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A Dangerous Area of Dodd-Frank – Mandatory Reporting raises concerns for everyone involved

Published in the June issue of LiveValuation Magazine:

http://www.livevalmag.com/articles/june-2011/463-dodd-frank-a-dangerous-area-of-dodd-frank.

Reprinted with Permission

By: Jeff Dickstein

State appraisal agencies and the Appraisal Subcommittee (ASC) have been tasked with a large and important assignment as a result of the passage of Dodd-Frank: to make sure that appraisals reflect the actual value of a property, as well as market conditions and condition of the subject property. The appraisal is once again an important “C” in the three C’s of lending: credit, capacity and collateral, and one of the most important documents in the lending of funds for home ownership. Without confidence in the appraisal, the finances of the entire housing market comes into question.

The Dodd-Frank Financial Reform Act was signed into law July 21, 2010. Within the act are a number of changes that impact our profession. They include:

  • Title XIV, the Mortgage Reform and Anti-Predatory Lending Act
    • Subtitle F, Appraisal Activities
      • Section 129E, Appraisal Independence Requirements

Section 129E addresses appraiser independence, prohibitions on conflicts of interest, mandatory reporting, no extension of credit, appraisal report portability, customary and reasonable fee, the sunset of HVCC and outlines penalties for violations. While customary and reasonable fee has been given most of the attention, it is important to point out that a violation of any item in this act carries the same penalty of a fine of not more than $10,000 for first violation and not more than $20,000 for subsequent violations.

Lenders, bankers, brokers, real estate brokers and appraisal management companies should all be concerned about the mandatory reporting section of the act. Most concerning is that as we come closer to the one-year anniversary of the passage of Dodd-Frank, rules are still confusing and/or incomplete as written.

The original draft of the mandatory reporting section reads as follows:

‘‘(e) MANDATORY REPORTING. – Any mortgage lender, mortgage broker, mortgage banker, real estate broker, appraisal management company, employee of an appraisal management company, or any other person involved in a real estate transaction involving an appraisal in connection with a consumer credit transaction secured by the principal dwelling of a consumer who has a reasonable basis to believe an appraiser is failing to comply with the Uniform Standards of Professional Appraisal Practice, is violating applicable laws, or is otherwise engaging in unethical or unprofessional conduct, shall refer the matter to the applicable State appraiser certifying and licensing agency.”

The first feedback I saw from the appraisal community on this issue was the concern around “unprofessional conduct.” What would be considered “unprofessional conduct”? How is it defined? If an appraiser wears shorts to inspect a dwelling, would that be considered unprofessional? If the appraiser didn’t take off his shoes while completing an interior inspection, or if dust was spread when inspecting an attic, would those instances be “unprofessional” enough to warrant reporting the appraiser to the applicable state appraisal agency?

Mortgage lenders, brokers, bankers, real estate brokers, appraisal management companies and others would have to wait until the interim final Rule were released to see how the “board” would define this section of the act.

In December 2010, the interim final rule for section 129E was released. The interim rule implemented Section 129E of the Truth in Lending Act (TILA), which establishes new requirements for appraisal independence for consumer credit transactions secured by the consumer’s principal dwelling. This set of rules went into effect April 1, 2011.

The Interim final rule attempted to define the statute as passed, however did ask for additional comments be submitted to the board on:

“…whether reporting should be required only if a material failure to comply causes the value assigned to the consumer’s principal dwelling to differ from the value that would have been assigned had the material failure to comply not occurred by more than a certain tolerance, for example by 10 percent or more.”

It would appear the board is considering setting a tolerance level for material failure, but couldn’t a material failure also be a USPAP violation and have to be reported regardless of tolerance levels?

The interim final rule does go further to define reporting required, reasonable basis, examples of material failures to comply, coverage of reporting requirements, and timing of reporting.

“Reporting required” is defined as failure to comply with USPAP, or of an ethical or professional requirement under applicable state or federal statute or regulation, only if the failure to comply is material – that is, if it is likely to significantly affect the value assigned to the consumer’s principal dwelling.

California is one state that publishes a table of most frequent allegations found in complaints filed against appraisers that might fall outside the items outlined in mandatory reporting in the rule. California states that approximately 20 percent of all complaints are filed by a borrower/homeowner. Another 45 percent come from regulators or lenders, including Federal Deposit Insurance Corporation, Office of Thrift Supervision, Office of Comptroller of Currency, mortgage brokers, loan officers and review appraisers for banks. Appraisers file approximately 20 percent of the complaints and the remaining 15 percent fall into the “Other” category.

California frequent allegations include:

  • From Borrowers/Homeowners – Property description errors; errors in comparable sales information; errors in valuation; payment disputes; non-delivery of pre-paid appraisal; obnoxious behavior/rudeness; and untimely delivery or non-delivery of report.
  • From Brokers/Lenders – Unwillingness to correct errors in report; altered license; failure to provide operating income statement; and failure to return phone calls.
  • From Appraisers – Failure to recognize professional assistance by others; signing reports without reviewing them; competency; over-valuation; and fraud.

As you can surmise, mandatory reporting as it currently stands has a number of challenges. I have spoken with many appraisers who are currently performing forensic field review work for lenders, servicers and GSEs. Because the act states that creditors, brokers, bankers, real estate brokers, AMCs and “any other persons providing a service for a covered transaction” are responsible for reporting appraisers to appropriate state licensing boards, many are confused about when to get involved. Is the reporting of a historic appraisal under review that contains material failures the responsibility of the reviewing appraiser, the lender, servicer or GSE that requested the review, or all parties responsible? Also, item V, Effective Date and Mandatory Compliance Date in the interim final rule, states that compliance is mandatory for all applications received by a creditor on or after April 1, 2011. With so many appraisals being performed today for foreclosures and loan buybacks, when one uncovers “material failures which contributed to the value assigned to the consumers’ principal dwelling to have been overstated” in an earlier appraisal, does it have to be reported to the appropriate state agency if the credit application was dated before April 1, 2011?

The other challenge will be the actual reporting of these occurrences to the various state agencies. As we all know, most state agencies do not have the number of resources needed to effectively enforce regulation and investigate enforcement issues within their states. This was addressed in an open letter from the Association of Appraiser Regulatory Officials (AARO) to Chairman Christopher Dodd on June 14, 2010 (aaro.net/pdf/SenatorDodd.pdf).

It should also be noted that per the Appraisal Subcommittee State Operations and Requirement, there are still a number of states that operate on voluntary license/certification programs. Voluntary status is outlined as follows:

Certified/licensed appraisers not required for any appraisal/evaluation assignments. If appraisers wish to perform appraisals in such federally related transactions and real estate-related transactions, appraisers can choose to become certified/licensed and submit to the state’s regulatory jurisdiction.

States that are shown to be voluntary are Alaska, Iowa, Massachusetts, North Dakota, Oklahoma and Wyoming. That being said, some of these appraisers might not have a valid license or certification in these states.

The other challenge in reporting to the appropriate state agency is that most creditors, brokers, AMCs and servicers operate on a national level in all American states and territories. Currently there is no consistency in the reporting criteria for each state, and these national companies do not have the resources to keep up with all state and territory reporting requirements. Some examples of the differences between states include:

  • Texas – Two copies of the appropriate complaint form as well as any documents that assist the board need to be compiled and submitted.
  • California – A five-page complaint form with detailed information and data needs to be filled out and submitted.
  • Florida – A complaint form must be submitted, along with documentation including but not limited to: sales contract, canceled checks (front and back), lease/rental agreements, listing/management agreements, closing statement, multiple listing printout, appraisals, repair bills, monthly statements, correspondence, agency disclosure form and any judgment/civil lawsuit.

There is also an issue on disciplinary actions and enforcement from state to state. Some states require additional education based on infractions, some states simply fine the appraiser, and others do both.

State agencies have been given access to grants through higher fees paid to the Appraisal Subcommittee by appraisers and AMCs. We can only hope that the states will be able to properly staff and respond to these changes. Only time will tell if state agencies will see an increase in reporting and if there will be any consistency in enforcement and disciplinary actions if violations are uncovered.

State appraisal agencies as well as the ASC have to make sure that appraisals reflect the actual value of a property. Most good appraisers, AMCs, brokers and lenders have no issue with the tighter rules – most have been doing it right for many years. Unfortunately, after the financial meltdown, we will all need to “do it right” to bring back confidence in the market.

Here’s hoping that through a combination of more consistent appraisal practices, increased enforcement, education, and some long-needed economic good news, the housing market will soon once again be the engine that drives our economy.