HVCC:  The Cure Is Worse Than The Disease

By now, you've probably heard a lot about the Home Valuation Code of Conduct (HVCC), which sprang out of a March 3rd agreement reached between the Attorney General of New York (Andrew Cuomo), the OFHEO, and Fannie Mae and Freddie Mac.

To read it, click here.

In the settlement agreement, the parties resolved to address issues of appraisal coercion and independence in exchange for the Attorney General's office terminating its investigation. The agreement stated that the HVCC would be the standard of conduct followed by the parties, and would be complemented and overseen by a newly formed Independent Valuation Protection Institute, or IVPI. The IVPI is funded jointly by Fannie and Freddie for a period of 28 months under the terms of the agreement.

At first glance, the HVCC and the agreement that spawned it seem like an appraiser's dream. Both lead off with language regarding the need for sound appraisals produced free of any influence or coercion on the part of the lender or any other party. Perhaps for that reason, many appraisers initially applauded it. But, as is always the case with any governmental or even de facto regulation, the devil is in the details. And in this case, here at a la mode we believe the details create a misleading and dangerous environment for both borrowers and for appraisers.

The agreement itself seems to have its heart in the right place, and we really find no fault with its intent. However, where it refers to and hands off responsibility to the IVPI and HVCC, things get muddy.

The IVPI is murkily defined at best, and, considering its starring role in the implementation of sweeping changes to a bedrock layer of the national real estate industry, there should be far more transparency as to its makeup and mission. Since there's not much concrete information regarding the IVPI, to comment on it in detail now would be premature. The industry deserves detailed information immediately.

The HVCC however is quite clear, and we believe it strays significantly from the intent of the agreement. Though there are numerous small issues in the HVCC, which seem to indicate the hurried timeline in which it was drafted, we'll concentrate here on five major aspects of the HVCC which cause us concern. The five issues do not appear to be the result of simply a last-minute agreement, but rather seem to stem from intentional structuring. The HVCC was supposedly drafted by an as-yet-undisclosed group of industry participants, and the fingerprints seem to indicate substantial AMC and lender influence in its language.

The five aspects which we believe harm the appraisal industry and the consumer may be summarized as follows:

1. Under the HVCC, any lender using a professional appraiser incurs substantial regulatory risks and additional costs, whereas AVMs, BPOs, and other valuation alternatives are expressly and repeatedly exempted from the same regulations and liabilities. By singling out appraisers while clearly noting that the restrictions do not apply to alternative valuation products or other valuation entities, the HVCC creates a two-tier system of property valuation with numerous loopholes, encouraging a lender to circumvent licensed and certified appraisers at every step in the origination and underwriting process. A lender can pressure a BPO provider to "hit the number," or run multiple AVMs until a desired result is achieved, without one iota of concern that their actions will come under investigation using the mechanisms available in the HVCC. In other words, it places a massive liability on the use of actual appraisers, whereas alternatives are free of any liability whatsoever. The last independent watchdog on the borrower's behalf in the real estate transaction - the auditor if you will - will be rendered irrelevant by the HVCC's handcuffs.

We believe that lenders will redirect valuations to those other low-cost, low-liability providers unless the language is broadened to substitute "collateral valuation" for "appraisal" virtually everywhere it appears in the HVCC. If the restrictions on coercion, influence, and in-house operation and control are applied to all valuation products and services, then appraisers are on a level "business risk" playing field with AVMs, BPOs, and other alternatives.

The language in the HVCC's sections VIII and XI in particular make it crystal clear that the authors are aware of the distinctions in the document between appraisals and other valuation products, and lenders are thereby subtly encouraged to utilize the distinction as a loophole to replace appraisals with unregulated and unrestricted alternative valuation methods. This runs contrary to the clearly stated goals of the parent document, the settlement agreement establishing the HVCC.

2. The HVCC unduly restricts the appraiser's ability to operate a business in the same manner as the other parties already in the transaction. First, the HVCC virtually mandates that all appraisal orders must be placed through AMCs, which deprives independent fee appraisers of nearly half of their normal fees, and which will not result by itself in greater independence from coercion. (This massive push toward AMCs is all the more surprising given that the original lawsuit by the Attorney General was filed against eAppraiseIT, an AMC, accusing it of inflating appraisals to satisfy Washington Mutual's demands.)
The HVCC reduces competition to a handful of national appraisal management companies, acting in complete contravention to existing federal and state laws regarding anti-competitive behavior in consumer transactions.

Second, the HVCC bars appraisers from interacting at all with agents, mortgage brokers, loan officers, and others. Preventing appraisers from interacting with clients as part of the normal course of business is a "death sentence" restriction not imposed on any other provider under RESPA. RESPA in fact encourages competition between and interaction of the many parties involved in a real estate transaction, so long as disclosures are made and influence is eliminated.

The anti-coercion measures alone - if properly applied to all valuations - will protect the public from the influence of pressure, whether it were to come from lenders, management companies, mortgage brokers, real estate agents, or any other third party. If all parties in the transaction were licensed and governed, including mortgage brokers, then the problem of influence is much more efficiently handled and the appraisal market is allowed to still operate in a competitive, free market manner, while simultaneously protected from coercion, collusion, and abuse.

If left unchanged in the HVCC, instead of strengthening the appraisals used in collateral valuation, exactly the opposite will ensue as experienced appraisers leave the profession. They will have no other choice as 40% or more of their fees will be handed over to AMCs and their business relationships gleaned over decades will be made worthless with the stroke of a pen. No other RESPA entity is forced to suffer such an egregious restriction, especially the originators who engaged in the coercion in the first place.

3. Lenders must be prohibited from owning or controlling, in whole or in part, any sort of valuation entity or mechanism used in the origination of a loan. Under the HVCC as it currently stands, lenders can own up to 20% of a management company, and they can own 100% of an AVM, BPO, or other alternative valuation provider. In fact, lenders are expressly allowed to "develop, deploy, and use internal automated valuation models," with no restrictions on who is in control of the ordering or modeling process, nor with any requirements to disclose to the borrower that the AVM report is under the sole control of the lender's staff. AMCs, AVMs, and alternative valuation products must not be allowed to freely permeate the firewall being erected within the origination process, whether operated inside the lender or by third parties.

4. All valuations, regardless of method employed, must be provided to the borrower in the same manner. As it is currently written, a lender is barred from using secondary valuations only if the first valuation was an actual appraisal, and regardless of the quantity ordered, the lender is required only to provide a copy of an actual appraisal provided by a licensed or certified appraiser. Under this scenario, a lender could first order a BPO or AVM (possibly under their control), and if unhappy with the value, continue to order additional valuations (along with specific instructions as to the value needed), until the desired value is reached. Yet, none of those reports would have to be provided to the borrower. As stated above, all valuations used in the process of originating a loan must be equally managed and regulated under HVCC, and as such, any and all valuations produced by any means must be provided to the borrower.

5. Any complaints regarding the valuation process should be reported solely to the IVPI, not to the lender overseeing the origination. The reporting, investigation, and enforcement mechanisms in the current HVCC are solely managed by the lender, which makes the lender responsible for its own regulatory oversight and places the lender in control of the regulation of the appraiser. It's the classic "fox guarding the henhouse" scenario and must be addressed by involving the IVPI as the arbiter of first resort, not last.

The HVCC further mandates in section IX that any lender with a "reasonable basis" to believe an appraiser has engaged in wrongdoing must report such to the IVPI and to the state appraisal regulatory bodies, without providing in reverse an independent mechanism for the appraiser to report coercion. Appraisers and anyone else in the transaction must have a similar mandate and reciprocal method to report lenders who influence the valuation process. Again, the IVPI is the appropriate manager of the process.

We do believe that these five areas can be addressed, and that to fail to do so would fly in the face of the original intent of the agreement which spawned the HVCC - namely, to strengthen the independence and reliability of the valuations backing what is for most Americans the single largest source of their net worth. Eliminating coercion of appraisers is essential to ensuring that we have maximum transparency and accountability in the real estate transaction and the financial markets which depend upon them. However, a regulation which damages and circumvents the very industry it seeks to protect - and which in turn harms consumers and investors - will not get us as a nation any closer to that goal.

Modifying the HVCC to address these concerns is paramount. Click here to see our proposed revision to the HVCC which we believe addresses these five issues and more.