REO Valuation for the Mid-Tier Institution
The nation's largest mortgage lenders and servicers are currently in a battle for their lives. They are engaged in implementing new loan quality initiatives to stave off investor buyback requests, forensic reviews of past deals for risk assessment and trying to meet the government's demands for aid to troubled borrowers. Little time is left for seeking out new loan origination volume, and yet there is still business out there.
Over the past few weeks, we have identified a trend in which mid-tier banks are stepping up their correspondent lending efforts in order to gain market share while larger competitors are busy elsewhere. It's a good strategy, if the loans they originate perform.
Recent history and a continuing jobless recovery suggest that there is plenty of risk that these smaller institutions will be facing. It is highly likely that they will be taking on increased levels of REO in the future. If that happens, it is important that they understand how to value these distressed properties. These smaller institutions do not have the resources of the larger banks and can ill afford to make mistakes.
Accuracy is key
Most originators have been trained such that a valuation that exceeds the requirements of the loan program is a green light and no more attention need be spared for the appraisal.
That is certainly not the case for distressed properties—the game is different when it comes to mortgage loan servicing and there is great risk if the valuation is too high or too low.
If a property has been valued too low, for example, it could mean losing a loan because a competitor had a higher, more accurate value. It could lead to the servicer not offering the borrower the best possible loss mitigation solution to prevent foreclosure. It could lead to bidding too low at the foreclosure auction and not maximizing the total asset. And when the REO property is sold, it’s being sold well below market value, leaving money on the table the bank would otherwise lay claim to.
For the property that’s been over-valued, it could cause the bank to make a loan by lending too much and over-leveraging the property. The bank may end up offering the borrower a loss mitigation opportunity when there is insufficient equity to mitigate risk. The bank may bid too high at the foreclosure auction and foreclosing on a property that could have been sold at the auction third party. Simply put, listing an REO property too high lengthens the days on market, increases carrying costs and lowers overall asset recovery.
So the pressure is on to get accurate valuations. But how can smaller institutions that may not have as much experience on this side of the business ensure that the valuations they are receiving from their vendors are accurate?
Success metrics for REO valuations
Banks should be looking for valuation providers with AKE: Awareness, Knowledge, and Effort.
Awareness is a consciousness of the general marketplace: being familiar with market and its trends on a macro level. Knowledge involves knowing the default sector on a micro level. A valuation provider with both awareness of the general market and a more in-depth knowledge of the specific default division is armed with wisdom when making valuations. Maybe it goes without saying, but when people know what they’re doing, you can trust that they know what they’re doing.
Knowledge is of little use, of course, if the vendor isn't willing to put in the effort to produce a good result. This is why banks should be looking for a valuation provider with all three of these qualities. A valuation provider who cares about what he’s doing, and who cares about getting it right, will do the work it takes to get it right. That means doing the research, finding the right comps, taking all the photos—whatever it takes. No shortcuts.
Your valuation provider should not just be providing a number. When it comes to describing property condition, he should be providing you with the three C’s: consistency, common sense and commentary. This includes the reasoning behind his assumptions about the interior condition. If a subject is clearly dilapidated, vacant, and not secure, it wouldn’t be consistent or make any sense to assume that the condition of the interior is average, especially without commenting on why the assumption was made, for instance.
No good originator plans on originating and no mortgage servicer plans on inheriting non-performing loans. But it happens. When it does, knowing what to look for in a valuation provider will help bank executives rest a little easier about what kind of valuations reports they’ll get back and their ability to mitigate default risk for their portfolios.