the course, FHLBanks would remain focused on providing advances to members and providing a competitive and balanced finance and servicing system.  For members interested in retaining mortgages in portfolio the FHLBanks can continue to provide liquidity; for members interested in selling those mortgages, the banks have already demonstrated an ability to serve as a conduit to the secondary market.  And by serving as an aggregator in this process, the Banks are doing two important things; enabling community financial institutions to obtain better pricing and providing quality control by ensuring mortgages are securitized to meet the standards of the AMA programs.

DeMarco told the directors their most important role is to oversee and advise on the strategic planning process at their banks which means planning for the future.  For an organization to compete effectively it must build its strategic plan around its competitive advantage and for FHLBanks that advantage is their government-sponsored enterprise borrowing privilege.  It is the directors’ responsibility to product that privilege by using it to fund core mission activities safely and soundly.

DeMarco told the directors that the key to planning is to envision the future before it arrives.  Unfortunately, he said, because almost everything about the future is uncertain and unpredictable, “The question that faces the strategic decision-maker is not what his organization should do tomorrow.  It is ‘What do we have to do today to be ready for an uncertain tomorrow?’   “This,” he told the directors, “is your role.”

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