Evaluating the EvaluationBank Evaluation Programs

Doug Potts, MAI, VPCommerce Bank

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.

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”

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

<$100M <$250M <$500M <$1MM > $1MM -

1,000

2,000

3,000

4,000

5,000

6,000

$-

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000 LOAN STRATIFICATION v PROFITABILITY

Loan Size Bracket

# of

Not

es

Earn

ings

MM

72% of profit

2% of profit

50% of volume

10% of volume

23%

30%

48%

Job Stratification by Function

Appr Eval NM Eval Valid

3 Evals for 1 Appraisal

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”

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)

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

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?

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.

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.

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.

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

Evaluation Scope -

Defining the Problem

Research&

Descriptions

Inspection &

Descriptions

Selecting Appriorate

Data

Calculating an

Answer

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

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

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?

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

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

Eval Content - Fingerprints

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

Evaluation Scope -Defining the

Problem

Research&

Descriptions

Inspection & Descriptions

Selecting Appriorate

Data

Calculating an

Answer

Limitations

• Shelf life of evaluations• Tailoring for loan-specific issues• LTV adequacy• Lease structures

• Environmental impacts & offsets• As-is value v prospective value

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?

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…

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

External Products

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

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

Some OptionsName Type Coverage Best

Concentration Performed by

Boxwood Comml Natl Urban/Suburb Appraiser

Mountainseed Comml Natl Urban/Suburb Appraiser

Clear Capital Comml & Res Natl Urb/Sub/Rural Broker

Collateral Analytics Res 1-4 Natl Urban/Suburb AVM

Corelogic Comml & Res Natl Urb/Sub/Rural Appr Brkr AVM

DataQuick Res 1-4 Natl Urban/Suburb Appr Brkr AVM

First American Comml & Res Natl Urban/Suburb Appr Brkr AVM

Inside Valuation Comml & Res Natl Urban/Suburb Broker

ProTeck Res 1-4 Natl Urb/Sub/Rural Appr Brkr AVM

Valligent Res 1-4 Natl Urban/Suburb Appr

ValueNet Res 1-4 Natl Urban/Suburb Appr AVM

Veros Res 1-4 Natl AVM

Comparison MethodsOrder # 130219-53537A

121026-52344A121026-52450A

1334928.3 -- -- 1004000579

Date 2/21/2013 10/26/2012 11/19/2012 2/12/2012 2/12/2012 12/23/2011Property Location Address; assmt tax ID Y,N Y Y Sanitized, MN Y,Y Y,Y Y,Y

Property DescriptionBldg size, bldg age, lot size, bed, bath

Y,Y,Y,Y,Y Y,Y,Y,Y,Y Y,Y,Y,Y,Y Y,Y,Y,Y,Y Y,Y,Y,Y,Y Y,Y,Y,Y,Y

Property Current UseBldg Use Type (SFR, MFH, Condo, Offc, Retail, Ind, etc.)

Y N Y - narrative N N Y

Property Projected UseProposed construction or renovation, change in bldg use

N N N N N N

Property Market Value Est "As-Is"Must state "value" not "price"

Y Y Y Y Y Y

Property Zoning Designation Local zoning citation N N N N N N

Effective Date of Value"as is" = Date of Drafting"as proposed" = Future Date

Y Y Y Y Y Y

Limiting Conditions N N Y Y Y Y

Physical Condition ConfirmationInspection or not; proof of inspect

Sep Rpt Sep Rpt Y Y Y Y

Describe Method of Analysis Unknown -- is a display grid suffi cient?

Y - inf/eq/sup N - no analysis Y - ranking Y - AVM Y - AVM Y - ranking

Supporting Information - SalesUnknown -- is a display grid suffi cient?

Y - comps Y - comps Y - comps Y Y Y - comps

Supporting Information - ListingsUnknown -- is a display grid suffi cient?

N N Y Y Y Y

Describe Supplemental Information N N Y Y Y YIndicate External Data Sources N N Y - MLS Y - MLS Y - MLS Y - MLSIndicate Property Specific Data Sales history; assmt Y N Y Y Y YIndicate Evidence of Property Inspect Sep Rpt Sep Rpt Y Y Y YProperty Photos Sep Rpt Sep Rpt Y Y Y Y

Neighborhood Description N Sep Rpt Y Y Y YLocal Market Conditions N Sep Rpt Y Y Y YPreparer Name & Signature N N Y N N Y

Order portal avail? Y Y Y Y Y

Other banks using? PNC; SuntrustBOK, Soverign, Bank of West;

State Farm

Independent 3rd party validation avail? No No NAValidation Frequency? Monthly to AnnualCan product be upgrade to appraisal? Yes extra fee Yes extra fee Yes extra fee Yes extra feeCompliance with C & R

Optional items: Cert Appr Signs non-appr revs non-appr revs Cert Appr Signs

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

Evaluation Review Questions1. Adequately identifies the collateral property (e.g. legal description, tax number,

street address, etc.)?2. Adequately describes the collateral’s current and (if applicable) projected use?3. 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?4. 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)?

5. Describes the analysis that was performed and the supporting information that was used in valuing the property?

6. Evidence of a sufficient property inspection (e.g. photographs, comments)?7. Includes all other relevant information (described as needed in Comments

below)?8. Report includes preparer name and signature?

A Primitive Example

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).

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

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?

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

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?

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

Internal Evaluation RisksDefining the

Problem

Research&

Descriptions

Inspection & Descriptions

Selecting Appriorate

Data

Calculating an

Answer

• 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

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

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?

Comparing possible programs

• Outside vendor appraisal• Appraisal-centric eval• Internal team eval – non licensed• Internal team eval –licensed

Research Intensity

Inspection Intensity

Results Precision

Delivered Cost

Fulfillment Probability

Threat to State Licensure

Vendor Appraisal – ConventionalLow HighMod

Research Intensity

Inspection Intensity

Results Precision

Delivered Cost

Fulfillment Probability

Threat to State Licensure

Vendor Appraisal-Centric EvalLow HighMod

Research Intensity

Inspection Intensity

Results Precision

Delivered Cost

Fulfillment Probability

Threat to State Licensure

Internal Eval – Licensed StaffLow HighMod

Research Intensity

Inspection Intensity

Results Precision

Delivered Cost

Fulfillment Probability

Threat to State Licensure

Internal Eval – Unlicensed StaffLow HighMod

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

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.

What are Peers Doing? from CART

0 1-100 101-1000 101-5000 >5000

CART -- How many internal evaluations last year?

2013 2014

Volume of Evals

# of

Ban

ks

TAV

TAV w F...

Insured...

Restrict

e...AVM

BPO

Comp ...Other

0

5

10

15

20

25

30

35

40

45

CART - What does Bank permit for eval support?

2013 2014

# of

Ban

ks

Never Up to $250M

Up to $500M

Up to $1MM

Up to $5MM

Over $5MM

Other0

5

10

15

20

25

30

35

40

45

50

CART -- do you use the tax value w adj factor?

2013 2014

# of

Ban

ks

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

Reg B Notice & Disclosure

LOAN PURPOSE V COLLATERAL CLASS PROBLEM

COLLATERAL CLASS

LOAN PURPOSE

Consumer Business

Reg B Mandated1-4u dwelling

Notice & Disclosure No Notice & Disclosure

Reg B ExemptEverything else

Notice / No disclosure No Notice / No disclosure

Is This a Dwelling?

Reg B Impacts Community Banks• Increases financing & liability risk• Forces disclosure of potentially inaccurate but otherwise

adequate analysis• Requires deal restructure – financing unsecured to avoid

documentation of value• Potentially inaccurate but otherwise adequate can be

misconstrued or misused by borrower• Alternative is to order more vendor product to deflect risk

• Limits credit access to community borrowers• Inflexible rules don’t sync with the physical collateral world• Added cost of vendor product• Added delay of vendor product

Reg B Impacts Consumers• Increases confusion• Blurs distinctions from consumer to biz deals• Treats all “valuations” equally for disclosure

• Increases cost• Vendor products more costly than internal products• Prioritizes precision over adequacy

• Increases delay• Vendor products take additional time• Risk of fulfillment failure

Homebuilder Impacts• Reg B intended to give each of thousands of

individual consumers an individual appraisal.but instead ….

• Reg B requires a handful of homebuilders to receive thousands of appraisals

Hybrid Product – the BPO Eval• Can it “shift the risk” ?• How to qualify the valuation elements?• Opine price or value -- both?• IAG limitations• Review based qualification of BPO opinion?• Separate opinion using BPO elements only?

• Convert into bank-issued estimate of value• Who inks it?• Qualification v state compliance risk• Wiggle words - disclaimers

• E & O need?

Research Intensity

Inspection Intensity

Results Precision

Delivered Cost

Fulfillment Probability

Threat to State Licensure

BPO Vendor – Evaluation HybridLow HighMod

Appraisers Re-enter the Eval Space

• USPAP & state restrictions• Economics• E & O coverage

Techtonic Shifts• AI Standards v USPAP• FRTs v RET? Where do evaluations fit?• Should we cage USPAP into FRT only?• HR 5148 (Leutkemeyer TILA High Risk Mortgage Bill)• Federal pre-emption – supremacy clause• See Gibbons v Ogden 22 US 1 (1824)• See Gade v National Solid Wastes Mgmt Assoc 505

US 88.98 (1992)• See Florida Lime v Avocado Growers Inc v Paul 373

US 132, 142-43 (1962)

The Pre-Flight Evaluation• The good-housekeeping seal of approval• Post-eval changes to loan– Impact on eval reliability

• Ordering a subsequent appraisal– Valuation priority of place

Foreclosure Evaluations

• What is allowed – de minimis rules.• Risks v benefits of use• Can you manage the inspection?

• How to manage accounting needs• Fair Value• Liquidation / Distress Value

• Pre-foreclosure requirements• Post-foreclosure surprises

The Forensic Evaluation

• Multiple evaluations over time• Same asset• Allows a measure of market change• Retrospective analysis to test an appraisal• Showing editorial selection process• What comps were uncovered but not used

Evaluation in Portfolio Monitoring• The Nexus of Accuracy v Adequacy• Existing collateral & the subsequent transaction• Transaction cost v flat profitability shift

• Floor values on file as adequacy filter• Against current balance? Increasing balance?• Declining value? Physical deterioration?

• Methods?• Owner occupied class• Investment class• Special cases

Our Friend IRV

Inc

Rate

Value

2011Q1 2012 2013Appraisal Data Prior Actual Prior Actual Forecast

$0

$1,000,000

$2,000,000

$3,000,000

$4,000,000

$5,000,000

$6,000,000

$7,000,000

$8,000,000

$9,000,000 Capitalization Modeling

Annual ExpensesNOI

LOAN BALANCE

7.9% RO7.0% RO

IRV Example

Oct-06

Feb-08Jul-09

Nov-10Apr-1

2Aug-13

Dec-14

$0.00

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$70.00 Sales Trends

Orig SalesOrig AvgValue Opinion @ OrigUpdate SalesUpdate AvgSuggested Current Value

Date

Pric

e $/

sf

Trend Tech Specs

3/27/07 $13,600,000 834,012 330,190 1981 41.19$ 3/25/09 $21,600,000 2,178,000 500,000 2007 53.50$ 2/8/08 $19,265,671 1,692,306 403,960 2007 44.79$ 2/5/08 $18,722,866 1,494,233 408,151 1998.2 46.02$ 0.8% 16.2% 41.6% 16.6% 0.6% 10.3%

12/1/09 $7,657,546 583,704 226,576 1961 28.12$ 6/26/13 $23,531,680 3,242,171 500,000 2009 50.54$ 10/25/11 $15,750,000 1,300,266 368,944 1988.5 41.15$ 10/4/11 $15,672,307 1,606,602 366,116 1986.75 40.24$

1.6% 57.8% 76.0% 37.4% 1.2% 25.8% Sales Avg Sales COV

Sales Low Sales High

Sales Median

UPDATED BUILDING SALES

Address Sale Date Sale PriceLand Area

(sf)Bldg Area

(sf)Year Built $/SF Comments

Sales Low Sales High

Sales Median Sales Avg Sales COV

APPRAISAL DATA IN FILE -- BUILDING SALES -- UNADJUSTED

Address Sale Date Sale PriceLand Area

(sf)Bldg Area

(sf)Year Built $/SF Comments

Gas Station Validation

Gross Profit Multiplier Value

Gas Station Performance

Multiplier Trending

Experiences

• How is Reg B working for you?• How are evaluations working for you?

Thanks for Attending!