Appraisal & Evaluation
By: Dave A. Anderson
It is rare
to find a bank that regulators have not cited for an evaluation or
appraisal-related violation in the last three years, particularly if they have a
commercial real estate (CRE) concentration.
In my experience in the regulatory world,
evaluation and appraisal-related questions are the most frequently asked
questions by bankers despite the numerous Supervision and Regulation letters (SR
letters-FRB), Financial Institution Letters (FILs-FDIC) and Bulletins and
Advisory Letters (OCC) issued on the topic. I would surmise that the number of
clarifications I have provided as a regulator or banking consultant is either
because this guidance is too broad, subject to regulatory interpretation, poorly
written, or bankers and/or lenders just don’t read it (no offense please).
This article will attempt to provide answers to
the most commonly sought questions by bankers regarding evaluations and
appraisals. Specifically, it will provide guidance on when you do, and when you
do not need an appraisal or evaluation. Various regulators seem to have
differing opinions/interpretations, although they all have contact with each
other and opine with each other on various appraisal/evaluation issues and they
do not always agree. Therefore, in unique situations, it is best to check with
your regulatory contact before deciding whether to forgo obtaining a new
appraisal or evaluation or whether to prepare an internal, independent
evaluation instead of obtaining a third party appraisal.
While extremely important and a current
regulatory hot button, this article will not focus on independence issues and
evaluation and appraisal content, which will be addressed in a future Bank
Strategies LLC article.
So when do you need a new independent appraisal
When are Evaluations Required?
the transaction value of a real estate loan (total amount extended to one
borrower) is $250 thousand or less and in the case of a business loan
(typically owner occupied) has a transaction value of $1 million of less. We
do not advise splitting loans (i.e. two $150 thousand loans to the same
borrower) to avoid exceeding the thresholds requiring an appraisal, as
regulators are likely to cite you with a violation for circumventing the
intent of the rules if you only have evaluations to support the value of
the real estate. In addition, the $1 million business loan exemption (when
an appraisal is not required) is not applicable to loans that are dependent
on the sale of, or rental income derived from real estate as the primary
source of repayment, more about the business exemption later in this
an existing loan refinancing or renewal, provided there has been no obvious
and material change in market conditions (rare these days) or physical
aspects of property that threaten the bank’s collateral protection (even
with additional advances) or there is no new money
extended (other than closing costs). Typically, there is no new money
advanced, so some bankers think this is an exemption for an existing
extension of credit, and it is with regard to appraisals. However, at the
end of the exemption section of each regulator’s appraisal regulation, there
is a section (b) that explains that although an appraisal is not needed in
the situation described above, an evaluation is required. Therefore, at a
minimum, an updated evaluation is always required for an existing loan
refinancing or renewal.
Conversely, some bankers believe that if there has been a material change in
market conditions (common these days) and the bank refinances the real
estate related extension of credit, the bank needs a new appraisal if the
loan exceeds $250 thousand. This is only the case if examiners believe an
appraisal is necessary due to safety and soundness concerns (section (c) in
each regulator’s appraisal regulation) or where you extend new money. See
the second bullet point below under “When Appraisals are Required."
However, you do need to prepare or obtain a new evaluation when renewing or
refinancing a loan in this situation. Transactions involving loan workouts,
debt restructurings, loan assumptions, and the addition or subtraction of
borrowers generally require an evaluation since regulators generally view
these transactions as renewals, refinancings and other subsequent
transactions. However, the bank does not need a new evaluation when it
advances funds to protect its interest in a property, such as to repair
damaged property to its original condition. You should document this
decision and you need to monitor repairs to ensure completion.
during the term of a real estate transaction, the property type changed
(e.g. single-family construction to rental property) or the project has
stalled (e.g., land development project).
qualifies for the appraisal exemption for existing extensions of credit.
Therefore, under federally related regulations pertaining to appraisals, an
institution is not required to obtain an appraisal, but is required to
obtain an evaluation within a reasonable period before or after the bank
takes title to the property (valid evaluation). However, please be
cognizant of state banking laws that are generally more stringent than
federal regulations as it relates to OREO. Most states require an appraisal
upon acquisition and then on a periodic basis thereafter. The more
stringent regulation nearly always applies, and as such, banks are
encouraged to refer to state law with regard to OREO.
the transaction value of a real estate loan (total amount extended to one
borrower) is greater than $250 thousand and in the case of a business loan
(typically owner occupied) has a transaction value of greater than $1
million. Please note that when you take multiple properties to secure a
loan greater than these thresholds, you must obtain an appraisal for each
property despite its value relative to the loan amount.
examiners have sufficient reason to believe that, the bank’s collateral
position has deteriorated materially and could expose the bank to current or
future losses (safety and soundness concerns). Examiners should allow you a
reasonable amount of time to obtain these new valuations, the expectation is
that you will to react to changing circumstances/market conditions in a
timely manner. If an examiner requests that you obtain a new appraisal on a
real estate dependent loan, the examiner will likely classify the loan as
doubtful with the expectation that when you receive the appraisal you will
write off any deficiency.
a loan is renewed or refinanced and is in excess of the aforementioned
thresholds, new money is extended, and there has been a material change in
market conditions or physical aspects of the property.
during the term of a real estate transaction of the greater of $250
thousand or more than $1 million in the case of a business loan, the
property type changed (e.g. single family construction to rental property)
or the project has stalled (e.g., land development project).
Business and Abundance of Caution Exemptions
We receive many questions regarding when the
business or abundance of caution exemptions are applicable since these
exemptions may result in the borrower or bank recognizing considerable
savings by avoiding the cost of an appraisal or evaluation. We have listed
below a few observations with regard to the business and abundance of
intent of the business exemption is to benefit small businesses. Ownership
of many of these small businesses is by the principal (owner of the
business) and leased to the principal’s business entity. This arrangement
is usually due to tax consequences. Regulators have generally agreed that
you can use the business exemption if the business entity guarantees the
loan to the principal. Ideally, there should be a written guarantee and an
assignment of lease payments to the bank.
the business loan is to a farm or ranching business, does it qualify for the
exemption? We have discovered a very pertinent document that is logical,
provides examples, and should address any regulatory concerns regarding
loans secured by farm/ranch land. It can be located at:
a real estate parcel is taken as “an abundance of caution” an appraisal is
not required; The abundance of caution exemption should be well
documented in the borrower’s loan file and is intended for occasions
where the decision to enter into a transaction are well supported by the
borrower’s income or collateral other than the real estate in question.
Banks often take several parcels of real estate to secure a loan. To the
extent you are relying on any real estate collateral taken to shore up the
bank’s LTV to acceptable levels, the abundance of caution exemption
typically does not apply.
We hope this provides some clarification with
regard to the ever-troubling question of “What type of valuation do I need,
if any?" I would advise you to be proactive in obtaining new
appraisals or evaluations, particularly if the real estate collateral is
securing a troubled loan. It is generally more favorable to the bank to
write off or reserve a portion of a problem loan based on a current
collateral valuationthan to have examiners classify the loan doubtful since
they cannot determine the value of the underlying collateral. However wee
at Bank Strategies LLC, understand that the benefits of a new appraisal must
also be weighed against the cost of the appraisal which often must be
absorbed by the bank.
One additional thought, make
sure that when you engage an appraiser you ask specifically for “market
value”. While it is beneficial to obtain “liquidation value”, examiners
should appropriately classify a loan based on the market value of the
collateral and the borrower’s repayment ability. If you have additional
questions either contact your primary regulator or email me your thoughts at
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