Tag: real estate appraisal

The importance of appraisal reviews in protecting financial institutions

Written by admin on September 25, 2025. Posted in Blog, Risk Management.

By Casey Simpson; consultant and manager of appraisal review services, Young & Associates

In the real estate industry, accurate and unbiased property appraisals are critical. These influence lending decisions, investment strategies, tax assessments and legal outcomes. Appraisal reviews are a safeguard for financial institutions, investors and the public. Additionally, the regulators outlined this process as a requirement.

Accurate and unbiased property appraisals drive critical decisions in lending, investment strategies, tax assessments and legal outcomes. Appraisal reviews provide safeguards for financial institutions, investors and the public, and regulators mandate the process.

Although appraisal value thresholds have changed over time, the obligation to review appraisals has not. Financial institutions must still conduct a review whenever an appraisal supports a transaction.

The Interagency Appraisal and Evaluation Guidelines from 2010 specifically states, “As part of the credit approval process and prior to a final credit decision, an institution should review appraisals and evaluations to ensure that they comply with the Agencies’ appraisal regulations and are consistent with supervisory guidance and its own internal policies. This review also should ensure that an appraisal or evaluation contains sufficient information and analysis to support the decision to engage in the transaction.”

Appraisal Disciplinary Actions chart — Disciplinary cases show that nearly all appraisal deficiencies could have been remediated or prevented through proper reviews. *Data: Ohio Appraiser Disciplinary Actions 2020-2025*

What are real estate appraisal reviews?

A real estate appraisal review evaluates an appraisal report for completeness, accuracy, consistency and compliance with applicable standards.

Qualified professionals who are independent from the subject transaction and have experience in the relevant property type should perform appraisal reviews to maximize the benefits. Use consistent review checklists with a clear understanding of the client’s scope of work. Align with client-specific requirements and regulatory compliance. Provide a detailed narrative of the transaction appraisal that documents findings and highlights deficiencies or recommendations.

Key benefits of real estate appraisal reviews

Enhances accuracy and reliability: Errors, omissions, or flawed assumptions in an appraisal can result in inaccurate valuations. A review identifies discrepancies and unsupported conclusions to ensure the final report is accurate and defensible.
Mitigates financial risk: For lenders and investors, misvalued properties carry significant risks. Reviews serve as a risk.
Ensures regulatory and standards compliance: Financial institutions are subject to strict regulatory requirements, including the Uniform Standards of Professional Appraisal Practice (USPAP), the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) and the Dodd-Frank Wall Street Reform and Consumer Protection Act. Appraisal reviews help ensure compliance with these requirements, protecting the institution from legal or regulatory penalties.
Improves consistency across valuations: For organizations managing multiple appraisals, reviews promote consistency in methodology, terminology and value conclusions. This supports transparency and establishes quality standards.
Cost limitations: Financial institutions with qualified in-house reviewers can use them as a resource to reduce risk. However, third-party providers can provide review services, with costs passed on to the customer as a line item on the closing settlement sheet.

Regulatory compliance explained

Uniform Standards of Professional Appraisal Practice (USPAP)

The purpose of USPAP is to promote and maintain a high level of public trust in appraisal practice by establishing requirements for appraisers. It sets forth standards for all types of appraisal services, including real property, personal property, business, appraisal review and mass appraisal. It is essential that appraisers develop and communicate their analyses, opinions and conclusions to intended users in a manner that is meaningful and not misleading. (source: www.appraisalfoundation.org and www.appraisers.org)

The Dodd-Frank Wall Street Reform and Consumer Protection Act

Commonly known as Dodd-Frank, it is legislation that was passed by the U.S. Congress in response to financial industry behavior that led to the financial crisis of 2007–2008. It sought to make the U.S. financial system safer for consumers and taxpayers. It established a number of new government agencies tasked with overseeing the various components of the law and, by extension, various aspects of the financial system. The Dodd Frank Act aimed to protect the independence of appraisers, reasonable and customary appraisal fees, appraiser certification and education standards, requirements for Appraisal Management Companies (AMC’s), standards for Automated Valuation Models (AVMs) and Broker Price Opinions (BPOs), additional provisions for high-risk mortgages, among other issues. (source: www.investopedia.com by Adam Hayes updated February 01,2025 and Regulatory Issues Facing the Real Estate Appraisal Profession)

Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA)

FIRREA has reshaped lending practices, particularly in real estate and mortgage financing. Lenders must adopt rigorous underwriting standards to ensure loans are extended to creditworthy borrowers, reducing the risk of defaults and enhancing financial system stability. Certified appraisals are now required to ensure accurate property valuations, critical for mitigating systemic risk in mortgage-backed securities. (source: www.accountinginsights.org Published Feb 13, 2025 and Regulatory Issues Facing the Real Estate Appraisal Profession)

Financial institutions face heightened risk if appraisals are not thoroughly reviewed. Independent reviews reduce risk, ensure adherence to standards and save valuable staff time. At Young & Associates, we provide independent appraisal reviews that give your team confidence in lending decisions while reducing compliance burdens. Let Young & Associates help you navigate appraisal compliance with confidence and efficiency. Reach out for a consultation.

Managing CRE Credit Risk Amid Market Shifts

Written by admin on October 26, 2023. Posted in Advice, Consultation, CRE & AG Stress Testing, Lending & Loan Review, Liquidity Review, Management & Planning, Regulatory Enforcement.

By: Jerry Sutherin, President & CEO of Young & Associates

The landscape of commercial real estate (CRE) lending is shifting due to current economic events, presenting both challenges and opportunities for community financial institutions deeply entrenched in this sector. The challenges range from the profound impact of remote work trends and the uncertain future of office spaces to growing concerns about inflation and higher interest rates bringing CRE risk into the spotlight. This volatility has garnered increased attention from internal and external stakeholders, as well as regulatory authorities. Consequently, identifying the most pressing threats among these challenges and proactively mitigating risk has become a top priority for financial institutions with CRE exposure.

In the face of rising interest rates and delinquencies, many financial institutions are preparing to confront these economic stressors. In fact, some were already scaling back lending before the recent collapses of Silicon Valley Bank and Signature Bank. We have all witnessed the tightening of lending standards resulting from that event, and many analysts anticipate further tightening among all community financial institutions. This constriction is also impacted by limited deposits and liquidity forcing financial institutions to be selective in how they deploy their capital. These facts leave many analysts predicting when credit problems will emerge in the CRE sector.

The evidence speaks for itself. According to S&P Global Market Intelligence, the delinquency rate for all CRE loans held in U.S. banks has increased by five basis points year over year. Moreover, within a single quarter earlier this year, the delinquency rate for nonowner-occupied nonresidential property loans spiked by a significant 24 basis points. This has led to tighter lending standards at origination, reflecting the concerns of institutions. Further, financial institutions are taking proactive measures to mitigate CRE risk after origination. Some have set aside high-single-digit percentage allowances for office loans. Others have reduced exposure through portfolio sales. Overall, loan originations have fallen, CRE sales have slumped, and forecasts indicate a drop in CRE prices.

The tightening of lending standards, the slowdown in the growth of CRE loans, and the impact on loan originations have emerged as central concerns in the financial sector. What unifies these factors is their inherent risk and whether they act as warning signals or responses. Managing CRE credit risk is undeniably intricate, but leveraging available strategies and tools empowers community banks, credit unions, and financial institutions to effectively navigate the ever-changing CRE lending sector. This enables them to proactively assess and plan for risk mitigation, rather than merely react to these changes.

Understanding Commercial Real Estate Risk

As CRE loans represent a substantial part of many banks’ loan portfolios and higher yielding assets, especially within community financial institutions, understanding the significance of CRE credit risk is paramount. Community banks and credit unions often operate in areas experiencing job and population growth, leading to a high demand for CRE lending and, in turn, a high concentration of CRE loans. This growth and its corresponding effects on loan portfolio concentration pose new challenges for banks in terms of risk monitoring and control.

While larger financial institutions commonly maintain experienced staff and even entire departments to manage these risks, it is generally not cost effective for smaller financial institutions to hire and maintain qualified resources to help mitigate the inherent risks. In the absence of an internal CRE risk management team, it is imperative for financial institutions to rely on independent third-party resources to assist in this crucial process.

Historical Context and Lessons from Past Experiences

A retrospective examination underscores the importance of proactive risk management. Many significant historical banking failures were largely attributed to overinvestment in CRE loans and the lack of an effective risk management process. Weak underwriting standards and poor portfolio management led to an oversupply of CRE properties and borrower defaults. Over time, regulatory improvements, such as stricter underwriting and risk management requirements, have been implemented. Nevertheless, predicting the future remains uncertain. We can only analyze past patterns and the shortcomings to properly assess future risks.

In 2023, community and regional financial institutions comprise approximately 72% of the CRE loan market, taking on an above-average amount of CRE credit exposure. Recognizing such circumstances is vital, as you should be alert to potential red flags. Identifying and managing CRE credit risk is critical.

Identifying Emerging CRE Risk

A comprehensive understanding of CRE credit risk highlights the increasing complexity of its landscape. CRE credit risk is multifaceted, with numerous risk categories affecting CRE lending, including market risk, asset risk, liquidity risk, and credit risk, among others. To construct a robust risk management strategy, all these variables must be explored and considered.

To assess your financial institution’s CRE loan segment’s health, a systematic approach is needed. When determining if your CRE portfolio exceeds your institution’s risk appetite and how to quantify that risk and respond effectively, the answers lie in developing a comprehensive, tailored framework for assessing and analyzing your CRE loan market. The most recent regulatory interagency Statement on Prudent Risk Management for Commercial Real Estate Lending notes that institutions that successfully monitored risk have:

Established appropriate loan policies, underwriting standards, and concentration limits.
Conducted cash flow analyses based on realistic rates and expenses to ensure repayment ability and assessed borrowers’ ability to repay during interest rate fluctuations and loan structure changes.
Analyzed the impact of economic changes on the loan portfolio’s quality, earnings, and capital.
Provided boards and management with information to adapt lending strategies in changing market conditions.
Maintained information systems to manage concentration risk effectively.
Implemented appropriate appraisal review and collateral valuation processes.

With the many challenges faced by community financial institutions, the need to effectively identify, measure, and manage these risks has become paramount. While established best practices exist to address these risks, financial institutions must transition from assessing each risk in isolation to recognizing the interconnectedness and synergy between them. A more holistic approach to risk management is required, allowing institutions to confidently inform their capital planning, risk tolerance, and overarching strategy.

Strengthening CRE Risk Management in Community Financial Institutions

A comprehensive risk management strategy empowers financial institutions to adapt to market dynamics, instilling confidence among stakeholders and regulators. Alongside the factors discussed in the previous section, regulatory guidelines highlight two critical facets of CRE risk management: stress testing and portfolio reviews. While community financial institutions can execute these internally, outsourcing can offer efficiency and effectiveness.

CRE Portfolio Stress Testing

Stress testing and sensitivity analyses are indispensable tools for evaluating CRE risk and gauging the impact of economic fluctuations on asset quality, earnings, and capital. These assessments should align with the portfolio’s size and risk profile. CRE stress tests inform strategic and capital planning, credit concentration limits, policy, and underwriting. Integrating stress testing into risk management and strategic planning is essential to anticipate and mitigate risks, especially given current market uncertainties.

Although loan-level stress testing serves a purpose on a transactional level at origination, financial institutions should also regularly perform portfolio-level stress testing that encompasses a bottoms-up and a top-down approach. The bottom-up approach allows financial institutions to gauge the risks of individual, seasoned loans by stressing each transaction through interest rate changes, collateral values, and other market factors. Implying moderate and high stress scenarios to each transaction allows for early identification of potential losses and their impact on the capital of your organization. The top-down approach takes the remaining portfolio not identified on a loan-level analysis and uses the same stressors to further identify any possible impact to capital.

Independent Loan Reviews for CRE Risk Mitigation

Thorough loan reviews are pivotal for identifying and mitigating potential CRE portfolio risks. They enable banks to assess loan quality, maintain compliance with regulations, and make necessary adjustments on a loan and portfolio level. An effective loan review function is crucial for assessing asset quality, evaluating underwriting and ongoing monitoring, and identifying exceptions to policies. Proactive issue resolution ensures risk mitigation before regulatory scrutiny or asset quality deterioration.

To further safeguard against future losses, it is critical that a loan review be independent. If maintained internally at the organization, it should report directly to the audit committee of the board of directors or the full board of directors. If a third-party firm is contracted to perform this work, it too should report all findings to the board of directors or a committee thereof.

Tactical Approaches to Limit CRE Risk in an Unpredictable Market

To minimize exposure to CRE credit risk, institutions should enhance communication with borrowers, allocate additional resources for portfolio management, understand collateral, and manage interest rate risk. Effective market area monitoring, adaptable to the institution’s unique risk exposure and appetite, is essential. Clear communication of risk tolerance from the board down to lending staff fosters alignment and clarity.

Community financial institutions must not become complacent in their approach to risk management. It is critical to remain agile and continually adapt to changing environments and emerging risks, especially in the currently volatile realm of CRE lending. By staying proactive and employing a comprehensive risk assessment and management approach, banks and credit unions can successfully address CRE credit risk, safeguard their portfolios, and maintain their success.

Optimize Your Risk Management Strategies with Young & Associates

With over four decades of experience, Y&A specializes in helping community financial institutions manage risk. Our enduring presence in the industry reflects our ability to adapt to evolving financial landscapes. Our seasoned consultants, who have backgrounds in banking, bring firsthand experience of market fluctuations.

Outsourcing CRE Stress Testing

Young & Associates offers a CRE portfolio stress testing service that efficiently and insightfully assesses your portfolio. Using data specific to your bank, we stress your CRE portfolio across various factors. Our report quantifies potential impacts on earnings and capital resulting from collateral value decreases, changes in property net operating incomes, or increases in interest rates. What sets us apart is our ability to handle the stress testing process efficiently, allowing your institution’s management to focus on other important initiatives.

Outsourcing Loan Review

For most community financial institutions, outsourced loan review is the best choice due to size and the need for an independent party. Our loan review service, applied to your CRE portfolio, not only uncovers individual credit assessments but also evaluates the alignment of your credit standards, analysis, and continuous credit monitoring with the specific characteristics of your CRE portfolio. Our findings not only inform you about existing portfolio risks but also provide recommendations for effective risk management.

Contact us to explore how we can support your journey in addressing CRE credit risk effectively.

Key Elements of Effective Credit Underwriting

Written by admin on July 27, 2022. Posted in Lending & Loan Review, Uncategorized.

By: Ollie Sutherin, Principal, Y&A Credit Services

The focus of this article is to provide an overview of what Y&A Credit Services, LLC views as key elements during the underwriting process. While there are many variables needed to effectively underwrite credits, below are the primary focal points of any quality credit presentation that we underwrite or review.

Cash is King
“Cash is king” is a saying that we use often as it translates to, “if you don’t have the cash to repay, you shouldn’t have the loan.” So often we are presented with transactions that aren’t the strongest, don’t show cash flow, and the underlying organization has no business being lent money. Lenders often try to form complex explanations regarding the guarantor’s wherewithal, global cash flow, etc., and they lose sight of the actual company, its financial condition, and its ability to service the debt on a stand-alone basis. Every analysis should begin with the subject company and its ability to service debt. If it is a real estate holding company and the note is secured by a specific property, what is the cash flow of that property? If the most recent tax return statement, compiled, audited, etc., does not evidence the ability to service debt, what is the trend of the company? What are they doing to improve from the previous year and what is the YTD revenue/expenses compared to the prior year?

Eventually, we take into consideration the guarantor’s wherewithal and how it impacts the cash flow; however, the primary focus should always be on the company itself (the primary repayment source). If a transaction is being presented where repayment is heavily reliant on the guarantor, then the following questions must be asked: What is their character like? Have all of the assets and liabilities been verified on their personal financial statement(s)? Are other contingent liabilities factored in as well? So often, mistakes are caught when analysts simply say, “John Doe has $1,000,000 in cash and is clearly able to service the subject note should it be needed” without doing the proper due diligence verifying the source of the cash.

Quality of Information
If the cash flow of the company is the backbone of the transaction, then the quality of information is the legs, providing the necessary base for everything. We are always looking at the reliability of this information as it minimizes the risks of inaccuracy and subsequently the risk of default. For example, if borrowers only give internal statements that are hastily prepared and communicate lease details in one-two sentences in an email, this poses a much greater risk than detailed property information in the actual tax return and actual signed lease agreements provided for review. Furthermore, as it pertains to C&I transactions, internally prepared statements rarely reconcile, which makes performing a UCA Cash Flow analysis much more difficult. Tax returns and audited or compiled statements always reconcile, providing an accurate analysis.

Collateral Values
As it relates to the property or equipment securing an obligation, an appraisal is always going to be the safest way to measure the value. Too often, internal evaluations or estimates are utilized to justify a request during underwriting. To meet regulatory standards, the collateral securing an obligation must support the amount being considered and obtaining the appraisal during the underwriting phase can potentially save a significant amount of work if the value is insufficient to support the debt. For existing credits that are being refinanced, another important aspect of collateral valuations includes site visits by the account officers. Having photos and notes from the site visit will provide added support to the collateral pledged for the transactions.

Stress Testing
Stress testing individual loans during underwriting is becoming increasingly necessary, especially in today’s rising rate environment. This was a regulatory focus back in the late 2010s as there was a rising interest rate environment. Variable rate notes, property values, vacancy rates and ultimately cash flow for debt service were adversely impacted. At the beginning of the pandemic in March 2020, rates dropped markedly and remained flat until just recently. To curb inflation, the Federal Reserve began increasing rates and the extent of the impact on variable rate loans has yet to be determined.

Stressing individual loans at origination provides the institution with a tool to better understand the impact of rate increases on cash flow, property values, and vacancy rates in different scenarios. The result is a more informed credit decision during the underwriting phase. Ultimately, these variables help determine the breakeven point of a business’s cash flow and provide great insight to the actual strength of the primary borrower.

Projections / Proformas
These are something that all lenders should request from a borrower/potential borrower to justify the strength of a transaction. However, often these projections will paint an excellent picture of the company and a stellar cash flow that is more than adequate to service the underlying transaction. The intent of requesting and analyzing projections is to compare them to historical results, in many instances where the projected cash flow is higher than historical results. This is typically due to the borrower understating expenses which leads to overstated cash flow and debt service coverage. Given all of this, it is still important to obtain projections and to compare them to actual statements when available. Should they vary significantly, it will open the door to questions and force a deeper look into smaller details such as management of the company.

Y&A Credit Services, LLC
Over the past few years, a defined need has developed in the community financial institution industry. Specifically, it has been difficult for financial institutions to hire and retain quality credit professionals, especially in rural areas, to underwrite loans and perform other necessary tasks necessary for adequate credit administration. This need has led Young & Associates, Inc. to create a wholly-owned subsidiary (Y&A Credit Services, LLC) to meet the needs of these organizations. Y&A Credit Services, LLC has the mission of filling the voids of clients who have limited or even no credit staff to perform these necessary tasks. If your organization has a need for credit services, please feel free to contact us at 330.422.3482. Our services include spread sheet analyses, annual reviews, full credit underwriting and review of prepared presentations along with a full complement of other credit-related services through Young & Associates, Inc.

Agencies Amend Real Estate Appraisal Regulations (September 27, 2019)

Written by admin on November 27, 2019. Posted in Lending & Loan Review.

By: Kyle Curtis, Director of Lending Services

The OCC, Board, and FDIC adopted a final rule to amend the regulations requiring appraisals of real estate for residential real estate transactions. The rule increases the threshold level at or below which appraisals are not required for residential real estate transactions from $250,000 to $400,000.

The rule defines a residential real estate transaction as a real estate-related financial transaction that is secured by a single 1-to-4 family residential property. For residential real estate transactions exempted from the appraisal requirement as a result of the revised threshold, regulated institutions must obtain an evaluation of the real property collateral that is consistent with safe and sound banking practices.

The requirements for an evaluation are set forth in the 2010 Appraisal Guidelines, and are more extensive than what many smaller institutions do for evaluations. Readers may wish to review the requirements in that document and determine whether changes need to be made regarding your evaluation practices.

The rule also amends the agencies’ appraisal regulations to require regulated institutions to subject appraisals for federally related transactions to appropriate review for compliance with the Uniform Standards of Professional Appraisal Practice.

Effective Dates
The provisions of much of this final rule will be effective by the time you read this; however, the evaluation requirement for transactions exempted by the rural residential appraisal exemption and the requirement to review appraisals for compliance with the Uniform Standards of Professional Appraisal Practice are effective on January 1, 2020.

Incorporation of the Rural Residential Appraisal Exemption
Congress amended Title XI to add a rural residential appraisal exemption. Under this exemption, a financial institution need not obtain a Title XI appraisal if the property is located in a rural area; the transaction value is less than $400,000; the financial institution retains the loan in portfolio, subject to exceptions; and not later than three days after the Closing Disclosure Form is given to the consumer, the financial institution or its agent has contacted not fewer than three state-certified or state-licensed appraisers, as applicable, and has documented that no such appraiser was available within five business days beyond customary and reasonable fee and timeliness standards for comparable appraisal assignments.

Given the general rule increase to $400,000, essentially these requirements become moot.

Addition of the Appraisal Review Requirement
The Dodd-Frank Act amended Title XI to require that the agencies’ appraisal regulations include a requirement that Title XI appraisals be subject to appropriate review for compliance with USPAP.

Appraisal review is consistent with safe and sound banking practices, and should be employed as part of the credit approval process to ensure that appraisals comply with USPAP, the appraisal regulations, and a financial institution’s internal policies. Appraisal reviews help ensure that an appraisal contains sufficient information and analysis to support the decision to engage in the transaction. We recently had a discussion with a banker who did not review an appraisal. When they “got around to it” they discovered that the appraisal was “not even close,” and ordered a new appraisal. Based on the new appraisal, their LTV was over 130%.

Many financial institutions may already have review processes in place for these purposes. Evaluations need not comply with USPAP. While financial institutions should continue to conduct safety and soundness reviews of evaluations to ensure that an evaluation contains sufficient information and analysis to support the decision to engage in the transaction, the USPAP review requirement in Title XI does not apply to such a review.

The agencies decided to implement the requirement that financial institutions review appraisals for federally related transactions for compliance with USPAP. The agencies encourage regulated institutions to review their existing appraisal review policies and incorporate additional procedures for subjecting appraisals for federally related transactions to appropriate review for compliance with USPAP, as needed.

Conclusion
Readers who wish to read the entire 80-page document as prepared by the regulators can find it at:
https://www.fdic.gov/news/board/2019/2019-08-20-notice-sum-b-fr.pdf?source=govdelivery&utm_medium=email&utm_source=govdelivery

Young & Associates, Inc. can offer assistance with appraisal review, and any other compliance topics. Please feel free to contact me for information regarding these services at kcurtis@younginc.com or (330) 422.3445.

Proposed Rulemaking – Changes to the Appraisal Threshold for Residential Real Estate-Related Transactions

Written by admin on August 20, 2019. Posted in Lending & Loan Review.

The OCC, Federal Reserve Board, and FDIC (collectively, the agencies) jointly issued a notice of proposed rulemaking titled Real Estate Appraisals, dated December 7, 2018 which was published in the Federal Register for a 60-day comment period. The Appraisal NPR proposes to increase the threshold for residential real estate transactions requiring an appraisal from $250,000 to $400,000. Evaluations would still be required for transactions exempted as a result of the proposed threshold. In addition, the agencies are proposing several conforming and technical amendments to their appraisal regulations.

The agencies are proposing to define a residential real estate transaction as a real estate transaction secured by a single 1-to-4 family residential property, which is consistent with current references to appraisals for residential real estate.

The proposed rule would amend the agencies’ appraisal regulations to reflect the rural residential appraisal exemption in the list of transactions that are exempt from the agencies’ appraisal requirement. The amendment to this provision would be a technical change that would not alter any substantive requirement, but the proposal would require regulated institutions to obtain evaluations for transactions secured by residential property in rural areas that have been exempted from the agencies’ appraisal requirement pursuant to the Economic Growth, Regulatory Relief and Consumer Protection Act, commonly known as the rural residential appraisal exemption, and would fulfill the requirement to add appraisal review to the minimum standards for an appraisal.

Evaluations
With the proposed increase in the threshold, it is expected that many institutions will now utilize internal staff to prepare evaluations for transactions that are less than $400,000, so it might be time to revisit the Interagency Appraisal and Evaluation Guidelines (Federal Register, Vol. 75, No. 237), as well as the Interagency Advisory on Use of Evaluations in Real Estate-Related Financial Transactions (FDIC, FIL 16-016). While the Guidelines state that an evaluation is not required to be completed by a state-licensed or state-certified appraiser or to comply with USPAP, the evaluation preparer should, however, be knowledgeable, competent, and independent of the transaction and the loan production function of the institution. Evaluations may be completed by a bank employee or by a third party. In smaller communities, bankers and third-party real estate professionals have access to local market information and may be qualified to prepare evaluations for an institution.

An evaluation should provide a reliable estimate of the market value of the property and, therefore, the approach or approaches used in an evaluation should be appropriate to the property being valued, and the intended use, so it may be appropriate to omit one or more of the three approaches to value. If the income approach is the primary approach for a tenant-occupied, income-producing
property, it may be appropriate to omit the sales comparison approach and the cost approach. Similarly, if the sales comparison approach is the primary approach for a single-family residence, it may be appropriate to omit the cost approach and the income approach.

The Guidelines provide information regarding the minimum content that should be contained in an evaluation. Unlike an appraisal report that must be written in conformity with the requirements of USPAP, there is no standard format for documenting the information and analysis performed to reach a market value conclusion; but like an appraisal report, the evaluation should contain sufficient information to allow a reader to understand the analysis that was performed to support the value conclusion and the institution’s decision to engage in the transaction.

Appraisal and Evaluation Reviews
The proposed rule would make a conforming amendment to the minimum requirements in the agencies’ appraisal regulations to add appraisal review. The agencies propose to mirror the statutory language for this standard. As outlined in the 2010 Guidelines, which provide guidance on the review process, the agencies have long recognized that appraisal review is consistent with safe and sound banking practices.

The agencies are proposing to implement the appraisal review provision in Section 1473(e) of the Dodd-Frank Act, which amended Title XI to require that the agencies’ appraisal regulations include a requirement for institutions to subject appraisals for federally related transactions to appropriate review for compliance with the Uniform Standards of Professional Appraisal Practice (USPAP). While most institutions follow the guidance, the proposed rule would implement this statutory requirement.

For more information on this article or on how Young & Associates, Inc. can assist with the appraisal review process, contact Kyle Curtis at 330.422.3445 or kcurtis@younginc.com.

Changes to the Appraisal Threshold

Written by admin on May 18, 2018. Posted in Lending & Loan Review.

By: Kyle Curtis, Senior Consultant

The OCC, Federal Reserve Board, and FDIC (collectively, the agencies) have adopted a final rule to amend the agencies’ regulations requiring appraisals of real estate for certain transactions. The final rule increases the threshold level at or below which appraisals are not required for commercial real estate
transactions from $250,000 to $500,000. The final rule defines commercial real estate transaction as a real estate-related financial transaction that is not secured by a single 1-to-4 family residential property. It excludes all transactions secured by a single 1-to-4 family residential property, and thus construction loans secured by a single 1-to-4 family residential property are excluded. For commercial real estate transactions exempted from the appraisal requirement as a result of the revised threshold, regulated institutions must obtain an evaluation of the real property collateral that is consistent with safe and sound banking practices.

The agencies have adopted a definition of commercial real estate transaction that excludes construction loans secured by single l-to-4 family residential properties. Specifically, the final rule defines commercial real estate transaction as a real estate-related financial transaction that is not secured by a single 1-to-4 family residential property. This definition eliminates the distinction between construction loans secured by a single l-to-4 family residential property that only finance construction and those that provide both construction and permanent financing. Under the definition in the final rule, neither of these types of loans will be commercial real estate transactions; they will both remain subject to the $250,000 threshold. However, a loan that is secured by multiple 1-to-4 family residential properties (for example, a loan to construct multiple properties in a residential neighborhood) would meet the definition of commercial real estate transaction and thus be subject to the higher threshold.

Evaluations

With the increase in the threshold, it is expected that many institutions will now utilize internal staff to prepare evaluations for commercial transactions that are less than $500,000, so it might be time to revisit the Interagency Appraisal and Evaluation Guidelines (Federal Register, Vol. 75, No. 237), as well as the Interagency Advisory on Use of Evaluations in Real Estate-Related Financial Transactions (FDIC, FIL 16-016). While the Guidelines state that an evaluation is not required to be completed by a state-licensed or state-certified appraiser or to comply with USPAP, the evaluation preparer should, however, be knowledgeable, competent, and independent of the transaction and the loan production function of the institution. Evaluations may be completed by a bank employee or by a third party. In smaller communities, bankers and third-party real estate professionals have access to local market information and may be qualified to prepare evaluations for an institution.

An evaluation should provide a reliable estimate of the market value of the property and, therefore, the approach or approaches used in an evaluation should be appropriate to the property being valued, and the intended use, so it may be appropriate to omit one or more of the three approaches to value. If the income approach is the primary approach for a tenant-occupied, income-producing property, it may be appropriate to omit the sales comparison approach and the cost approach. Similarly, if the sales comparison approach is the primary approach for a single family residence or an owner occupied commercial property, it may be appropriate to omit the cost approach and the income approach.

The Guidelines provide information regarding the minimum content that should be contained in an evaluation. Unlike an appraisal report that must be written in conformity with the requirements of USPAP, there is no standard format for documenting the information and analysis performed to reach a market value conclusion, but like an appraisal report, the evaluation should contain sufficient information to allow a reader to understand the analysis that was performed to support the value conclusion and the institution’s decision to engage in the transaction.

Young & Associates, Inc. offers a Third-party Appraisal Review service designed to provide financial institutions with a qualified, independent review of appraisals, consistent with the requirements listed in the 2010 Interagency Appraisal and Evaluation Guidelines. For more information on this article or the interpretation of the appraisal guidelines, contact Kyle Curtis at
kcurtis@younginc.com or 330.422.3445.

Regulatory Attention on CRE Portfolios is Rising

Written by admin on February 18, 2016. Posted in Lending & Loan Review.

By: Tommy Troyer, Senior Consultant and Loan Review Manager

Over the last several months, it has become increasingly difficult to miss the fact that the federal regulatory agencies (the FDIC, Federal Reserve, and OCC) believe that credit risk is on the rise across the banking industry and particularly within Commercial Real Estate (CRE) portfolios. While industry-wide developments are of course not necessarily reflective of the situation of any single bank, it is the case that regulatory concerns about building credit risk in CRE portfolios makes it more likely that your bank’s CRE policies, underwriting, and portfolio management will be closely scrutinized in your next safety and soundness exam. Note that in this context, CRE refers to what are sometimes called non-owner occupied commercial real estate loans: loans for which the sale of the property, take-out financing, or third-party rental/lease income are the primary sources of repayment.

Recent Comments on Increasing CRE Risk
On December 18, 2015, all three federal bank regulatory agencies issued the interagency Statement on Prudent Risk Management for Commercial Real Estate Lending, an existing guidance on CRE lending. In fact, the statement itself contains no new guidance or regulatory expectations. Its purposes, instead, appear to be to “remind financial institutions of existing regulatory guidance on prudent risk management practices” for CRE and, perhaps more importantly, to highlight the belief that credit risk in CRE portfolios is increasing and must be carefully monitored and managed. The guidance highlights several reasons to believe that CRE portfolios may experience some strain over the next several years. These include both market factors (historically low capitalization rates are cited) and findings from recent exams (easing of underwriting standards along several dimensions, increasing frequencies of underwriting policy exceptions, and insufficient monitoring of market conditions).

The new interagency statement is far from the only suggestion of increased concern regarding the CRE market. The OCC’s Semiannual Risk Perspective for Fall 2015 cites easing underwriting standards, increasing CRE concentrations (especially in multifamily), and for community banks, strong growth in CRE lending as possible risks. The December 2015 – January 2016 RMA Journal includes the final installment of the publication’s annual rundown of “Today’s Top Credit Risk Issues.” Multifamily lending makes the list, suggesting that the Risk Management Association, a respected industry group unaffiliated with any financial regulators, also sees notable risk in the CRE market.

The fact that the CRE market remains competitive in many areas, combined with low interest rates, has thus far meant that several traditional but lagging indicators of credit risk (for example, delinquency and non-accrual rates) have not yet shown signs of weakening. Nonetheless, as has been demonstrated in past credit cycles, the risk factors cited above can often lead to increases in credit risk that do eventually result in deteriorating asset quality and increasing charge-offs.

Prudent CRE Risk Management for Community Banks
The good news is that the keys to effectively managing risks in the CRE portfolio are not mysteries and are achievable for any disciplined and committed community bank. The recent interagency statement provides a good summary. It notes that, in part, banks that successfully manage CRE risk:

Establish and adhere to appropriate policies, underwriting standards, and concentration limits
Conduct accurate cash flow analysis on the project, borrower, and global levels at underwriting and on an ongoing basis
Effectively monitor market developments (supply and demand, vacancy and rental rates, etc.)
Implement appropriate appraisal review and collateral valuation processes

In addition to the factors described above, two additional critical features of CRE risk management, CRE Stress Testing and Independent Loan Review, are mentioned. These processes can be performed internally by community banks, but due to resource and other constraints may be both more efficient and more effective if outsourced.

Stress Testing the CRE Portfolio
The interagency statement notes that “market and scenario analyses” that “quantify the potential impact of changing economic conditions on asset quality, earnings, and capital” are an important aspect of CRE risk management. This is a reference to stress testing the CRE portfolio. Further, the 2006 interagency Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices states that any institution with a CRE concentration “should perform portfolio-level stress tests.” Even if your bank does not meet the concentration thresholds defined in the 2006 guidance for identifying institutions with “potentially…significant CRE concentration risk,” stress testing the CRE portfolio can have a number of important benefits. By quantifying the impact of several adverse scenarios on asset quality, earnings, and capital, a CRE stress test can inform your bank’s strategic and capital planning processes, your internally established credit concentration limits and practices, and your credit policy and underwriting requirements.

Young & Associates, Inc. offers a CRE Portfolio Stress Testing service that provides an insightful and efficient stress testing solution. Our service uses data specific to your bank’s portfolio to stress your CRE portfolio across several factors. Our report will assist in quantifying the possible impact to earnings and capital that could result from decreases in collateral value, property net operating incomes, or increases in interest rates. In the current environment in which interest rate increases are likely over the next several years and decreases in collateral values are at least a distinct possibility, understanding your bank’s possible exposure is key to maintaining a safe and sound bank and demonstrating effective risk management to your examiners. Our CRE Stress Testing service is performed remotely, meaning that no travel expenses are associated with the service. More importantly, once the project has been discussed and you have provided a response to our initial data request, bank management can remain free to work on the many other initiatives that require attention, while we make use of our existing systems and expertise, making the stress testing process an efficient one. Our service includes a detailed report documenting the results of the stress test and, if desired, a phone presentation of the findings to management or the board.

Independent Loan Review
An effective independent loan review function is critical to assessing asset quality in the CRE portfolio, determining the accuracy and effectiveness of both underwriting and the ongoing monitoring of CRE credits, and identifying whether exceptions to credit policies or underwriting standards are being appropriately identified and approved by the bank. Any issues identified by loan review can be proactively addressed by the bank, helping to ensure risk mitigation is in place before the issues are identified by examiners or are revealed by deteriorating asset quality.

Most community banks find that their size and the requirement that loan review be performed by a qualified, independent party means that outsourcing loan review is the best option. Young & Associates, Inc. has extensive experience providing loan reviews for community banks. Our loan review of a sample of your CRE portfolio may identify individual credits of concern, but more importantly, will provide perspective regarding whether your credit standards, credit analysis, and ongoing monitoring of existing credits are adequate for the nature of your CRE portfolio. In this way, our findings not only inform management and the board about existing risks in the portfolio, but provide recommendations for effectively managing that risk. We can perform loan reviews on-site or, if your technological capabilities allow, remotely, allowing you to reduce or eliminate the travel expenses associated with the loan review.

For information regarding Young & Associates, Inc.’s CRE Stress Testing service, please contact Kyle Curtis at 1.800.525.9775 or click here to send an email. For information regarding Young & Associates, Inc.’s Independent Loan Review service, please contact Tommy Troyer at 1.800.525.9775 or click here to send an email.