Evaluating the Evaluation Bank Evaluation Programs

2. Evaluating the EvaluationBank Evaluation Programs Doug Potts, MAI, VPCommerce Bank

3. A Few Questions • True/False? • Most loan transactions require appraisals. • True/False? • Evaluations are killing the appraisal profession. • True/False? • Reg B will eventually create more business for appraisers. • True/False? • Reg B will - in time - increase available consumer credit.

4. A Primer on Bank Lending • Major Purposes • New Loans (new collateral) • Subsequent Transactions (existing collateral) • Problem Loan Management (“exiting” collateral) • Major Loan Categories • Consumer purpose lending (GSE / HELOC) • Commercial business lending (C & I) • Commercial investment lending (CRE) • Unclassified lending – the “junk drawer”

5. Bank Portfolios--Risks & Rewards • Where does most of a bank’s workload sit? • Do renewals generate new $ for added cost? • New loans generate growth in profits • 80/20 rule with a vengeance • Loan profitability sits in the 20% • But the workload sits in the 80% • Renewed loans generate $0 added profit • But comprises the bulk of a bank portfolio

6. 72% of profit 50% of volume 10% of volume 2% of profit

7. 3 Evals for 1 Appraisal

8. The Point Is …. • When you combine the 80/20 rule with the $0 profit rule …… • You need a cost-effective solution to meet • Underwriting need • Regulatory requirements • The key is “adequacy”

9. The Purpose of Evaluations • Regulations require every loan get a value • Only some deals require an appraisal. • But they also provide for cost effectiveness • Spread thin but broadly • Load balance tool • Balance risk & reward • Risk sensitized • For loan size (e.g. <$250M de minimis) • For repayment reliance (CRE v C&I v Consumer) • For portfolio concentration & workload (new v renewal)

10. Program Basics • External Vendor Procured • Proliferating Options • Growing array of vendors • Growing array of evaluation styles & products • Coverage & Fulfillment • Internally Developed • Licensed or Unlicensed Team Members • Qualifications & Training • Data Sourcing & Inspections • QA / QC Controls

11. Evaluation – Scope of Work • Interagency Appraisal & Evaluation Guidelines • Flexibility v rigidness • When & where to use • Defining the problem • Creating the solution What will your regulator permit?

12. 2010 IAG Requirements • Should contain sufficient information • Details analysis, assumptions, conclusions • Should be documented in the credit file or reproducible. • Identify the location of the property. • Provide a description of the property and its current and projected use. • Provide an estimate of the property’s market value in its actual physical condition, use and zoning designation as of the effective date of the evaluation (that is, the date that the analysis was completed), with any limiting conditions. • Describe the method(s) the institution used to confirm the property’s actual physical condition and the extent to which an inspection was performed.

13. 2010 IAG Requirements #2 • Describe the analysis that was performed and the supporting information that was used in valuing the property. • Describe the supplemental information that was considered when using an analytical method or technological tool. • Indicate all source(s) of information used in the analysis, as applicable, to value the property, including: • External data sources (such as market sales databases and public tax and land records); • Property-specific data (such as previous sales data for the subject property, tax assessment data, and comparable sales information); • Evidence of a property inspection; • Photos of the property; • Description of the neighborhood; or • Local market conditions.

14. 2010 IAG Requirements #3 • Include information on the preparer when an evaluation is performed by a person, such as the name and contact information, and signature (electronic or other legally permissible signature) of the preparer.

15. Let’s Re-Arrange the IAG Ideas Evaluations have 5 major elements • Define the problem to be solved • Get needed research elements • Make needed inspections as appropriate • Selecting the right data • Doing the math & calculations

16. Evaluation Scope - • Defining the Problem • Calculating an Answer • Research • & Descriptions • Selecting Appriorate Data • Inspection & Descriptions

17. Eval Content - Preliminaries • Defining the Problem • Complexity • Effective date(s) – what is this? • Limiting conditions • Can the premise be prospective? • Can the zoning be prospective? • Basic research & descriptions - • Property specific records • Neighborhood & market trends • Current & projected use • Current zoning designation

18. Eval Content – Inspection Elements • Methods to confirm physical condition • Describe extent of inspection • Evidence of inspection • Descriptions inspection details - granularity • Property photos

19. More on Inspections • “Methods to confirm physical condition” • “Describe extent of inspection” • What about? • Out of territory property • Borrower or lender representation? • Shelf life of the representation/inspection? • Origination v Renewal? • Flexible standard? • Credit Quality? Pass v non-pass?

20. Eval Content –Selecting Data • “As applicable” data • External sales databases etc. • Local market conditions • Comparable sales

21. Eval Content – Calculate an Answer • Provide value in actual physical condition • Is that the only condition allowed? • Describe analysis performed • Describe supporting information • Data sourcing & selection • What valuation technique? What methods? • Analytical method or technological tool • Analysis performed & supporting information • Supplemental information

22. Eval Content - Fingerprints • “When performed by a person” • Name / contact info • Actual signature • Electronic signature • Is the evaluator qualified? • What about state restrictions?

23. Evaluation Scope -

24. Limitations • Shelf life of evaluations • Tailoring for loan-specific issues • LTV adequacy • Lease structures • Environmental impacts & offsets • As-is value v prospective value

25. Evaluation Options & Risk What program to develop and use? “You get to pick your problems, you don’t get to pick no problems….” • Internal Program • External Vendor Program • Appraisal Only – “no evaluations” • Hybrid? • What about BPO?

26. The Nexus -- Risk v Regulation • Triangulating competing elements • Accuracy • Adequacy • Efficiency • Cost effectiveness • Does an evaluation need to be accurate? • Is accuracy always cost effective? • Is precision always necessary? • What about low LTV transactions? • Using a shotgun to shoot a fly…

27. External v Internal Eval Programs • Consider the business model -- • Collateral class – conventional v oddball • Market coverage – urban v tract suburb v rural • External Model • Consistency & uniform product – predictable • Within its limits – highly reliable system • Fulfillment failure risk • Internal Model • Flexibility & adaptability • Precision subordinated to practicality of business • Disclosure Risks

28. External Products • Appraiser-centric or broker-centric • Available options • How to compare them? • How to review them? • Fulfillment issues • E & O dynamics

29. Vendor List • Product type – residential v commercial • Geographic coverage • National • Urban coverage • Rural coverage • Appraiser- v broker-centric • Branch from national appraisal firm • Local vendor based approach

30. Some Options

31. Comparison Methods

32. Evaluation Review Needs • General v specific • Checklist only? • Part of the purpose is speed/efficiency • Drags on velocity • Secondary data confirmations • Secondary corroborating data • Secondary inspections

33. Evaluation Review Questions • Adequately identifies the collateral property (e.g. legal description, tax number, street address, etc.)? • Adequately describes the collateral’s current and (if applicable) projected use? • Provides an estimate of the collateral’s market value in “As is” condition & use & (if applicable) zoning as of the effective date of the Alternate Valuation? • Indicates all source(s) used in the analysis, as applicable, to value the property (e.g. external data sources, property specific data, photos, neighborhood description, description of local market conditions)? • Describes the analysis that was performed and the supporting information that was used in valuing the property? • Evidence of a sufficient property inspection (e.g. photographs, comments)? • Includes all other relevant information (described as needed in Comments below)? • Report includes preparer name and signature?

34. A Primitive Example

35. Here’s an Interesting Wrinkle This review intends to fulfill Regulation B requirements for Residential 1- to 4-unit dwellings. Transactions secured by 1- to 4-unit dwellings that qualify for an evalution by law may be valued for xxxx by outside providers. The valuation document under review may be labeled “Appraisal;” but because of its limited content, it is reviewed under “evaluation” content standards outlined in the Interagency Appraisal & Evaluation Guidelines (effective Dec-2010).

36. Vendor Management • Fulfilling possibilities • List of serviced counties • How many active vendors • How many jobs by county last year • Avg fee by county • How many fulfillment failures by county • Contracts – NDAs - Processing • The follow-up process • What changes can be incorporated to improve? • Portals & ownership

37. To AMC or Not to AMC • Geographic coverage • Panel control • Customary & Reasonable Fees • Waterfall process - upgrades • Portals • Invoicing • Compliance challenges • Would it just be cheaper to bring it in house?

38. Automated Valuation Modeling • Products & Options • Hit Rates • Confidence Intervals & FSD • AVM Cascades & Selection Tables • Program Benefits • Speed – returns in moments • Cost effective – even in a cascade/waterfall

39. AVM Validation - Challenges • Regulatory compliance – modelling policy • Sample spread • Sample size • Sample cost • Sample frequency • Validations methods applied to each event • Who owns the validation process?

40. Trends in Vendor Mgmt • Fed management requirements are heavy • And getting heavier • Escalating compliance costs • Many banks are considering moving to in-house programs • More product control • Compliance is no worse than vendor management • Cost is ≤ to vendor management

41. Internal Evaluation Risks • Adequacy of Facts • Sufficient documentation • Potential inaccuracies • Adequacy of Opinions • Recognize all needed elements? • Disregard elements? • Value precision? • Does adequate alone = misleading? • Misleading to whom? • Potential inaccuracies acceptable – big picture • Risk is internal business decision

42. Disclosure Risks • Does it matter if an opinion is not disclosed? • Can a consumer recognize the difference between an evaluation and appraisal? • Consumer wounded ego. • What about credit denial? • Consumer uses a disclosed eval in unintended ways • Eval walks to another bank – portability • Divorce litigation or tax appeal • Price representations & negotiations • Personal financial statement • Estate planning or donation

43. What About Fed/State Compliance • The enforcement referral • The court subpoena • The patchwork quilt of state regulators • Mandatory v non-mandatory states • Scope of practice Issues • State enforcement risk to an internal program • Built-in exemptions • Fed requirements for qualified evaluators • What about AI Ethics/Standards?

44. Comparing possible programs • Outside vendor appraisal • Appraisal-centric eval • Internal team eval – non licensed • Internal team eval –licensed

47. Can BPOs Help? • Shifting risks from in-house to ….. • Out-house? • The importance of broker/agent skill • Local knowledge & customary thinking • Can BPOs function as in-lieu evaluations? • The IAG restriction? • Work arounds? • State brokers regulatory prohibitions • NAR lobbying in the States

48. What is NAR Up To? • Challenges from Zillow’s sometimes misleading zestimates • RealtyAlliance v Local MLSs • The RET server: • Who owns the MLS data? What level of access? • RPR – the NAR AVM – 600 MLS servers feed it. • Not making money. Trying to grow • New NAR rules allow broker developed AVMs in all markets • Issuing rules to keep MLS data from being proprietary by local MLS systems • NAR pursuing inroads to allow brokers to prepare evaluations for financial institutions without a potential listing.

49. What are Peers Doing? from CART

50. Dodd Frank & Reg B / ECOA • Key New Definitions • Borrower • Transaction • Collateral – what is a dwelling? • Notification v disclosure • Consumer purpose or • Secured by 1-4 Unit Dwelling • The Dwelling Trump Card • Mission creep from law to rule-making