March 31, 2015

Mitch Kreeger, MAI, SRA, MBA

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v Speaker qualifications

v Who are “Examiners”? (Good Cop, Bad Cop)

v What are Examiners looking for?

v Costs of Non-Compliance (Examples)

v Best Practice Tips v Prior to Audit

v During Audit

v Post Audit

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Commercial, Residential - Appraiser, Reviewer §  30+ years mostly with lenders

§  Senior Appraiser at small and too-big-to-fail lending institutions §  Chief Appraiser (2x) at small to mid-size banks §  Managed appraisal, environmental, seismic policies & procedures §  Managed up to 150 vendors (appraisers, reviewers, RIMS, CoStar)

§  SME - Nationally known by peers, vendors, bankers, examiners §  Education: Bach. Sci. in RE Finance + MBA (honors) §  Certified General Appraiser (CA) §  MAI, SRPA, SRA

§  Appraisal Institute, RMA CART, CRN, Chief Appraiser Groups

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Webinar builds on EDR Insight articles “How to Survive an Appraisal Compliance Audit” and “Is Your Appraisal Compliance Manual Up To Par?”

o Additional Best Practices

o Appraisal Compliance Focus (excl. Environmental)

o Updated Regulator Tips

(Attendees will get links to these articles after this webinar)

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Old days = “Bad Cop” impression }  Fear of talking to examiners – internal and external ◦  Might criticize if we do/say something wrong, OR

◦  Might “hit tail-light” (dig deeper, find concerns), then criticize

}  Regulators were unknown, or only looking to criticize

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Now = “Good Cop” emerging }  Regulators encourage lenders to seek them out for advice

or interpretation of regs/laws (offer guidance) ◦  “Safety and Soundness” guidance available, albeit usually vague

}  Will respond to actual or hypothetical Q’s

}  Share common findings and “best practices” tips

v  Still tough on high risk takers and willing non-compliance

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Must-Have Resources §  FIRREA Title XI and USPAP (1989) §  Interagency Guidelines for Real Estate Lending

Policies (1992) §  Interagency Appraisal & Evaluation Guidelines

(1994, 2010) §  Financial Information Letters (FILs, when issued) §  OCC CRE Lending Handbook (2013)

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Should-Have Resources §  FDIC Guidance for Managing 3rd Party Risk (2008)

§  FRB Managing Outsourcing Risks (2013)

§  OCC 3rd Party Relationships Guidance (2013)

§  Other Supervisory guidance… §  FDIC, OCC, FRB, NCUA, GSEs, CFPB, SBA, AI Guide Notes, etc.

Ø  Peer Networking for audit-approved “best practices”

Ø  Prior exam comments, recommendations

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v Safe and Sound lending and banking practices: ü  High-Risk Banking Practices (Operations, CRA) ü  High-Risk Lending, Credit Practices ü  Compliance Risk Practices:

ü Appraiser Independence ü Consistency with Regulatory Guidance (FFIRA; FIRREA) ü Consistency with Policies, Procedures, Exceptions (Institution) ü Fair Lending Practices – regardless of intent ü IA&EG, USPAP, Dodd-Frank, Sarbanes-Oxley, ECOA, Privacy Act…

v ANYTHING that puts DEPOSITERS AT RISK (or taxpayers)

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Appraisal Process must be INDEPENDENT: }  Not subordinate to lending or credit operations ◦  Align under Compliance Risk or Risk Management

(larger lenders)

}  Not tied in any way to lender or credit officer who has accept/decline vote or influence

}  Small or Rural Institutions: Prudent safeguards

must isolate collateral valuation from loan production influence or interference

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Ø Staffing and Vendors

Examiners will review steps taken by an institution to ensure that persons who perform the institution’s appraisals and evaluations are qualified, competent, and not subject to conflicts of interest.

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Ø Staffing and Vendors “Who’s driving the train?”

(Bob Parson, OCC Appr. Policy Spec., SoCal Chief Appr Mtg 2015) •  Governance, regulatory sources •  Internal & External:

•  Competency, qualifications •  Independence •  Authority (who’s the boss?); Processes

•  Vendor management processes

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“An institution’s real estate appraisal and evaluation policies and procedures will be reviewed as part of the examination of the institution’s overall real estate-related activities.

“Examiners will consider the size and the nature

of an institution’s real estate-related activities when assessing the appropriateness of its program.” (IA&EG)

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High Risk: }  CRE Construction Lending based on proposed,

“subject to”, or hypothetical appraised values Ø Recognize, understand: q “subject to completion”, q “as if complete”, q “hypothetical”, q “subject to stabilization” q similar terms…

…indicate the value is not yet real, or value is hypothetical and may never actually occur.

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High Risk: (FDIC OIG, Comprehensive Study on the Impact of the Failure of Insured Depository Institutions Report EVAL-13-002; 2013) •  Most common cited violations in bank failures:

•  Failure to obtain required appraisal or evaluation •  Failure to achieve minimum appraisal standards •  Failure to obtain appraiser with required independence or

competency

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High Risk: •  Most bank failures were smaller banks (FDIC OIG; 2013)

•  Risk Exposure = Deciding factor on L-T soundness and ability to withstand economic downturns or cycles

•  Repeat Violations – 75% of failed banks were previously cited for: (AI Material Loss Reports, Regulatory Impact on Consumers and Business; 2012)

•  Various appraisal violations •  Failing to obtain appraisals where required •  Insufficient bank resources to manage, oversee appraisal function

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KEYS to Risk Mitigation:

}  Loan structuring

}  Managing all types of risk exposure, tolerance

}  Appraisal process independence

}  “As Is” Value required for all FRTs

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Non-compliance with…“Agencies’ appraisal regulations or to maintain a sound appraisal and evaluation program consistent with supervisory guidance will be cited in supervisory letters or examination reports and may be criticized for unsafe and unsound banking practices. Deficiencies will require appropriate corrective action.” (IA&EG)

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Actual criticism of a bank from recent US DOJ civil fraud case: “Citigroup Settles Mortgage Probe, Pays Record Penalty” (AI ANO, 7/16/14)

US DOJ criticism: •  “Despite Citigroup learned of serious and widespread defects

among the increasingly risky loans they were securitizing, the bank and its employees concealed these defects.” (US AG Holder; Reuters; AI ANO)

•  Citi knew “significant percentages” of securitized loans did not comply with underwriting guidelines but pooled anyway.

Penalty: •  $7 BILLION – largest civil fraud penalty ever levied by USDOJ

“Penalty is appropriate, given the strength of the evidence of the wrongdoing by Citi” (US AG Holder; Reuters; AI ANO)

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Actual criticism of a bank from recent FRB Exam: }  BPOs ordered for loan monitoring by lenders = Unacceptable

FRB criticism: •  BPOs are acceptable for loan monitoring, with restrictions:

•  Must be ordered independent of loan production. •  Price advocacy of BPO preparers may create bias:

•  Vendor selection must avoid bias and promise of future work. •  BPOs must be reviewed and scrutinized

•  although there are no BPO compliance standards (odd request IMO) •  Bank told to redo all BPOs w/appraisals or evaluations,

independent of loan production. No penalty initially, but must fix and not repeat by next audit.

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FIRREA Violation Penalties: }  1st Tier – simple violation ◦  Up to $5k/day until resolved

}  2nd Tier – recklessly unsafe, unsound; pattern of misconduct; causes loss to institution; insider gain ◦  Up to $25k/day until resolved

}  3rd Tier – knowingly engages unsafe and unsound practices; causes substantial loss or insider gain ◦  Up to $1MM/day (person), and/or ◦  Up to $1MM or 1% of total assets, per day (institution)

Mitigants considered: Size of financial resources, good faith, gravity of violation, history (prior violations)…

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}  Retain a 3rd party or independent staff auditor, for pre-exam evaluation to identify areas of weakness to be improved prior to arrival

}  Make available all policies, procedures and as much quantifiable data as possible to demonstrate institution’s commitment to safe and sound risk management principles ◦  Be ORGANIZED and CONSISTENT ◦  Work WITH Regulators, not against them – save time

and money in covering trails, quickly digging up exceptions, and backdating compliance efforts…do it right the first time.

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Document, Document, Document!!!

q Document “notes to file” for each assignment: •  Why you selected a certain vendor for each job.

•  Vendor Ratings, Qualifications, Competency, Approved List •  Why you varied from policy or procedure

•  Exceptions - How you notified the institution of variance •  Appraisal report or process deficiencies found •  How deficiencies were resolved, corrected, or

deemed nominal impact on value or compliance •  Paper trail (electronic okay)

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Document, Document, Document!!! q Time, Date, and Details for verbal discussions.

q Good practice to follow-up phone calls with email summary.

q Email or “cc” yourself (Note to File) any/all supporting comments and correspondence as back-up actions.

q  If asked why you did an action, “Notes to File” will establish audit trail: ü You recognized issues, ü You acted correctly, and ü You documented facts.

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FILE MGMT PLATFORMS

-  RIMS (ExactBid) -  Lender Portal (EDR) -  FNC -  YouConnect (Realwired) -  AppraisalTrac -  Other platforms (new or in development) -  Proprietary (lender’s custom platform)

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FILE MGMT PLATFORMS

v IT Security (potentially high risk vendor) ü Encrypted secured transmission of NPPI - privacy o  Job Manager must control “need to know” distribution

ü Time, Date & User stamp all actions ü Offsite redundant back-up systems o Minimal down time, data loss

v Access (independence; controlled, limited authority)

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FILE MGMT PLATFORMS

v Reports (audit-assisting data output) ü Electronic storage for most exam-requested docs o Appraisal, Review, Title, Leases, Sale docs, etc.

ü Output reports – vendor activity & ratings, related transactions, concentrations, etc.

ü Shift to paperless file storage (pdf, doc, xls,…) o Examiners may request e-docs or paper docs

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FILE MGMT PLATFORMS

v Legal (vendor contract; data storage rights)

v Efficiency (net effective job, vendor mgmt.) ü Vendor file mgmt: Licenses, E&O, niche, geo

coverage, performance ratings, contact info ü Job management portal, filing system, archives

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Ø Always tell the truth

Ø Be concise - answer questions in as few words as possible, like legal testimony § Do not provide ammo to be used against you § Do not hide discoverable facts

Ø If you do not know or are unsure of an answer, say “I do not know“ or “I cannot recall” … then be quiet §  If Examiner asks for add’l research, do it right away

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v Do not be intimidated by silence of interviewing examiners § Do not fill in empty space … stay quiet

v If deficiencies are discovered, take remedial action in a timely manner

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q Do not merely focus on regulatory compliance or appearance of regulatory compliance, focus on how to leverage these functions to improve earnings reliability, reduce losses and reduce loss severity.

q Focus on long-term sustainable earnings, not short-term fee income as a means to achieve long-term financial stability and earnings reliability.

}  Goal of the bank should be to make informed decisions, “eyes wide open”.

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“Institution should not directly or indirectly coerce, influence, or otherwise encourage an appraiser or a person who performs an evaluation to misstate or misrepresent the value of the property.”

(IA⪚ also related state and federal laws) }  Appraisal Independence – it’s the law.

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“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.

“Determine whether the methods, assumptions, and value conclusions are reasonable. “ (IA&EG)

}  Appraisal Review = a compliance and prudent

risk management function.

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Ø Vendor Selection – characteristics and complexity of each assignment…not faster & cheaper •  Right Vendor for the Right Job

Ø Vendor Relationship – document experience ◦  Regulatory compliance, consistency ◦  Job performance standards – need for corrections ◦  Competency, license status, areas of expertise ◦  Attempt to validate vendor’s own diversity, privacy,

and other legal practices (“Know Your Vendor”)

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}  Using unqualified or underqualified people to detect risks harms the institution

}  Ineffective Appraisal, Review and Collateral Risk programs contribute to and amplify losses

}  Paying more to obtain and retain higher qualified internal talent to review appraisals has proven to be cost justifiable over time (various statistical studies)

}  Civil Litigation risk may dwarf “Regulatory Risk” ◦  Competent Appraisal, Review, and Collateral Risk managers

and programs are best defense in mitigating risk exposure

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Program Compliance (IA&EG 2010)

ü  Policy: Create system to ensure appraisals, evaluations provide credible market values

ü  Policy: IA&EG, USPAP compliant; Regulator Guidance alignment

ü  Policy: Independence from loan production influence §  Internal and External

ü  Procedure: Vendor competency assurance §  Right appraiser for the assignment; Verify credentials

ü  Procedure: Valuation review process ü  Procedure: Vendor selection based on prior experience ü  Procedure: Report, repair deficiencies in timely manner

v Avoid practices inconsistent with policies, procedures

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}  Do not dispute with Examiners ◦  May inflame the situation ◦  May appear institution is in denial on problems, challenges ◦  May trigger “Bad Cop” ◦  Example: Assumption vs Extraordinary Assumption …best to

accept minor criticism than spark undesirable debate }  Develop a corrective action plan and demonstrate factual,

tangible steps taken to address findings and concerns.

Senior FDIC Examiner…”I expect bankers to challenge examiners if they think their process is okay. Just be

professional.”

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}  If in doubt, ask your Regulator (authority) ◦  “Good Cop” will help you be “Good Bank” ◦  Do not back yourself into a corner with your policies

}  DOCUMENT, DOCUMENT, DOCUMENT ◦  Everything in writing (paper or electronic) ◦  Paper trails can be your best friend in an exam

}  Always work with an expert ◦  Use an expert, NOT faster & cheaper ◦  Know Your Vendors

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Mitch Kreeger, MAl, SRA, MBA Principal Consultant - Appraisal Review,

Environmental & Seismic Risk Policy Manager

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