oversight

Residential Appraisals: Regulators Should Take Actions to Strengthen Appraisal Oversight

Published by the Government Accountability Office on 2012-06-28.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                             United States Government Accountability Office

GAO                          Testimony
                             Before the Subcommittee on Insurance,
                             Housing and Community Opportunity,
                             Committee on Financial Services, House
                             of Representatives
                             RESIDENTIAL
For Release on Delivery
Expected at 10:00 a.m. EDT
Thursday, June 28, 2012

                             APPRAISALS
                             Regulators Should Take
                             Actions to Strengthen
                             Appraisal Oversight
                             Statement of William B. Shear, Director
                             Financial Markets and Community Investment




GAO-12-840T
                                             June 2012

                                             RESIDENTIAL APPRAISALS
                                             Regulators Should Take Actions to Strengthen
                                             Appraisal Oversight
Highlights of GAO-12-840T, a testimony
before the Subcommittee on Insurance,
Housing and Community Opportunity,
Committee on Financial Services, House of
Representatives.


Why GAO Did This Study                       What GAO Found
Real estate valuations, which                Data GAO obtained from Fannie Mae and Freddie Mac (the enterprises) and five
encompass appraisals and other               of the largest mortgage lenders indicate that appraisals—which provide an
estimation methods, have come under          estimate of market value at a point in time—are the most commonly used
increased scrutiny in the wake of the        valuation method for first-lien residential mortgage originations. Other methods,
recent mortgage crisis. The Dodd-            such as broker price opinions and automated valuation models, are quicker and
Frank Act codified several                   less costly but are viewed as less reliable. As a result, they generally are not
independence requirements for                used for most purchase and refinance mortgage originations. Although the
appraisers and requires federal              enterprises and lenders GAO spoke with did not capture data on the prevalence
regulators to set standards for
                                             of approaches used to perform appraisals, the sales comparison approach—in
registering AMCs. Additionally, the act
                                             which the value is based on recent sales of similar properties—is required by the
expanded the role of ASC, which
oversees the appraisal regulatory
                                             enterprises and the Federal Housing Administration. This approach is reportedly
structure established by Title XI of         used in nearly all appraisals.
FIRREA. The act also directed GAO to         Conflict-of-interest policies have changed appraiser selection processes and the
conduct two studies on real estate           appraisal industry more broadly, raising concerns about the oversight of
appraisals. This testimony discusses         appraisal management companies (AMC), which often manage appraisals for
information from those studies,              lenders. Recent policies, including provisions in the Dodd-Frank Wall Street
including (1) the use of different real      Reform and Consumer Protection Act (Dodd-Frank Act), reinforce prior
estate valuation methods, (2) policies
                                             requirements and guidance that restrict who can select appraisers and prohibit
on appraiser conflict-of-interest and
                                             coercion. In response to market changes and these requirements, some lenders
selection and views on their impact,
and (3) ASC’s performance of its Title       have turned to AMCs. Greater use of AMCs has raised questions about oversight
XI functions. To address these               of these firms and their impact on appraisal quality. Federal regulators and the
objectives, GAO analyzed government          enterprises said they hold lenders responsible for ensuring that AMCs’ policies
and industry data; reviewed academic         and practices meet their requirements but that they generally do not directly
and industry literature; examined            examine AMCs’ operations. Some industry participants voiced concerns that
policies, regulations, and professional      some AMCs may prioritize low costs and speed over quality and competence.
standards; and interviewed industry          The Dodd-Frank Act requires state appraiser licensing boards to supervise AMCs
participants and stakeholders.               and requires the federal banking regulators, the Federal Housing Finance
                                             Agency, and the Bureau of Consumer Financial Protection to establish minimum
What GAO Recommends                          standards for states to apply in registering them. Setting minimum standards that
GAO previously recommended that              address key functions AMCs perform on behalf of lenders could provide greater
federal regulators consider key AMC          assurance of the quality of the appraisals that AMCs provide. As of June 2012,
functions in rulemaking to set minimum       federal regulators had not completed rulemaking to set state standards.
standards for registering these firms.
                                             The Appraisal Subcommittee (ASC) has been performing its monitoring role
The regulators agreed with or said they
                                             under Title XI of the Financial Institutions Reform, Recovery, and Enforcement
would consider this recommendation.
GAO also recommended that ASC
                                             Act of 1989 (FIRREA), but several weaknesses have potentially limited its
clarify the criteria it uses to assess       effectiveness. For example, ASC has not clearly defined the criteria it uses to
states’ compliance with Title XI and         assess states’ overall compliance with Title XI. In addition, Title XI charges ASC
develop specific policies and                with monitoring the appraisal requirements of the federal banking regulators, but
procedures for monitoring the federal        ASC has not defined the scope of this function—for example, by developing
banking regulators and the Appraisal         policies and procedures—and its monitoring activities have been limited. ASC
Foundation. ASC is taking steps to           also lacks specific policies for determining whether activities of the Appraisal
implement these recommendations.             Foundation (a private nonprofit organization that sets criteria for appraisals and
See GAO-11-653 and GAO-12-147.               appraisers) that are funded by ASC grants are Title XI-related. Not having
                                             appropriate policies and procedures is inconsistent with federal internal control
View GAO-12-840T or key components.
For more information, contact William B.     standards that are designed to promote the effectiveness and efficiency of
Shear at (202) 512-8678 or shearw@gao.gov.   federal activities.

                                                                                     United States Government Accountability Office
Chairman Biggert, Ranking Member Gutierrez, and Members of the
Subcommittee:

I am pleased to be here today to discuss our work on residential real
estate valuations and the role of the Appraisal Subcommittee (ASC) of
the Federal Financial Institutions Examination Council (FFIEC) in
monitoring requirements for real estate appraisals and appraisers. 1 Real
estate valuations, which encompass appraisals and other value
estimation methods, play a critical role in mortgage underwriting by
providing evidence that the market value of a property is sufficient to help
mitigate losses if the borrower is unable to repay the loan. However,
turmoil in the mortgage market raised questions about mortgage
underwriting practices, including the quality and credibility of some
valuations. An investigation into industry appraisal practices by the New
York State Attorney General led to an agreement in 2008 between the
Attorney General, Fannie Mae and Freddie Mac (the enterprises), and the
Federal Housing Finance Agency (FHFA), which regulates the
enterprises, that included the Home Valuation Code of Conduct (HVCC). 2
HVCC set forth certain appraiser independence requirements for loans
sold to the enterprises and took effect in 2009. Although the Dodd-Frank
Wall Street Reform and Consumer Protection Act (Dodd-Frank Act)
declared HVCC no longer in effect, it codified several of HVCC’s
provisions. 3 The Dodd-Frank Act also amended Title XI of the Financial


1
 FFIEC is a formal interagency body empowered to prescribe uniform principles,
standards, and report forms for the federal examination of financial institutions by the
Board of Governors of the Federal Reserve System, the Federal Deposit Insurance
Corporation, the National Credit Union Administration, the Office of the Comptroller of the
Currency, and the Bureau of Consumer Financial Protection and to make
recommendations to promote uniformity in the supervision of financial institutions.
2
  The enterprises purchase mortgages that meet specified underwriting criteria from
approved lenders. The enterprises bundle most of the mortgages they purchase into
securities and guarantee the timely payment of principal and interest to investors in the
securities. On September 6, 2008, the enterprises were placed under federal
conservatorship out of concern that their deteriorating financial condition and potential
default on $5.4 trillion in outstanding financial obligations threatened the stability of
financial markets.
3
 Pub. L. No. 111-203. Congress enacted the Dodd-Frank Act in July 2010. The Dodd-
Frank Act stated that HVCC ceased to be effective as of the date the Board of Governors
of the Federal Reserve System (Federal Reserve) issued interim final rules covering
appraiser independence. Dodd-Frank Act § 1472(a) (codified at 15 U.S.C. § 1639e(j)).
The Federal Reserve issued these rules on October 28, 2010. 75 Fed. Reg. 66554. The
enterprises have incorporated many of the other provisions of HVCC into their
requirements.




Page 1                                                                         GAO-12-840T
Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA),
which made reforms to address the quality of appraisals and appraiser
qualifications and created ASC to monitor Title XI’s implementation.
Among other things, the Dodd-Frank Act gave ASC additional
responsibilities and authorities.

The Dodd-Frank Act also directed us to perform two studies concerning
real estate appraisals. 4 The first, which we issued in July 2011, included
an examination of real estate valuation methods, including appraisals,
and conflict-of-interest and appraiser-selection policies. 5 The second,
which we issued in January 2012, included an assessment of ASC’s
monitoring functions and discussed challenges that ASC faces in
implementing its new responsibilities and authorities. 6

My statement today is based on information from those two reports.
Specifically, I will discuss (1) the use of different valuation methods for
single-family residential mortgages and the advantages and
disadvantages of each method, (2) policies on appraiser conflict-of-
interest and selection and views on the policies’ impact on industry
stakeholders and appraisal quality; and (3) ASC’s performance of its Title
XI functions that existed prior to the Dodd-Frank Act and challenges that it
faces in implementing additional responsibilities under the act. To do this
work, we analyzed proprietary data we obtained from the enterprises,
lenders, and a mortgage technology company on the use of different
valuation methods and appraisal approaches. 7 We reviewed academic
and industry literature on real estate valuation and examined federal
regulations and policies, as well as lenders’ and appraisal management
companies’ (AMC) internal policies on and procedures for selecting




4
Dodd-Frank Act § 1476.
5
 GAO, Residential Appraisals: Opportunities to Enhance Oversight of an Evolving
Industry, GAO-11-653 (Washington, D.C.: July 13, 2011).
6
 GAO, Real Estate Appraisals: Appraisal Subcommittee Needs to Improve Monitoring
Procedures, GAO-12-147 (Washington, D.C.: Jan. 18, 2012).
7
See GAO-11-653 for more information about the data we obtained for this study.




Page 2                                                                     GAO-12-840T
             appraisers. 8 We also reviewed ASC’s policies and procedures, including
             its rules of operation, policy and procedures manual, Title XI policy
             statements, and compliance review manual. In addition, we reviewed
             ASC records such as its annual reports to Congress, board-meeting
             minutes, state compliance review reports, and grant documents. We
             interviewed a broad range of appraisal and mortgage industry participants
             and stakeholders, including officials from the enterprises, FHFA, the
             federal banking regulatory agencies, and ASC. Additionally, prior to this
             hearing, we interviewed federal regulators to update the status of our
             recommendations. The work that this statement is based on was
             performed from July 2010 to June 2012 in accordance with generally
             accepted government auditing standards. Those standards require that
             we plan and perform the audit to obtain sufficient, appropriate evidence to
             provide a reasonable basis for our findings and conclusions based on our
             audit objectives. We believe that the evidence obtained provides a
             reasonable basis for our findings and conclusions based on our audit
             objectives.


             Before originating a residential mortgage loan, a lender assesses its risk
Background   through the underwriting process, in which the lender generally examines
             the borrower’s credit history and capacity to repay the mortgage and
             obtains a valuation of the property that will be the loan’s collateral.
             Lenders need to know the property’s market value, or the probable price
             that the property should bring in a competitive and open market, in order
             to provide information for assessing their potential loss exposure if the
             borrower defaults. 9 Real estate can be valued using a number of
             methods, including appraisals, broker price opinions (BPO), and
             automated valuation models (AVM). Appraisals are opinions of value
             based on market research and analysis as of a specific date. Appraisals


             8
              The Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. No. 111-203)
             defines an AMC as a third party that oversees a network or panel of more than 15
             appraisers within a state or 25 or more appraisers nationally in a given year and has been
             authorized by lenders to recruit, select, and retain appraisers; contract with appraisers to
             perform appraisal assignments; manage the process of having an appraisal performed; or
             review and verify the work of appraisers. Dodd-Frank Act § 1473(f)(4) (codified at 12
             U.S.C. § 3550(11)).
             9
              The enterprises and federal banking regulators define market value as the most probable
             price that a property should bring in a competitive and open market under all conditions
             requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and
             assuming the price is not affected by undue stimulus.




             Page 3                                                                         GAO-12-840T
are performed by state-licensed or -certified appraisers who are required
to follow the Uniform Standards of Professional Appraisal Practice
(USPAP). 10 A BPO is an estimate of the probable selling price of a
particular property prepared by a real estate broker, agent, or
salesperson rather than by an appraiser. An AVM is a computerized
model that estimates property values using public record data, such as
tax records and information kept by county recorders, multiple listing
services, and other real estate records. 11

In 1986, the House Committee on Government Operations issued a
report concluding that problematic appraisals were an important
contributor to the losses that the federal government suffered during the
savings and loan crisis. 12 The report stated that hundreds of savings and
loans chartered or insured by the federal government were severely
weakened or declared insolvent because faulty and fraudulent real estate
appraisals provided documentation for loans larger than what the
collateral’s real value justified. In response, Congress incorporated
provisions in Title XI of FIRREA that were intended to ensure that
appraisals performed for federally related transactions were done (1) in
writing, in accordance with uniform professional standards, and (2) by
individuals whose competency had been demonstrated and whose
professional conduct was subject to effective supervision. 13

Various private, state, and federal entities have roles in the Title XI
regulatory structure:

•    The Appraisal Foundation. The Appraisal Foundation is a private not-
     for-profit corporation composed of groups from the real estate industry
     that works to foster professionalism in appraising. The foundation



10
  USPAP covers both the principles appraisers must apply in developing appraisals and
the information the appraisal report must contain.
11
  A multiple listing service is a database set up by a group of real estate brokers to
provide information about properties sold and for sale.
12
 House Committee on Government Operations, Impact of Appraisal Problems on Real
Estate Lending, Mortgage Insurance, and Investment in the Secondary Market, 99th
Cong., 2nd sess., 1986, H. Rep. 99-891, 4-6.
13
  12 U.S.C. §§ 3331, 3339-3345. Federally related transactions are real estate
transactions that require the services of an appraiser and involve financial institutions
regulated by the federal government.




Page 4                                                                           GAO-12-840T
     sponsors two independent boards with responsibilities under Title XI.
     The first of these, the Appraisal Standards Board, sets rules for
     developing an appraisal and reporting its results through USPAP. The
     second board, the Appraiser Qualifications Board, establishes the
     minimum qualification criteria for state certification and licensing of
     real property appraisers. 14 The foundation is funded primarily by sales
     of publications but also receives an annual grant from ASC.

•    State-level regulatory entities. Title XI relies on the states to (1)
     implement the certification and licensing of all real estate appraisers
     and (2) monitor and supervise appraisers’ compliance with appraisal
     standards and requirements. To assure the availability of certified and
     licensed appraisers, all 50 states, the District of Columbia, and four
     U.S. territories have adopted structures to regulate and supervise the
     appraisal industry. 15 These structures typically consist of a state
     regulatory agency and a board or commission that establish
     requirements for education and experience, consistent with or in
     excess of Appraiser Qualifications Board criteria; license and certify
     appraisers; and monitor and enforce appraiser compliance.

•    Federal banking regulators. Title XI places responsibility for regulating
     appraisals and “evaluations” performed in conjunction with federally
     related transactions with the Board of Governors of the Federal
     Reserve System (Federal Reserve), Federal Deposit Insurance
     Corporation (FDIC), Office of the Comptroller of the Currency (OCC),
     and the National Credit Union Administration (NCUA). 16 To meet this
     responsibility, these financial institution regulators have established
     requirements for appraisals and evaluations through regulations and
     have jointly issued Interagency Appraisal and Evaluation Guidelines.
     The federal regulators have developed procedures for examining the
     real estate lending activities of regulated institutions that include steps


14
  Certified appraisers are qualified to appraise properties of greater complexity and value
than licensed appraisers and must meet higher requirements for education and
experience.
15
  The four territories are Guam, Northern Mariana Islands, Puerto Rico, and the Virgin
Islands.
16
   Evaluations are estimates of market value that do not have to be performed by a state-
licensed or -certified appraiser. The federal banking regulators permit evaluations to be
performed (consistent with safe and sound lending practices) in certain circumstances,
such as mortgage transactions of $250,000 or less that are conducted by regulated
institutions.




Page 5                                                                         GAO-12-840T
                            for assessing the completeness, adequacy, and appropriateness of
                            these institutions’ appraisal and evaluation policies and procedures.

                        •   Appraisal Subcommittee. ASC has responsibility for monitoring the
                            implementation of Title XI by the private, state, and federal entities
                            noted previously. Among other things, ASC is responsible for (1)
                            monitoring and reviewing the practices, procedures, activities, and
                            organizational structure of the Appraisal Foundation—including
                            making grants to the Foundation in amounts that it deems appropriate
                            to help defray costs associated with its Title XI activities; (2)
                            monitoring the requirements that states and their appraiser regulatory
                            agencies establish for the certification and licensing of appraisers; (3)
                            monitoring the requirements established by the federal banking
                            regulators regarding appraisal standards for federally related
                            transactions and determinations of which federally related
                            transactions will require the services of state-licensed or -certified
                            appraisers; and (4) maintaining a national registry of state-licensed
                            and -certified appraisers who can perform appraisals for federally
                            related transactions. Among other responsibilities and authorities, the
                            Dodd-Frank Act requires ASC to implement a national appraisal
                            complaint hotline and provides ASC with limited rulemaking authority.
                            To carry out these tasks, ASC has 7 board member positions and 10
                            staff headed by an Executive Director hired by the board. Five of the
                            board members are designated by the federal agencies that are part
                            of FFIEC—the Bureau of Consumer Financial Protection (also known
                            as the Consumer Financial Protection Bureau or CFPB), FDIC, the
                            Federal Reserve, NCUA, and OCC. The other two board members
                            are designated by the U.S. Department of Housing and Urban
                            Development (HUD)—which includes the Federal Housing
                            Administration (FHA)—and FHFA. ASC is funded by appraiser
                            registration fees that totaled $2.6 million in fiscal year 2011.

                        Available data and interviews with lenders and other mortgage industry
The Widespread Use      participants indicate that appraisals are the most frequently used
of Appraisals for       valuation method for home purchase and refinance mortgage
                        originations. Appraisals provide an opinion of market value at a point in
Mortgage Originations   time and reflect prevailing economic and housing market conditions. Data
Reflects Their          provided to us by the five largest lenders (measured by dollar volume of
Advantages Relative     mortgage originations in 2010) show that, for the first-lien residential
                        mortgages for which data were available, these lenders obtained
to Other Valuation      appraisals for about 90 percent of the mortgages they made in 2009 and
Methods                 2010, including 98 percent of home purchase mortgages. The data we
                        obtained from lenders included mortgages sold to the enterprises and



                        Page 6                                                            GAO-12-840T
mortgages insured by FHA, which together accounted for the bulk of the
mortgages originated in 2009 and 2010. The enterprises and FHA require
appraisals to be performed for a large majority of the mortgages they
purchase or insure. For mortgages for which an appraisal was not done,
the lenders we spoke with reported that they generally relied on validation
of the sales price (or loan amounts in the case of refinances) against an
AVM-generated value, in accordance with enterprise policies that permit
this practice for some mortgages that have characteristics associated with
a lower default risk.

The enterprises, FHA, and lenders require and obtain appraisals for most
mortgages because mortgage industry participants consider appraising to
be the most credible and reliable valuation method, for a number of
reasons. Most notably, appraisals and appraisers are subject to specific
requirements and standards. In particular, USPAP outlines the steps
appraisers must take in developing appraisals and the information
appraisal reports must contain. It also requires that appraisers follow
standards for ethical conduct and have the competence needed for a
particular assignment. Furthermore, state licensing and certification
requirements for appraisers include minimum education and experience
criteria, and standardized report forms provide a way to report relevant
appraisal information in a consistent format.

In contrast, other valuation methods such as BPOs and AVMs are not
permitted for most purchase and refinance mortgage originations. The
enterprises do not permit lenders to use BPOs for mortgage originations
and permit lenders to use AVMs for only a modest percentage of
mortgages they purchase. Additionally, the federal banking regulators’
guidelines state that BPOs and AVMs cannot be used as the primary
basis for determining property values for mortgages originated by
regulated institutions. However, the enterprises and lenders use BPOs
and AVMs in a number of circumstances other than purchase and
refinance mortgage originations because these methods can provide a
quicker, less expensive means of valuing properties in active markets.

When performing appraisals, appraisers can use one or more of three
approaches to value—sales comparison, cost, and income. The sales
comparison approach compares and contrasts the property under
appraisal with recent offerings and sales of similar properties. The cost
approach is based on an estimate of the value of the land plus what it
would cost to replace or reproduce the improvements minus depreciation.
The income approach is an estimate of what a prudent investor would pay
based upon the net income the property produces. USPAP requires


Page 7                                                          GAO-12-840T
appraisers to consider which approaches to value are applicable and
necessary to perform a credible appraisal and provide an opinion of the
market value of a particular property. Appraisers must then reconcile the
values produced by the different approaches they use to reach a value
conclusion.

The enterprises and FHA require that, at a minimum, appraisers use the
sales comparison approach for all appraisals because it is considered the
most applicable for estimating market value in typical mortgage
transactions. Consistent with these policies, our review of valuation data
from a mortgage technology company—representing about 20 percent of
mortgage originations in 2010—indicated that appraisers used the sales
comparison approach for nearly all (more than 99 percent) of the
mortgages covered by these data. 17 The cost approach, which was
generally used in conjunction with the sales comparison approach, was
used somewhat less often—in approximately two-thirds of the
transactions in 2009 and 2010, according to these data. The income
approach was rarely used. Some mortgage industry stakeholders have
argued that wider use of the cost approach in particular could help
mitigate what they viewed as a limitation of the sales comparison
approach. They told us that relying solely on the sales comparison
approach could lead to market values rising to unsustainable levels and
that using the cost approach as a check on the sales comparison
approach could help lenders and appraisers identify when this is
happening. For example, they pointed to a growing gap between average
market values and average replacement costs of properties as the
housing bubble developed in the early to mid-2000s. However, other
mortgage industry participants noted that a rigorous application of the
cost approach might not generate values much different from those
generated using the sales comparison approach. They indicated, for
example, that components of the cost approach—such as land value or
profit margins of real estate developers—could grow rapidly in housing
markets where sales prices are increasing. The data we obtained did not
allow us to analyze the differences between the values appraisers
generated using the different approaches.




17
  The enterprises and lenders we spoke with did not capture data on the prevalence of
approaches used to perform appraisals.




Page 8                                                                      GAO-12-840T
                        Recently issued policies reinforce long-standing requirements and
Conflict-of-Interest    guidance designed to address conflicts of interest that may arise when
Policies Have           direct or indirect personal interests bias appraisers from exercising their
                        independent professional judgment. In order to prevent appraisers from
Changed Appraiser       being pressured, the federal banking regulators, the enterprises, FHA,
Selection Processes,    and other agencies have regulations and policies governing the selection
with Implications for   of, communications with, and coercion of appraisers. Examples of
                        recently issued policies that address appraiser independence include the
Appraisal Oversight     now-defunct HVCC, which took effect in May 2009; the enterprises’ new
                        appraiser independence requirements that replaced HVCC in October
                        2010; provisions in the Dodd-Frank Act; and revised Interagency
                        Appraisal and Evaluation Guidelines from the federal banking regulators
                        that were issued in December 2010. Provisions of these and other
                        policies address (1) prohibitions against the involvement of loan
                        production staff in appraiser selection and supervision; (2) prohibitions
                        against third parties with an interest in the mortgage transaction, such as
                        real estate agents or mortgage brokers, selecting appraisers; (3) limits on
                        communications with appraisers; and (4) prohibitions against coercive
                        behaviors.

                        According to mortgage industry participants, HVCC and other factors
                        have contributed to changes in appraiser selection processes—in
                        particular, to lenders’ more frequent use of AMCs to select appraisers.
                        AMCs are third parties that, among other things, select appraisers for
                        appraisal assignments on behalf of lenders. Some appraisal industry
                        participants said that HVCC, which required additional layers of
                        separation between loan production staff and appraisers for mortgages
                        sold to the enterprises, led some lenders to outsource appraisal functions
                        to AMCs because they thought using AMCs would allow them to easily
                        demonstrate compliance with these requirements. In addition, lenders
                        and other mortgage industry participants told us that market conditions,
                        including an increase in the number of mortgages originated during the
                        mid-2000s and lenders’ geographic expansion over the years, put
                        pressure on lenders’ capacity to manage appraisers and led to their
                        reliance on AMCs. 18




                        18
                          Although industrywide data on lenders’ use of AMCs over time are unavailable,
                        appraisal industry participants told us that between 60 and 80 percent of appraisals were
                        currently ordered through AMCs. They provided varying estimates of AMC use prior to
                        HVCC that ranged from 15 percent to 50 percent of mortgage originations.




                        Page 9                                                                        GAO-12-840T
Greater use of AMCs has raised questions about oversight of these firms
and their impact on appraisal quality. Direct federal oversight of AMCs is
limited. Federal banking regulators’ guidelines for lenders’ own appraisal
functions list standards for appraiser selection, appraisal review, and
reviewer qualifications. The guidelines also require lenders to establish
processes to help ensure that these standards are met when lenders
outsource appraisal functions to third parties, such as AMCs. Officials
from the federal banking regulators told us that they reviewed lenders’
policies and controls for overseeing AMCs, including the due diligence
performed when selecting AMCs. However, they told us that they
generally did not review an AMC’s operations directly unless they had
serious concerns about it that the lender was unable to address. In
addition, a number of states began regulating AMCs in 2009, but the
regulatory requirements vary and provide somewhat differing levels of
oversight, according to officials from several state appraiser regulatory
boards.

Some appraiser groups and other appraisal industry participants have
expressed concern that existing oversight may not provide adequate
assurance that AMCs are complying with industry standards. These
participants suggested that the practices of some AMCs for selecting
appraisers, reviewing appraisal reports, and establishing qualifications for
appraisal reviewers—key areas addressed in federal guidelines for
lenders’ appraisal functions—may have led to a decline in appraisal
quality. For example, appraiser groups said that some AMCs selected
appraisers based on who would accept the lowest fee and complete the
appraisal report the fastest rather than on who was the most qualified,
had the appropriate experience, and was familiar with the relevant
neighborhood. AMC officials we spoke with said that they had processes
that addressed these areas of concern—for example, using an automated
system that identified the most qualified appraiser based on the
requirements for the assignment, proximity to the subject property, and
performance metrics such as timeliness and appraisal quality.

While the impact of the increased use of AMCs on appraisal quality is
unclear, Congress recognized the importance of additional AMC oversight
in enacting the Dodd-Frank Act by requiring state appraiser regulatory
boards to supervise AMCs. The Dodd-Frank Act requires the federal
banking regulators, CFPB, and FHFA to establish minimum standards for
states to apply in registering AMCs, including requirements that




Page 10                                                          GAO-12-840T
                           appraisals coordinated by an AMC comply with USPAP and be conducted
                           independently and free from inappropriate influence and coercion. 19 This
                           rulemaking provides a potential avenue for reinforcing existing federal
                           requirements for key functions that may impact appraisal quality, such as
                           selecting appraisers, reviewing appraisals, and establishing qualifications
                           for appraisal reviewers. Such reinforcement could help to provide greater
                           assurance to lenders, the enterprises, and federal agencies of the quality
                           of the appraisals provided by AMCs.

                           To help ensure more consistent and effective oversight of the appraisal
                           industry, we recommended in our July 2011 report that the heads of the
                           federal banking regulators, CFPB, and FHFA—as part of their joint
                           rulemaking required under the Dodd-Frank Act—consider including
                           criteria for the selection of appraisers for appraisal orders, review of
                           completed appraisals, and qualifications for appraisal reviewers when
                           developing minimum standards for state registration of AMCs. 20 The
                           federal banking regulators and FHFA agreed with or indicated that they
                           would consider our recommendation but as of June 2012 had not issued
                           a rule setting minimum standards for state registration of AMCs. 21


                           ASC has been performing its monitoring role under Title XI, but several
Several Weaknesses         weaknesses have potentially limited its effectiveness. In particular, ASC
Have Potentially           has not fully developed appropriate policies and procedures for
                           monitoring state appraiser regulatory agencies, the federal banking
Limited ASC’s              regulators, and the Appraisal Foundation. In addition, ASC faces potential
Effectiveness in           challenges in implementing some Dodd-Frank Act provisions.
Performing Its Title XI
Functions
Monitoring States’         ASC has detailed policies and procedures for monitoring state appraiser
Compliance with Title XI   regulatory programs and has issued 10 policy statements covering
                           different aspects of states’ implementation of Title XI requirements. The
                           policy statements cover topics including submission of data to the


                           19
                            Dodd-Frank Act § 1473(f)(2) (codified at 12 U.S.C. § 3353(a)).
                           20
                            GAO-11-653.
                           21
                             CFPB did not receive a draft of our July 2011 report in time to comment on our
                           recommendation.




                           Page 11                                                                      GAO-12-840T
national registry of appraisers, license reciprocity (which enables an
appraiser certified or licensed in one state to perform appraisals in other
states), and programs for enforcing appraiser qualifications and
standards. ASC primarily uses on-site reviews conducted by ASC staff to
monitor states’ compliance with the policy statements. ASC’s routine
compliance reviews examine each state every 2 years or annually if ASC
determines that a state needs closer monitoring. These reviews are
designed to encourage adherence to Title XI requirements by identifying
any instances of noncompliance or “areas of concern” and recommending
corrective actions. 22 ASC conveys its findings and recommendations to
states through written reports. In 2010, ASC reported 34 findings of
noncompliance, the majority of which concerned weaknesses in state
enforcement efforts, such as a lack of timeliness in resolving complaints
about appraiser misconduct or wrongdoing. At the completion of each
review, ASC executive staff and board members deliberate on the
findings and place the state into one of three broad compliance
categories: “in substantial compliance,” “not in substantial compliance,”
and “not in compliance.” According to ASC, in substantial compliance
applies when there are no issues of noncompliance or no violations of
Title XI; not in substantial compliance applies when there are one or more
issues of noncompliance or violations of Title XI that do not rise to the
level of not in compliance; and not in compliance applies when “the
number, seriousness, and/or repetitiveness of the Title XI violations
warrant this finding.” 23

We found that ASC had been using the three compliance categories in its
reports to states and annual reports to Congress (which provide
aggregate statistics on the number of states in each category). However,
it had not included the definitions of the categories in these reports or in
its compliance review manual or policy and procedures manual, and its
definition of “not in compliance” was not clear or specific. 24 As previously



22
  ASC defines an area of concern as one in which the state is in compliance but could
improve.
23
  Because a state only has to have one noncompliance finding to be “not in substantial
compliance,” this category can encompass a fairly wide range of performance. For
example, in 2009, states in this category had from one to seven findings of
noncompliance.
24
  In June 2012, ASC officials told us they had begun incorporating the definitions in ASC
reports and policies.




Page 12                                                                       GAO-12-840T
noted, the definition states only that the category is to be used “when the
number, seriousness, and/or repetitiveness of the violations warrant this
finding” and does not elaborate on how these factors are weighed or
provide examples of situations that would meet this definition. These
shortcomings are inconsistent with our internal control standards, which
state that federal agencies should have appropriate policies and
procedures for each of their activities. 25 Without clear, disclosed
definitions, ASC limits the transparency of the state compliance review
process and the usefulness of information Congress receives to assess
states’ implementation of Title XI. Further, by not incorporating the
definitions into its compliance review and policy and procedures manuals,
ASC increases the risk that board members and staff may not interpret
and apply the compliance categories in a consistent manner. To address
these shortcomings, we recommended in our January 2012 report that
ASC clarify the definitions it uses to categorize states’ overall compliance
with Title XI and include these definitions in ASC’s compliance review and
policy and procedures manuals, compliance review reports to states, and
annual reports to Congress. 26 In June 2012, ASC officials told us that they
had developed a revised system for rating states that included five
compliance categories (ranging from excellent to poor), each with specific
criteria. They said that they would soon be publishing the compliance
categories in the Federal Register to obtain public comments and would
include the final categories in appropriate manuals and reports.

In addition to this procedural weakness, ASC has functioned without
regulations and enforcement tools that could be useful in promoting state
compliance with Title XI. Prior to the Dodd-Frank Act, Title XI did not give
ASC rulemaking authority and provided it with only one enforcement
option—”derecognition” of a state’s appraiser regulatory program. This
action would prohibit all licensed or certified appraisers from that state
from performing appraisals in conjunction with federally related
transactions. ASC has never derecognized a state, and ASC officials told
us that using this sanction would have a devastating effect on the real
estate markets and financial institutions within the state. The Dodd-Frank
Act provides ASC with limited rulemaking authority and authorizes ASC to



25
  GAO, Standards for Internal Control in the Federal Government, GAO/AIMD-00-21.3.1
(Washington, D.C.: November 1999) and Internal Control Management and Evaluation
Tool, GAO-01-1008G (Washington, D.C.: August 2001).
26
 GAO-12-147.




Page 13                                                                  GAO-12-840T
                           impose (unspecified) interim actions and suspensions against a state
                           agency as an alternative to, or in advance of, the derecognition of the
                           agency. 27 As of June 2012, ASC had not implemented this new
                           enforcement authority. ASC officials said that determining the interim
                           actions and suspensions they would take against state agencies would be
                           done through future rulemaking.


Monitoring the Appraisal   Although Title XI charges ASC with monitoring the appraisal requirements
Requirements of the        of the federal banking regulators, ASC has not developed policies and
Federal Banking            procedures for carrying out this responsibility. While ASC’s policy manual
                           provides detailed guidance on monitoring state appraiser regulatory
Regulators                 programs, it does not mention any activities associated with monitoring
                           the appraisal requirements of the federal banking regulators. Further,
                           ASC officials acknowledged the absence of a formal monitoring process.
                           The absence of policies and procedures specifying monitoring tasks and
                           responsibilities limits accountability for this function and is inconsistent
                           with federal internal control standards designed to help ensure
                           effectiveness and efficiency in agency operations.

                           According to ASC officials, ASC performs this monitoring function through
                           informal means, primarily through its board members who are employed
                           by the federal banking regulators. However, minutes from ASC’s monthly
                           board meetings and ASC’s annual reports to Congress indicate that the
                           monitoring activities of ASC as a whole have been limited. For example,
                           our review of board-meeting minutes from 2003 through 2010 found no
                           instances of the board discussing the appraisal requirements of the
                           federal financial regulators. 28 Additionally, evidence of this monitoring
                           function in ASC’s annual reports is limited to a summary of any new
                           appraisal requirements issued by the federal financial regulators and
                           HUD during the preceding year.




                           27
                             The act also gives ASC the authority to remove a state-licensed or -certified appraiser or
                           a registered AMC from the national registry on an interim basis, not to exceed 90 days,
                           pending state agency action on licensing, certification, registration, and disciplinary
                           proceedings. In June 2012, ASC officials told us that they had developed policies to
                           implement this authority and planned to publish the policies in the Federal Register to
                           obtain public comment.
                           28
                            The minutes indicated that on at least two occasions, the HUD representative to the
                           ASC board provided updates on appraisal policies for mortgages insured by FHA.




                           Page 14                                                                        GAO-12-840T
Stakeholder views differ as to how to interpret the Title XI requirement
that ASC monitor the requirements established by the federal banking
regulators with respect to appraisal standards. 29 Specifically, some ASC
board members told us that they understand their monitoring role as
maintaining an awareness of the federal financial regulators’ appraisal
requirements. Further, one ASC board member told us that ASC’s
monitoring of the federal financial regulators was more limited than its
monitoring of states because (1) board members from the federal
financial regulatory agencies are knowledgeable of the appraisal
requirements of their agencies, (2) the federal regulators’ interagency
process for developing appraisal guidelines (in place since 1994) has
reduced the need for monitoring the consistency of guidelines across
agencies, and (3) monitoring the states’ appraiser requirements requires
in-depth review of state processes for licensing, certification, and
enforcement.

In contrast, some appraisal industry stakeholders and observers have
proposed a larger ASC role in monitoring the appraisal requirements of
the federal banking regulators. An ASC board member who conducted a
review of ASC’s operations in 2007 recommended a more structured and
active monitoring role for ASC. The board member’s report—which the
board never officially adopted—suggested that ASC staff could be
assigned to keep abreast of federal financial regulators’ requirements and
guidelines; the staff could then assess the impact of the requirements on
ASC’s operations and policies. Under this proposed recommendation,
which ASC did not implement, ASC staff would annually report the results
of this work to the ASC board members. 30 A former General Counsel of
ASC told us that ASC’s monitoring role should include critically assessing
the adequacy of the federal financial regulators’ appraisal requirements
and evaluating how well the requirements are being implemented. He
indicated that such assessment might have helped federal financial
regulators and policymakers address issues such as appraiser
independence, establishing dollar-based exemptions from appraisal
requirements, and referral of Title XI violations to state agencies. A
representative of an appraisal industry group expressed a similar view



29
 12 U.S.C. § 3332(a)(2).
30
  ASC adopted some of the report’s recommendations, such as creating a Deputy
Executive Director position and allowing states to respond to preliminary compliance
review findings prior to the issuance of final reports.




Page 15                                                                      GAO-12-840T
                           and noted that ASC’s annual reports did not provide substantive analysis
                           or critique of federal appraisal requirements.

                           However, appraisal industry stakeholders also noted that implementing a
                           more expansive interpretation of ASC’s monitoring role would pose
                           challenges. For example, existing ASC staff may not have the capacity to
                           take on additional monitoring responsibilities. Even if ASC staff were able
                           to independently analyze the federal regulators’ appraisal requirements,
                           the analysis would be subject to review by the ASC board, which,
                           because of its composition, is not independent from the agencies that
                           ASC is charged with monitoring.

                           To better define the scope of its monitoring role and improve the
                           transparency of its activities, we recommended in our January 2012
                           report that ASC develop specific policies and procedures for monitoring
                           the appraisal requirements of the federal banking regulators. 31 In June
                           2012, ASC officials told us that they recognized the need for ASC to
                           perform this monitoring function, were deliberating on ways to carry it out,
                           and expected to have policies and procedures in place later in the year.


Monitoring the Appraisal   As previously noted, the Appraisal Foundation is a private not-for-profit
Foundation’s Grant         corporation that sponsors independent boards that set standards for
Activities                 appraisals and minimum qualification criteria for appraisers. ASC
                           approves an annual grant proposal and provides monthly grant
                           reimbursements to the Appraisal Foundation to support the Title XI-
                           related activities of the foundation and its Appraisal Standards Board and
                           Appraiser Qualifications Board. The reimbursements cover the
                           foundation’s incurred costs for activities under the grant. From fiscal years
                           2000 through 2010, ASC provided the foundation over $11 million in grant
                           reimbursements, or about 40 percent of ASC’s expenditures over that
                           period.

                           Although ASC monitors the foundation in several ways, ASC lacks
                           specific policies and procedures for determining whether grant activities
                           are related to Title XI. ASC’s policies and procedures manual does not
                           address how ASC monitors the Appraisal Foundation. Instead, ASC uses
                           monitoring procedures contained in a memorandum prepared by a former



                           31
                            GAO-12-147.




                           Page 16                                                           GAO-12-840T
                          Executive Director. The memorandum describes how the Executive
                          Director reviewed the foundation’s grant activities but does not provide
                          criteria for deciding what is Title XI-related. When we asked current ASC
                          officials for the criteria they used, they indicated only that ASC staff
                          “review submissions from the Foundation and supporting cost
                          spreadsheets to determine that activities proposed in the annual grant
                          request or the monthly reimbursement processes meet the requirements
                          of Title XI.” They said that once staff determine whether or not a
                          submission falls within these parameters, they make a recommendation
                          to the ASC board. However, determinations about what activities are Title
                          XI-related are not always clear-cut. For example, in 2003, the Executive
                          Director at the time recommended that the foundation be reimbursed for
                          certain legal expenses in connection with a complaint filed with the
                          foundation’s ethics committee. However, the ASC board rejected the
                          reimbursement request because the expenses “were not sufficiently Title
                          XI-related.” ASC’s records do not indicate what criteria either the
                          Executive Director or the ASC board used as a basis for their decisions or
                          why they disagreed. Similarly, our review of ASC documents for more
                          recent grants found no supporting explanations for decisions about
                          whether grant activities were Title XI-related. One ASC board member
                          said the board had a common understanding of what activities were
                          eligible for grants but acknowledged that the basis for funding decisions
                          could be better documented. As previously noted, our internal control
                          standards state that federal agencies should have appropriate policies for
                          each of their activities. Without policies that contain specific criteria, ASC
                          increases the risk that its grant decisions will be inconsistent, limits the
                          transparency of its decisions, and lacks assurance that it is complying
                          with federal internal control standards. To address this limitation, we
                          recommended that ASC develop specific criteria for assessing whether
                          the grant activities of the Appraisal Foundation were related to Title XI
                          and include these criteria in ASC’s policy and procedures manual. 32 In
                          June 2012, ASC officials told us that they had been developing these
                          criteria and planned to finalize them by August 2012.


Implementing Dodd-Frank   The Dodd-Frank Act contains 14 provisions that give ASC a number of
Act Provisions            new responsibilities and authorities. Some of the tasks associated with
                          these provisions are complex and challenging, especially for a small



                          32
                           GAO-12-147.




                          Page 17                                                            GAO-12-840T
agency with limited resources. One of the more complex tasks for ASC is
to establish a national appraisal complaint hotline and refer hotline
complaints to appropriate governmental bodies for further action. 33
Appraisal industry stakeholders we spoke with noted that creating and
maintaining a hotline could be costly because it will likely require
investments in staff and information technology to fully ensure that calls
are properly received, screened, tracked, and referred. Stakeholders
indicated that screening calls would be a critical and challenging job
because frivolous complaints could overwhelm the system and identifying
valid complaints would require knowledge of USPAP.

Another complex task for ASC is providing grants to state appraiser
regulatory agencies to support these agencies’ compliance with Title XI.
Appraisal industry stakeholders cited challenges that ASC could face in
designing the grant program and the decisions it will need to make. Some
noted the challenge of designing grant eligibility and award criteria that (1)
do not reward states that have weak appraiser regulatory programs
because they use appraisal-related fee revenues (from state appraiser
licensing and examination fees, for example) for purposes other than
appraiser oversight and (2) will not create incentives for states to use less
of their own resources for regulation of appraisers. In addition, ASC
officials said they were unsure whether a January 2012 increase in the
national registry fee—from $25 to $40 per appraiser credential—would be
adequate to fund the grants and oversee them, especially in light of
recent declines in the number of appraisers. 34

As of June 2012, ASC had not implemented either the national hotline or
the state grant program but had completed some initial steps. For
example, ASC officials told us that they had developed initial protocols for
handling hotline complaints and had begun work on a complaint form,
website, and call center. In addition, ASC is in the process of hiring a
grants manager.



33
  The Dodd-Frank Act first required ASC to determine whether a national hotline existed
that received complaints of noncompliance with appraisal independence standards and
USPAP. ASC completed this task in January 2011, within the statutory deadline, and
reported that no such hotline existed. The Dodd-Frank Act requires ASC to establish and
operate such a hotline upon making that determination.
34
  Although the Dodd-Frank Act also authorizes ASC to collect registry fees from AMCs,
revenues from this source may not be available for several years because regulations for
AMC registration must be developed and implemented first.




Page 18                                                                     GAO-12-840T
                     Chairman Biggert, Ranking Member Gutierrez, and Members of the
                     Subcommittee, this concludes my prepared statement. I am happy to
                     respond to any questions you may have at this time.


                     For further information on this testimony, please contact me at (202) 512-
Contacts and Staff   8678 or shearw@gao.gov. Contact points for our Offices of
Acknowledgments      Congressional Relations and Public Affairs may be found on the last page
                     of this statement. Key contributors to this testimony include Steve
                     Westley (Assistant Director), Don Brown, Marquita Campbell, Emily
                     Chalmers, Anar Ladhani, Yola Lewis, Alexandra Martin-Arseneau, John
                     McGrail, Erika Navarro, Carl Ramirez, Kelly Rubin, Jerry Sandau,
                     Jennifer Schwartz, Andrew Stavisky, and Jocelyn Yin.




(250679)
                     Page 19                                                        GAO-12-840T
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