A Federal Reserve rule has sown widespread confusion about the way lenders pay housing appraisers, creating turmoil in an industry already burdened by expensive middlemen, falling home prices and diminished ranks.
A provision of the Dodd-Frank Act requires that lenders pay appraisers "customary and reasonable" fees, to ensure that banks and mortgage companies seek the most competent appraisers rather than the cheapest ones. But a Federal Reserve interim final rule that went into effect a year ago created two ways to satisfy the fee requirement that few in the industry agree on, and which many claim are contradictory.
Lenders and appraisers complain that regulators have not defined exactly what they mean by "customary and reasonable," leaving the complicated rule open to differing interpretations and adding confusion to an already-volatile appraisal landscape.
"It's muddied the waters," says Bill Waltenbaugh, chief appraiser at Kirchmeyer & Associates, a Buffalo, N.Y., appraisal management firm. "Everybody's interpretation is different. The lenders don't agree, the appraisers don't agree and the appraisal management companies don't agree."
The fee issue raises a host of concerns for banks, which are required to oversee the third-party appraisal management companies that have wedged themselves in between mortgage lenders and the people conducting appraisals of the properties they lend against.
Banks now must spend more time and money ensuring those third-parties' compliance with regulations; some lenders, including US Bancorp (USB), have reacted by bringing most of their appraisals in-house. The fee confusion also affects lenders' all-important property valuations, since cheaper appraisals do not necessarily provide the most accurate assessments of how much the homes they lend against are worth.
The overall confusion is a direct result of the Home Valuation Code of Conduct that took effect in 2009 and was folded into Dodd-Frank. The regulatory agreement prevented banks' staff and mortgage brokers from directly overseeing the appraisal process, in an effort to avoid conflicts of interest for loan officers or other salespeople who would have an interest in inflating real estate values. The code had the indirect result of encouraging banks to engage third-party appraisal management companies, in an effort to keep the appraisal process independent from salespeople.
These so-called AMCs, some of which are owned by large banks themselves, now order more than 80% of all appraisals. That marks a sharp reversal of the market before 2008, when 60% of appraisals were ordered by mortgage brokers. The third parties generally take a cut of the appraisal fees, meaning that the people actually doing appraisals now are paid less.
Some have said this trend has led to lower-quality appraisals, and indirectly to higher foreclosure rates. Banks would have far fewer losses if they had a good appraisal behind every bad loan, according to Tony Pistilli, chief residential appraiser at U.S. Bank. And that view is gaining traction among other bankers concerned about what they describe as the low quality and inconsistency of appraisals these days.
"Bad appraisers do bad appraisals," says Pistilli, who estimates that even a slight improvement in appraisal quality could reduce loan losses by tens of millions of dollars. "We've learned over the last few years that valuation matters."
Banks are spending millions of dollars every month on a wide array of appraisal products, many to determine the value of distressed and foreclosed properties. They also have been shelling out money on loan repurchase requests and out-of-court settlements with investors for faulty appraisals from the heady days of the housing bubble.
Yet bankers and appraisers say that the new regulations are creating more problems without resulting in better-quality appraisals.
Mark Chapin, the chief valuation officer at consulting firm Interthinx, says a core problem is that some AMCs use appraisals as "loss leaders," keeping fees low to help sell lenders other mortgage-related products, including title insurance, flood insurance and credit reports. Many AMCs are also vendor management companies, which provide a host of such products for lenders along with appraisals.
"The deal is usually originated by the appraisal, so if the appraisal doesn't work out for them, they don't get all these other products," says Chapin, who conducts due diligence on appraisals for lenders.
"That goes directly to the issue of appraiser pressure," he says. "If a bank contracts with an AMC for an appraisal and the appraisal works, then the AMC gets the revenue for other settlement services products. That is a recipe for pressuring the appraiser."
Jeff Schurman, a consultant and the former executive director of the Title and Appraisal Vendor Management Association, a trade group, acknowledges "the perception" that appraisals can be a "loss leader," primarily because margins are so low to begin with.
"In a situation where a company provides both title and closing services, there is more money in the transaction in issuing the title policy, and the full-serve vendor management companies like the larger fee that comes with title insurance," says Schurman. "So they will provide appraisals recognizing there are no real margins in appraisals and it's not a profit center for them."
The Fed's interim guidance allows a bank or appraisal management company to determine fees using two different methods. The first method, which has caused the most confusion, allows fees to be based on market rates that have been paid in the past year for similar assignments. But lenders or third parties also must take into account six variables to fulfill the standard for what is reasonable, including the type of property, scope of work, the time in which the appraisal is required to be completed, an appraiser's qualifications, experience and work quality.
The second method allows appraisal fees to be set based on specific third-party fee surveys, including private or government studies that exclude fees generated by appraisal management companies.
Some industry experts say the first method was created to take into account the practical reality that small banks in rural areas are unable to gauge customary fees if a market is dominated only by AMCs. Appraisers say AMCs have largely interpreted the rule as allowing them to maintain the status quo and continue paying low fees.
"So many good residential appraisers can't survive, they can't work for pennies on the dollar and produce the kinds of reports that folks are expecting," says Sara Stephens, president of the Appraisal Institute, a trade association. "Cheap isn't better."
She adds that appraisers are at risk of becoming "glorified data aggregators and form fillers, thanks partly to government policies."
The number of appraisers has dropped 4% in the past year, and 13% since 2007, to roughly 86,800 appraisers at year-end 2011, according to the most recent data from the Appraisal Institute. More than half of all appraisers are between the ages of 51 and 65. Fewer than 12% are under age 35.
"We are being put out of business," says Peter Vidi, president of the American Guild of Appraisers, an appraisal group affiliated with the AFL-CIO.
The Federal Reserve declined to comment for this article.
Vidi has petitioned the Federal Reserve and the Consumer Financial Protection Bureau to overturn the rule, claiming it violates the intent of Dodd-Frank, which originally excluded any fees paid by AMCs from the "customary and reasonable" definition.
"The appraiser is spinning in the wind trying to hold on to a fee that is now severely compromised," says Vidi. "The only person in the entire food chain that is not an advocate is the appraiser. Everybody else has a vested financial interest in the deal except the appraiser, who gets a flat fee."
Matthew R. Schneider, a managing director at the law firm Garvey Schubert Barer, who represents the appraisal guild, argues that the Fed's rule is contradictory: "It's not possible that a regulatory agency can implement a law with two [methods], one that permits something and one that prohibits the same thing. How can that be?"
But Don Kelly, executive director of the Real Estate Valuation Advocacy Association, a trade group of appraisal management companies, says the Fed "got it right," by allowing AMCs to rely on market rates.
"The AMC exclusion is what appraisers are crying about, arguing that all fees must ignore AMC assignments to be compliant with 'customary and reasonable'," he says. "That isn't how the Federal Reserve Board interprets it."
Some appraisers say the industry's flawed compensation system could be remedied easily if any one regulator clearly defined the terms "customary and reasonable."
Federal guidelines are clear that financial institutions cannot select an appraiser based solely on the low cost or fast turnaround times. Banks also are required to have internal controls for identifying, monitoring and managing the risks associated with third-party valuation services.
According to federal guidelines, "The decision to outsource any part of the collateral valuation function should not be unduly influenced by any short-term cost savings."
Some appraisers say fees may have increased ever-so-slightly in the past year - by $25 at most - but the work required of appraisers has mushroomed in part because of the distressed real estate market.
Waltenbaugh says appraisers "have a good argument" that their hourly pay has gone down "because everybody is asking for more and more work."
With distressed properties making up 30% of overall home sales, appraisers talk about "scope creep," in which they are asked to provide more than just three comparable sales of properties in a given neighborhood, which has been the typical number used for years.
Now lenders or an AMC will ask an appraiser for three "comps," plus two active listings and a pending sale. Some want as many as nine comparable sales, including real estate-owned properties. There are more requirements for interior, exterior and aerial photos, and of photos taken of the street in several directions from the property. For prospective mortgages that will be sold to Fannie Mae or Freddie Mac or for existing mortgages that are government-insured, an appraiser must fill out a "Market Condition Addendum" form intended to provide a lender with a deeper analysis of market trends and conditions in a specific neighborhood.
Chapin at Interthinx says he could call 10 appraisers and ask what they are paid on average and get 10 different responses. He pays appraisers roughly $500 and gives them 10 business days to turn in a detailed assignment.
He also says that despite regulatory changes, pressure still exists - this time from AMCs.
"There are entities pushing appraisers to ignore the not-so-savory properties," he says. "They are being asked not to include half of the neighborhood that is real-estate owned, or show that a property backs up to the 110 freeway."
