Community Banking Advisor: Appraisal or Evaluation? A Look at the Rules

When valuing real estate in connection with lending transactions, banks often hesitate to rely on evaluations in lieu of appraisals — even though they can be quicker and more cost-effective. That’s usually because they fear criticism from examiners. However, the federal banking agencies’ regulations permit using evaluations as part of an appropriate real estate valuation program. Here’s a quick look at the rules.

When to Use Evaluations

According to the federal banking regulators’ Interagency Appraisal and Evaluation Guidelines (the “Guidelines”), evaluations are permitted for:

  • Transactions valued at $250,000 or less (a proposal to increase this threshold to $400,000 is being considered),
  • Business loans valued at $1 million or less, provided they don’t rely on the sale of or rental income from real estate as the primary source of repayment, and
  • Renewals or refinancings of existing extensions of credit, provided 1) there has been no obvious and material change that threatens the collateral’s adequacy, or 2) no new money is advanced.

Even though the regulations allow evaluations for these types of transactions, the Guidelines state that banks should establish policies and procedures for determining when to obtain appraisals for higher risk transactions, such as those with combined loan-to-value ratios that exceed supervisory limits, atypical properties, properties outside the bank’s traditional lending market, or high-risk borrowers.

Qualifications

While an appraisal requires a state-certified or licensed appraiser, the Guidelines state that those who perform evaluations should have “the appropriate appraisal or collateral valuation education, expertise and experience relevant to the type of property being valued.” Examples include appraisers, real estate lending professionals, agricultural extension agents or foresters.

You can even use internal staff to perform evaluations, provided they possess the necessary training and qualifications and you take steps to maintain the independence of your real estate valuation program. Generally, that means a complete separation of the collateral valuation program from the loan production process. Maintaining such a separation may be difficult for smaller banks. According to the Guidelines, if the only person qualified to evaluate real estate collateral is another loan officer, director or bank official, the bank should ensure that person’s independence by requiring him or her to abstain from any vote or approval involving loans for which they ordered, performed, or reviewed an appraisal or evaluation.

For banks lacking the resources to hire and train their own personnel to perform evaluations, the most cost-effective way to address independence issues may be to use a third party for evaluations.

Requirements

The Guidelines detail the minimum content requirements for an evaluation and provide guidance on evaluation development. Banks have some flexibility in selecting appropriate valuation methods, if the evaluation is consistent with safe and sound banking practices and supports the bank’s credit decision. The Guidelines also emphasize the importance of understanding the property’s physical condition. Typically, that means conducting a site visit and physical inspection — a drive-by estimate likely won’t suffice.

Note that automated valuation models and broker price opinions (BPOs) can be useful tools but they are not, by themselves, evaluations. The Guidelines state, however, that BPOs can be used for monitoring collateral values, when appropriate.

Program Review

If your bank uses or plans to use evaluations, you’ll need to review your real estate valuation program to ensure it complies with the Guidelines and appraisal regulations. Among other things, establish criteria for determining when to use an evaluation in lieu of an appraisal and ensure the independence of those ordering, performing and reviewing them. In addition, monitor and evaluate those who perform them and take any other necessary steps to ensure your program meets regulatory expectations. Contact your Elliott Davis advisor if you have questions or need assistance.