Lines of Defense in Real Estate Collateral Risk Management – Valuation Buzz | Region & Cash

As we all know, home appraisal is an integral part of the lending process that helps Americans on their journey to home ownership. It’s an honor to play such an important role, but it’s also important to remember that lending programs must follow strict practices to protect lenders and their investors from collateral risk. This series of articles examines the role of appraisal verification processes in the risk system in the format of mortgage lending for 1- to 4-family homes. In doing so, I will address current practices and processes of valuation review, measuring change through observation and insight into what is to come.

In practice, the mortgage lender and mortgage aggregator/investor focus on three lines of defense when managing risk. The first involves the development and application of processes to ensure that regulatory and policy requirements are met by the business unit’s mortgage products. This part of the program focuses on maintaining the independence of rating processes and ensuring that the rating received from the lender meets the requirements for the specific loan product. The second is an internal oversight function that owns the risk policies and frameworks and advises on controls and implementations to ensure that policy requirements and objectives are met. The third is when parties outside the lender’s business unit (e.g., auditor, investor, regulator) review the effectiveness of controls and practices.

This three-part series focuses on the first two lines of defense when dealing with valuation-related risk with a deeper focus on valuation audit processes.

The appraisal

The Appraisal Institute’s Dictionary of Real Estate Appraisal, 7th Edition, defines appraisal appraisal as β€œthe act or process of developing an opinion about the quality of another appraiser’s work (i.e., a report, part of a report, or a combination thereof), performed as part of an appraisal or appraisal review engagement.” While this definition is offered in the context of real estate appraisal practice, the following question arises: Can an appraisal review be performed by a person or process that is not part of an appraisal practice?

If you look at current regulatory and stakeholder guidance, it is clear that a review can be reviewed by someone who does not have review authority if it is an internal process and the outcome of the process does not produce an opinion on market value purposes of lending. If the appraisal test provides an appraisal, including a value match, most states require appraisal eligibility.

Many lenders and valuation management companies employ appraisers to meet government requirements and to have a level of expertise they can rely on for complex issues. However, many lenders, particularly smaller lenders or non-bank lenders, do not have certified appraisers to conduct their review process and rely on appraisers to provide a review review as a review service.

Appraisal processes are necessary because the lender must have a full understanding of the collateral that is being posted for a mortgage loan or line of credit. While current default risk remains at historic lows, lenders and investors need to stand their ground to prepare for economic downturns and mounting defaults.

The objective of any assessment test, whether developed internally or externally by the business, is to ensure that the assessment report obtained in connection with a loan application contains sufficient information to enable the lender to make a credit decision.

Most lending verification policies and procedures are formulated to match two sources. The first source is the written assessment requirements published for loan programs by interest groups such as HUD/FHA, the Veterans Administration, and Fannie Mae and Feddie Mac. The second source is the Interagency Real Estate Appraisal and Evaluation Guidelines, the source for regulated banks and credit unions to follow to ensure their appraisal programs, including appraisal testing, are adequate to comply with lending regulations applicable to real estate lending.

Quality Control and Quality Assurance

Assessment reviews take place in two distinct processes within an institution’s risk system – quality control and quality assurance. The two terms are often used interchangeably, but they are distinctly different processes.

While both terms refer to processes and activities, quality control focuses on analysis and inspection and aims to ensure quality is at a specified level to maintain the product being manufactured. However, quality assurance focuses on monitoring and evaluating the manufacturing process to ensure quality standards are maintained and maintained. In essence, quality assurance is a testing program to gain confidence that quality control processes are working as intended. Whether you are making a car or a mortgage, the manufacturer needs to control quality and ensure quality is consistent.

In summary, the valuation review process is an essential part of a lender’s risk program in order to perform the required level of due diligence to provide confidence that the business practices meet the objectives of safety and soundness for the lender and associated investors . Without this trust, the lender risks a loss to the business and ability to participate in a system focused on managing systemic risk in real estate lending. The next article focuses on the steps a lender will use in developing its quality control and quality assurance programs.

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