Did the Office of the Comptroller of the Currency's guidance memo of May 2005 make you wonder about your institution's use of alternative approaches to appraisals?
If so, you're not alone. Soon after release of "Credit Risk Management Guidance for Home Equity Lending," many lenders started reexamining their home equity lending practices in view of the memo's goal of promoting "sound credit risk management practices for institutions engaged in home equity lending..."
Do AVMs still have a place in a lender's toolkit of closing in light of the OCC memo? We believe so. In fact, the memo put down in writing some of the important considerations that we have been advocating for years about sound credit risk management practices.
Here are a few tips to help lenders evaluate which situations make sense for AVM usage:
* Know Your Own Risk Appetite. From a risk-management perspective, each lender needs to understand their institution's tolerance for risk. Lenders need to develop their own risk-reward analysis or equations. These should be based on safety and soundness, loan size, collateral profile, credit, collateral reliance, operating efficiencies and cost objectives. These policies will shape their strategy for deciding on the methods they apply for value determination.
* Develop a Policy: Lenders need to develop a set of polices that assure them that what they are doing to value real estate is appropriate. These policies should put risk parameters in writing and give guidance about the most appropriate valuation methodology to use under different circumstance. Naturally, they will be developed around the notion of equating risk with cost.
Often our clients develop a matrix to simplify the process. It might recommend that, for example, a member with a high credit score and low debt-to-income or low loan-to-value would be an appropriate candidate for a quicker, less expensive means of doing collateral evaluations, such as an AVM. As risk parameters indicate a greater degree of risk then a more thorough evaluation of collateral might well be indicated.
* Understand What AVMs Can Deliver. AVMs provide an independent unbiased determination of value. They can be used alone with or without an insurance enhancement, or in conjunction with other valuation methods as part of a validation strategy. The attraction of AVMs is that they give property values almost instantaneously (not in two to three weeks like traditional approaches). In addition, they reduce costs and processing time, two critically important competitive advantages in today's marketplace.
* Understand the Market: In the home equity market the name of the game is speed to decision. There's no ignoring the fact that speed to decision can lead to larger market share. You know your competitors are trying to convince borrowers that they need home equity lines of credit. "It's a simple process so why not get it?" they ask in their ads. You also know that any time you throw up an obstacle like an appointment for a formal appraisal you lose the consumer's interest.
AVMs can be one of the key components to overcoming consumer reluctance because they eliminate obstacles.
* Partner With the Right Provider: Especially in light of the OCC guidance, it is particularly important that lenders work with recognized providers that offer a range of services. These providers also need to be able to design a program to match a lender's needs that includes documenting criteria for choosing one method of valuation over another.
Develop your programs on the assumption that you will need to be able to support your decisions with data and provide that data to the regulators. Experienced vendors should be able to help in that process. They should provide tools to help lenders build the justification for the risk programs they design.
In short, we believe that the OCC guidance memo was a wake-up call to lenders. Federal regulators acknowledged that the rapid, ongoing evolution in collateral valuation practices is something they haven't kept up with, but that may soon change.
Right now, they have no formal policy guidance for AVMs but the memo suggests that creating such guidance is a "top priority." Until the regulatory landscape for AVMs becomes clear, we advise lenders to adopt "best practices"; to document to the extent possible why they chose one valuation method over another and to continue to respond to the needs of the marketplace with the most appropriate valuation approach.
In the end, lenders will need to develop their own risk acceptance criteria around the notion of equating risk with cost and then be prepared to document the reasons for those criteria.
D. Cameron Rogers is Senior VP in Fiserv Lending Solutions Valuation Services. Wayne B. Bzdula is a Senior VP-Director of Risk Management for Fiserv Lending Solutions. They can be reached at 1-800-842-8423.
