As published in Mortgage Banking Magazine, July 2010
PDF of Mortgage Banking article
Three Legs of the Appraisal Management Stool
There’s no question that the appraisal industry has been turned on its head by the many unintended consequences of the Home Valuation Code of Conduct (HVCC). However, while the spotlight is stolen by discussions of appraisal management companies (AMCs) versus appraisers or unfair fee splits, there’s another little-noticed consequence to ponder: Mortgage lenders are forgetting that prudence in the appraisal management field requires more than simply complying with the HVCC.
Value pressure is down from the heady days of the boom, but that likely would have happened with or without the HVCC as buying power evaporated in the credit crisis. Regulation alone neither solved the problem nor will prevent the next round of abuses.
It’s valuable, then, to look at traditional regulatory compliance as just one leg of a stable “three-legged stool” of collateral valuation policies, with the other two being proactive quality assurance and fraud management. All three need to be employed in common-sense fashion as part of a comprehensive approach to risk factors affecting every institution.
“Common sense” means that they can’t be treated as mere checklist items in a policy review. They have to drive actual daily lending behavior, in balance with each other and consistent with safe and sound banking policy.
Traditional alphabet-soup compliance
Today, collateral valuation is affected by a wide variety of “alphabet soup” agencies, policies and laws. The most common abbreviation heard today is the HVCC. However, the Federal Housing Administration’s (FHA’s) recent guidance (Mortgagee Letter 09-28) on appraiser independence—often mistakenly cited as “FHA adopting the HVCC”—threw another variation on appraisal management into the mix.
To make matters still more interesting, the Interagency Appraisal and Evaluation Guidelines—issued jointly by the Federal Reserve, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), the Office of Thrift Supervision (OTS) and the National Credit Union Administration (NCUA)—affect appraisal policy even more broadly.
Add to that the Gramm-Leach-Bliley Act (GLB), which affects security, privacy and record-keeping, and which expressly covers appraisals. And finally, the Federal Housing Finance Agency (FHFA) recently issued rules regarding required submission of appraisal reports in MISMO® extensible markup language (XML) format under its Uniform Mortgage Data Program, with the first portions to be implemented by Jan 1, 2011. If you think about this in terms of the time required to change workflows to accommodate those data requirements, that’s right around the corner.
And one more thing: As this article goes to press, Congress is expected to eliminate the HVCC and replace it with “something else” as part of the financial reform legislation package.
Yes, it’s a mess. The best way to approach the interwoven policies is to find the commonalities and the differences. Then craft a set of policies that meet the strictest standards in each overlapping area and take into account the unique areas covered only by one set of governing standards. A short list of areas to check in your organization might look like the following:
It’s easy for front-line personnel to assume that many of these issues are infrequently addressed by regulatory audits, and there’s little chance of a lapse rising to the level of regulatory trouble for the lender. There are two primary reasons why that kind of thinking must be combated at the executive level.
First, whether responding to an audit or even litigation, the best strategy is to show that your compliance is not just on paper, and that it’s backed by proactive audits and commercial best efforts such as those noted here.
Second, the various regulations do indeed foster safe and sound mortgage banking and have a solid foundation in common sense. The decisions made by a lender’s staff, and the valuations received on its collateral, will be aided by following these policies as part of a comprehensive approach to enhancing loan portfolio quality. And that’s what leads directly to the importance of the second leg of the appraisal management stool—quality assurance.
Quality assurance, rather than just quality control
Quality assurance (QA) and quality control (QC) are terms usually used interchangeably, which is dangerous to any lender’s operations.
In a nutshell, quality assurance is the human-driven activity that gives you confidence that you have an appropriate, improving process that is explainable and rational, and it results in a valuable specification of what the end result should be. QA is the domain of managers—it is strategic and it isn’t always measurable. QA owns the question, “Does it make sense?”
Quality control, on the other hand, is a set of narrow tests that measure each copy of the product against acceptable variations from standards derived from the product’s specifications. QC is generally performed by line-level people, is highly tactical and is always measurable. QC owns the question, “Does it meet the specified criteria?”
Quality, as the term is applied to appraisal management today, is characterized by voluminous QC but not much QA at all.
Appraisals are scored against review rules, and very authoritative-sounding statistical analyses are kicked out showing how many appraisal reports were caught by the systems in place. Appraisers are given reams of additional forms to fill out, and more data to explain. Appraisals that meet the criteria are accepted, and those that fail are rejected. All must be well. The spreadsheets say so, right down to the Sixth Sigma.
Sound familiar? There was also a QC-only focus at the core of the recent lending and real estate market crisis. Shoddy loans passed through underwriting because they passed the QC tests: Documentation met the criteria, credit score was within range, down payment was acceptable and so on.
Millions of loans passed the QC checks and yet ultimately were failures, because the QA process—the safe-and-sound banking standards quality umbrella—was nearly non-existent. The QC standards were met, but they were set illogically low by a failed QA environment. The QA question of “Does it make sense?” wasn’t even asked.
In valuation today, that step can’t be skipped. A process of real quality assurance handed down from the executive offices would start by asking specific questions, such as:
A good place to start asking these questions (outside the boardroom) is to ask your own appraisers these things on a quarterly basis. There are numerous online services that allow you to immediately design a survey that gets you both narrative answers as well as statistical breakdowns of questions where you limit the responses. And remember, you’re likely to get more honest responses with an anonymous questionnaire.
At first, you’re likely to get an earful—but you’ll also uncover gaping holes in your QA strategy and the logic behind your QC criteria. More important, you’ll be able to design QC processes that really do uncover real quality problems, and which also will prevent the third leg—fraud prevention and detection—from being kicked out from under the stool.
Deterring fraud before it happens, instead of after it’s too late
Appraisal fraud generally falls into three common categories: identity fraud, where the appraiser is either fictitious, unlicensed or otherwise misrepresented; document fraud, where the appraisal document itself has been modified by either third parties or internal staff to meet their needs; and value fraud, where the market value of the property has been skewed up or down (flipping or flopping) by the parties to directly profit from the sale or the loan.
Most lenders put in place systems to detect value fraud using public records data, automated valuation models (AVMs) and so on, but very few deter document or identity fraud before it ever occurs in the first place. However, here are some simple, free deterrent options.
These deterrents obviously have to work in conjunction with your other fraud-control and quality-control processes as part of a holistic approach to deterring what you can, catching what you can’t and managing the rest in a consistent fashion. This approach also has the benefit of aiding in the detection of non-malicious value fraud caused primarily by incompetence. Disciplinary action is usually simple in those cases, as the value deviation almost always follows USPAP violations.
In conclusion, but not really
Managing appraisal compliance, quality and fraud is a moving target: Each month brings new regulations, new factors and new threats. Lenders that approach each discipline separately, treating it as a static paper task that can be completed, will think they’ve achieved regulatory appraisal compliance, controlled appraisal quality and detected appraisal fraud—when in fact they’ve simply perched themselves, blindfolded, on a rickety one-legged stool.
Those who rely on a dynamic balance of all three, as more of an ongoing cultural quest than just a destination, will be there when the others fall. [MB] (Published in Mortgage Banking Magazine, July 2010)