July 2023 OBA Legal Briefs

  • Appraisal bias – Part II
  • Reconsideration of value
  • 1071 – Small Business Lending Rule, Basics


Appraisal bias – Part II

By Andy Zavoina

In March 2021 HUD approved a settlement between JPMorgan Chase and an African American woman over appraisal bias. There was no admission of fault on Chase’s side, but the bank agreed to pay the woman $50,000, and to improve and increase training of its staff, particularly on Reconsideration of Value (“ROV”) processes related to appraisals. The training includes specifics on how to manage complaints of discrimination in the appraisal process and the process for customers to submit an ROV request. The CFPB has said a lender’s reconsideration of value process must ensure that all borrowers have an opportunity to explain why they believe that a valuation is inaccurate and the benefit of a reconsideration to determine whether an adjustment is appropriate.

An ROV is a request to the appraiser to reconsider the analysis and conclusions the appraisal was based on and potentially information not presented in the appraisal report. Only the lender may request an ROV from an appraiser on the borrower’s behalf and most would be due to the appraised value being less than what the seller or borrower desires. ROVs became common vernacular when appraisal bias was in the news and in the courts and many regulators believe it should be routinely discussed with borrowers now.

Back to that Chase settlement, one provision of the agreement is that when a borrower gets a copy of the appraisal as required by Reg B, they’ll also get a cover letter and part of it will say:

Chase is committed to maintaining appraiser independence and preventing attempts to influence appraisers in the preparation of appraisal reports, as well as avoiding any discrimination or bias in the appraisal process. If you believe that any person has attempted to influence the appraiser in the preparation of the appraisal of your property or have any concerns with the reliability or credibility of the appraisal, please contact Chase mortgage support by calling 1-855-242-7346 Option “0”, as soon as possible to report any concerns of discrimination or bias or to discuss your options to contest the reliability of the appraisal.

Appraisals will be changing. On May 5, 2023, the Appraisal Standards Board voted to adopt the Fifth Exposure Draft of proposed changes to the Uniform Standards of Professional Appraisal Practice. Exposure drafts are developed by the Appraisal Standards Board and released for public comment. The new edition will be available this fall and will become effective on January 1, 2024. Press releases did not highlight the changes and I have not seen the draft yet, but bankers doing appraisal reviews should review it, and look for educational opportunities on them when finalized. ROVs and appraisal bias will be of special interest, although I did not find these in a keyword search of the latest draft. The Fifth Exposure Draft is available here, https://appraisalfoundation.sharefile.com/share/view/s1c715f1ed49541e6a5170f7bda14329f and the Appraisal Foundation says on its website that even if the comment period is over, and this draft closed in April, they still welcome comments on the rules.

Reconsideration of value

By Andy Zavoina

Well, no sooner than we went to press with last month’s Legal Briefs discussing appraisal bias and the regulatory agencies, the Office of the Comptroller of the Currency (OCC), Federal Reserve Board (FRB), Federal Deposit Insurance Corporation (FDIC), Consumer Financial Protection Bureau (CFPB) and even the National Credit Union Administration (NCUA) (collectively referred to as the regulators) issued proposed guidance on Reconsiderations of Value (ROV) of Residential Real Estate Valuations. This is just an interagency proposal, but because your bank has compliance obligations today under anti-discriminatory laws and regulations, if you do not already have a compliance and risk management plan to deal with this issue, this proposal will certainly help you with interim steps to comply. By interim steps, I recommend you take your existing policy and procedures and consider incorporating key compliance techniques here, or if you are starting from nothing, use these recommendations as a starter document to help you comply with the existing requirements today. Starting from scratch is not a bad thing, because the agencies do not currently have any uniform ROV guidance.

This proposal will be a new concept to many lenders and contains and alters no existing law or regulation; it simply helps your bank to direct compliance actions to requirements that you already have, and where you may not have recognized there was a specific need. You may ask, “is there really a need?” The answer is a resounding Yes. Just refer to last month’s Legal Briefs. Mortgage applicants may ask about it, appraisal rules are being altered to comply, and since each of the federal regulators is a part of this guidance proposal, you can expect your examiners to ask what your bank is doing, are you proactive on these compliance needs, and how often you may have heard from an applicant who disagreed with an appraisal, so it is known that your bank actively seeks out compliant appraisals.

I will refer to the applicant as an interested party, but the guidance is focused on consumers. These terms should be used interchangeably and recognize that this could be a buyer or seller and a claim of a discriminatory process carries weight regardless of who it is from. And to be clear, in this context an appraisal includes any valuation your bank is using. I believe the “proactive” issue here may be the most important for many banks. You cannot afford to wait until there is a problem or until your examiners recommend you take action.

The proposal can be found here, https://www.consumerfinance.gov/about-us/newsroom/agencies-propose-interagency-guidance-on-reconsiderations-value-residential-real-estate-valuations/ As of this writing it has not been published in the Federal Register, but it will be, and banks will have 60 days to comment. The proposal contains all the information to include objectives and where to send your comments to each agency. With this pre-release you may start gathering thoughts now as to if and what you would comment on. We will point out some of the objectives below, but there are nuggets of compliance ideas in this proposal regardless. So, improve your existing procedures with these nuggets today, and finalize them in approved policies and procedures after the guidance is finalized.

Your bank is now aware that there have been obvious appraisal issues affecting the mortgage loan process and discriminatory practices whether they were overt, covert, or just the way the numbers came out, as some appraisers have put it. This is not a solution in search of a problem. Examinations and complaints indicate this is a nationwide problem. Two questions to ask are, have you experienced this discriminatory practice, and would you have recognized it if you had seen it? Appraisal reviews may need enhanced procedures. Applicants may need to be aware of their rights. And absolutely all mortgage lenders and those involved in the appraisal process must be cognizant of their responsibilities both to the applicant and the appraiser.

This proposed guidance describes how financial institutions may create or improve ROV processes that comply with existing laws and regulations yet preserve appraiser independence, which is an equally key element required in the mortgage lending process. You do not want to jump from the frying pan into the fire as you conduct ROV processes.

Comments requested on specific issues in the proposal aside, let’s look at some of those nuggets that you may use to improve compliance procedures surrounding appraisals immediately.

Justification – Issues to Mitigate

In October 2022, the CFPB blogged an opinion piece, “Mortgage Borrowers Can Challenge Inaccurate Appraisals Through the Reconsideration of Value Process, clearly stating that applicants have rights to contest a valuation. (Also refer to June 2023’s Legal Briefs.) In June 2023, the FDIC also published its “FDIC Consumer News,” in which it states when appraisals are required, and the applicant will pay some or all the costs. It goes on to explain, “Once the appraisal has been completed, a lender is required to provide you with a copy of the appraisal as soon as reasonably possible, but no later than three days prior to closing. Therefore, if you receive an appraisal that you suspect has inaccuracies that affect the resulting value, some initial work on your part may help to expedite a secondary review of the valuation and assist in closing on time.

“One thing you can do to prepare is to ask your lender early in the loan process whether they have a process for re-analyzing an appraisal, particularly if a consumer provides information that may affect the valuation. This process of re-analyzing an appraisal is also known as a reconsideration of value. If your lender has such a process, ask what information they will need and what their procedures are to request a reconsideration of value. Also, to set expectations, find out how the lender will keep you informed about the status of the review of the information you provide and of any action the lender may take to address your concerns.”  It later states, “If you believe your property appraisal was not accurate, suspect any possible discrimination in the lending process, or have an appraisal-specific complaint, you should contact your lender to request reconsideration of value, if they have a process to do so, or to file a complaint regarding the appraisal with the lender if they do not.

“If you believe that the lender has not addressed your concerns, you can contact the lender’s primary federal regulator.”

Consumers are being made aware of the ability to dispute an appraised value and essentially encouraged to do so. This challenge may be made when they feel the valuation was completed with a bias or simply errors. Improperly completed appraisals may devalue the collateral. These could be caused by errors, omissions, poor comparable properties, or discrimination, all of which may affect the final valuation as being either incorrectly stated high or low. Undervaluing a property value can have long reaching negative effects and overvaluing it could be a safety and soundness issue for the lender. (Also refer to the Interagency Appraisal and Evaluation Guidelines, 75 FR 77450 (Dec. 10, 2010)). If an appraisal is questioned, corrective actions may include ordering a second appraisal or attempting to resolve the issue with the appraiser directly. Let’s assume the bank has discussed any noted shortcomings with the appraiser that both the bank and applicant brought to light and they have not adjusted it to your satisfaction.

It makes sense that the proposed guidance says that an ROV is a request from the financial institution to the appraiser to reassess the report based on potential deficiencies or other information that may have affected the value. It does not say any other party may make that request and because the financial institution made the request and understands the importance of appraiser independence, we will hope this also makes the final guidance.

The goal is to design an ROV procedure which is consistent with safety and soundness requirements, complies with pertinent laws and regulations, respects the appraiser independence requirements, and responds in a suitable manner to the applicants. The proposed guidance will assist you, as it has four intentions.

  1.  It describes the risks when collateral valuations are incorrect.
  2.  It outlines applicable statutes, regulations, and existing guidance that govern ROVs and collateral valuations.
  3.  It explains how ROV processes and controls can be incorporated into existing risk management functions, such as your appraisal review and complaint management programs.
  4.  It provides examples of ROV policies, procedures, and controls.

As you begin to outline your policy and procedures, consider these elements:

Why. Accurate valuations of all collateral, especially for mortgage loans, are essential to the loan process.

What. Deficiencies identified in appraisals, whether through appraisal review processes or from the applicant-provided information, may be a basis for financial institutions to question the credibility of the appraisal or valuation report.

How. Anyone reviewing the appraisal, whether for the bank or the applicant, may believe the valuation is biased based on some form of:

  • discrimination,
  • errors or omissions,
  • valuation methods,
  • assumptions,
  • data sources, or
  • conclusions that are otherwise unreasonable, unsupported, unrealistic, or inappropriate.

Laws, Regulations and Guidance

Resources for your policy and procedures should include meeting the compliance requirements of the following:

  • Equal Credit Opportunity Act (ECOA) and Reg B. These prohibit discrimination in any aspect of a credit transaction, and the valuation is a part of the transaction.
  • Fair Housing Act, as it prohibits discrimination in all aspects of residential real estate-related transactions.
  • Unfair, Deceptive, or Abusive Acts or Practices UDA(A)P – Section 5 of the Federal Trade Commission Act (UDAP) which prohibits unfair or deceptive acts or practices and the “Abusive” addition from the Consumer Financial Protection Act which prohibits any covered person or service provider of a covered person from engaging in any unfair, deceptive, or abusive act or practice. Undervaluing property deprives the borrower and potentially a seller of funds which translates into many issues such as wealth, funds for education, business, home improvements, etc.
  • Truth in Lending Act (TILA) and Reg Z, which prohibit compensation, coercion, extortion, bribery, or other efforts that may impede the appraiser’s independent valuation in connection with any covered transaction.However, Reg Z explicitly clarifies that it is permissible for covered persons (which includes creditors, mortgage brokers, appraisers, appraisal management companies, real estate agents, and other persons that provide “settlement services” per RESPA and Reg X) to request the preparer of the valuation to consider additional, appropriate property information, including to, among other things, request the preparer of the valuation to consider additional, appropriate property information, including information on comparable properties or to correct errors in the appraisal.
  • The appraisal regulations issued by the regulatory agencies require these valuations to conform to the Uniform Standards of Professional Appraisal Practice (USPAP) (the latter is currently being revised and may be finalized for use in January 2024). USPAP requires compliance with ECOA and the FH Act.

The proposal reminds bankers that they are to conduct an independent review prior to providing the consumer with a copy of the appraisal. Additional review may be warranted if the consumer provides information that could affect the value conclusion or if deficiencies are identified in the original appraisal. This in itself justifies an ROV based on the applicant’s request, but the bank must continue respecting the appraiser’s independence.

If during the review process or based on information from the applicant, you determine that the appraisal does not meet the minimum standards outlined in the appraisal regulations and if the deficiencies remain uncorrected, that appraisal cannot be used as part of the loan decision.

When this issue arises, there are three actions the bank may employ as corrective action.

  • Resolve the deficiencies directly with the appraiser.
  • Use an independent party who is qualified (perhaps a state certified or licensed appraiser) to review the valuation and the suspected deficiencies.
  • Obtain a second appraisal.

Authority vs. Responsibility

As with all vendor/third party relationships, the bank may delegate its authority to act for the bank, but the responsibility for compliance with all laws and regulations remains with the bank. That is the reason any appraisal potentially tainted with a discriminatory bias must be resolved.

ROV Policy & Procedures

Any of three issues may trigger an ROV process. There may be discrepancies found during the bank’s review activities, after a complaint or other information is received from the applicant, or any request to the loan officer or other lender representative.

The ROV must be requested by the bank. When there are potential issues either from the bank’s review or the applicant’s complaint, the bank must understand the issues and react accordingly. The Interagency Appraisal and Evaluation Guidelines from December 2010 state, “An institution should establish policies and procedures for resolving any inaccuracies or weaknesses in an appraisal or evaluation identified through the review process, including procedures for:

  • Communicating the noted deficiencies to and requesting correction of such deficiencies by the appraiser or person who prepared the evaluation.
  • An institution should implement adequate internal controls to ensure that such communications do not result in any coercion or undue influence on the appraiser or person who performed the evaluation.
  • Addressing significant deficiencies in the appraisal that could not be resolved with the original appraiser by obtaining a second appraisal or relying on a review that complies with Standards Rule 3 of USPAP and is performed by an appropriately qualified and competent state certified or licensed appraiser prior to the final credit decision.
  • Replacing evaluations prior to the credit decision that do not provide credible results or lack sufficient information to support the final credit decision.”

The applicant will typically receive their copy of the appraisal after the bank has completed its review. Chronologically then, the bank will have had its opportunity to review the appraisal and have any discrepancies it found corrected. That last version is what goes to the applicant.

The applicant may then place a complaint or inquiry preferably denoting specific, verifiable information which was not in the final appraisal either because it was omitted or was not available at the time the appraisal was being completed. This may include such things as‚ including comparable properties which were not identified in the appraisal, specific characteristics of property being evaluated, or other information about the property that may have been incorrectly reported or was not considered but may affect the valuation.

If your bank has a Complaint and Inquiry Procedure to compliment UDA(A)P, your ROV procedures may refer to that, or that Complaint Procedure may refer to the ROV procedure in these specific instances, but one should refer to the other for reasons of accountability. I do not recommend being redundant as one of the two may be revised at some point and then the procedures would be out of sync and potentially lead to confusion and noncompliance. That is not desired, but what is important is that the bank has an effective policy and procedure for UDA(A)P and discrimination/ROV issues. The Complaint and Inquiry procedures should be already established and should record desired information broadly about all products and services as well as who complained, why, where, how, and the resolution with both start and end dates to ensure the bank’s actions were timely. The reason a separate procedure may be desired for ROVs is because of the sensitivity of the complaint, the necessary skillset to respect the appraiser’s independence and the prescribed steps required while also considering the pending loan request.

The Appraisal Bias Part I from June 2023, and the Appraisal Bias Part II in this month’s issue each support the reasons why this deserves immediate attention and without waiting for final guidance from the regulators. Basing the bank’s corrective actions on the three resolution methods above should be described in your procedures so there is a roadmap for staff to follow.

The proposal also makes suggestions you can use while developing your risk-based ROV policies, procedures, control systems, and complaint processes that identify, address, and mitigate the risk of problematic appraisals that may involve prohibited discrimination. Here are the eight topics with six additional subtopics:

  • Consider ROVs as a possible resolution for consumer complaints related to residential property valuations.
  • Consider whether any information or other process requirements related to a consumer’s request for a financial institution to initiate an ROV create unreasonable barriers or discourage consumers from requesting an ROV.
  • Establish a process that provides for the identification, management, analysis, escalation, and resolution of valuation related complaints across all relevant lines of business, from various channels and sources (such as letters, phone calls, in person, regulators, third-party service providers, emails, and social media).
  • Establish a process to inform consumers how to raise concerns about the valuation sufficiently early enough in the underwriting process for any errors or issues to be resolved before a final credit decision is made. This may include suggesting to consumers the type of information they may provide when communicating with the financial institution about potential valuation deficiencies.
  • Identify stakeholders and clearly outline each business unit’s roles and responsibilities for processing an ROV request (e.g., loan origination, processing, underwriting, collateral valuation, compliance, customer experience or complaints).
  • Establish risk-based ROV systems that route the request to the appropriate business unit (e.g., ROV requests that allege discrimination could be routed to the appropriate compliance, legal, and appraisal review staff that have the requisite skills and authority to research and resolve the request).
  • Establish standardized processes to increase the consistency of consideration of requests for ROVs:
    • Use clear, plain language in notices to consumers of how they may request the ROV;
    • Use clear, plain language in ROV policies that provide a consistent process for the consumer, appraiser, and internal stakeholders;
    • Establish guidelines for the information the financial institution may need to initiate the ROV process;
    • Establish timelines in the complaint or ROV process for when milestones need to be achieved;
    • Establish guidelines for when a second appraisal could be ordered and who assumes the cost; and
    • Establish protocols for communicating the status of the complaint or ROV and results to consumers.
  • Ensure relevant lending- and valuation-related staff, inclusive of third parties (e.g., appraisal management companies, fee-appraisers, mortgage brokers, and mortgage servicers) are trained to identify deficiencies (inclusive of prohibited discriminatory practices) through the valuation review process.

Automated Valuation Models

The problem of appraisal bias in residential real estate appraisals has been a hot topic for regulators and promises to continue as it is fueled by court cases, complaints, and settlements with regulatory agencies like the Federal Housing Administration, and as they are reported by the news media and social media. This proposed ROV guidance follows by a week a proposed rule with a request for comments to implement quality control standards for automated valuation models (AVMs). Third-party relationships and tools used for mortgage loans are under scrutiny. That AVM proposal – request is at https://files.consumerfinance.gov/f/documents/cfpb_automated-valuation-models_proposed-rule-request-for-comment_2023-06.pdf. This AVM proposal would require mortgage originators and secondary market insurers that use AVMs to adhere to quality control standards designed to:

1) ensure a high level of confidence in the estimates,

2) protect against the manipulation of data,

3) seek to avoid conflicts of interest,

4) require random sample testing and reviews, and

5) comply with applicable nondiscrimination laws.

1071 – Small Business Lending Rule, Basics

By Andy Zavoina

Is 1071 approaching and do you need to worry about it yet? The answer is, “it depends” because there are many variables. There are optional compliance dates and mandatory dates. We will focus on the mandatory for now. The final rule, which is Subpart B of Regulation B, https://www.bankersonline.com/regulations/12-1002-subpart-B was issued in March of this year. Banks can begin collecting data as early as October 2023, but for the higher tier banks mandatory collection begins in October 2024. The smallest tier is required to begin collection in January 2026. 2026 you say! Yes, if you are in the smallest tier, you have a lot of work to do, but 1071 is not an immediate front-burner task on your to-do list. The immediate task is to know where you fall in the tier breakout so you know when you will be required to begin reporting. To define your tier, you have to know how many qualified loans your bank has made in the immediate past, and therefore you have to know what a covered loan is.

Covered Loans

Sometimes compliance definitions are basic, like Reg Z and its definition of closed end credit, “Closed-end credit means consumer credit other than ‘open-end credit’.“ That’s a very basic definition and fortunately we do get a little more in Regulation B describing a covered loan under Subpart B, but just a little more. The term “covered credit transaction” includes all business credit (including loans, lines of credit, credit cards, and merchant cash advances) unless otherwise excluded under § 1002.104(b). So, all business loans unless excluded. So, what is excluded?

  • Trade credit, (The financing arrangement between businesses for goods or services from without immediate payment in full. This will not likely hit your radar. The CFPB has opined this trade credit as being a business loan and will add the relationship between franchisees and franchisors to its purview with the lending entity considered a financial institution);
  • HMDA-reportable transactions (Yes – if you are not a HMDA bank, you need to learn what these are);
  • Insurance premium financing, (generally financing when a business agrees to repay a bank the proceeds advanced to an insurer for payment of the premium on the business’s insurance contract and the business assigns to the bank certain rights, obligations, and/or considerations in its insurance contract to secure repayment of the advanced proceeds);
  • Public utilities credit (see 1002.3(a)(1));
  • Securities credit (see 1002.3(b)(1)); and
  • Incidental credit (see 1002.3(c)(1), but without regard to whether the credit is consumer credit, is extended by a creditor, or is extended to a consumer).

A covered origination is a covered credit transaction that the financial institution (your bank) originated to a small business. Refinancings can be covered originations. (A refi is a loan created when an existing loan is satisfied and replaced by a new one by the same borrower.)  Note, extensions, renewals, and other amendments of existing transactions are not considered covered originations even if they increase the credit line or credit amount of the existing transaction.

Tier 1
If your bank originated at least 2,500 covered loans in both 2022 and 2023, you must begin collecting data and otherwise complying with the final rule on October 1, 2024.

Tier 2
If your bank originated 500 to 2,499 covered loans in both 2022 and 2023 and at least 100 in 2024, you must begin collecting data and otherwise complying with the final rule on April 1, 2025.

Tier 3
If your bank originated at least 100 covered loans in both 2024 and 2025, you must begin collecting data and otherwise complying with the final rule on January 1, 2026.

Guidance Documents – Tools

Above we note that “trade credit” is likely something your bank will not be involved in. It isn’t impossible, but it is not likely in my experience. The CFPB offered this guidance as its interpretation rather than formally update the Reg B interpretations/commentary. You can find the rule, FAQs, a data points chart, a key dates chart  and more on the CFPB’s resource page  here https://www.consumerfinance.gov/compliance/compliance-resources/small-business-lending-resources/small-business-lending-collection-and-reporting-requirements/ to help guide you through creating your 1071 Small Business Lending Rule implementation process.