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Appraisal & Evaluation Guidance 101


September 15, 2011

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 or evaluation?

When are Evaluations Required?

  • When 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 article.

  • Involves 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.

  • If 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).

  • OREO 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.   

When are Appraisals Required?

  • When 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.

  • When 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.

  • If 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. 

  • If 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).

      Small 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 caution exemptions.

  • The 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.

  • If 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: http://www.fca.gov/Download/BusinessLoanAppraisalExemption.pdf

  • If 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. 

      Summary

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 Dave@BankStrategiesLLC.com.

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