Financial Lending Notes
February 25, 2010

UNDER SCRUTINY
Take a Fresh Look at Your Appraisal Process

As discussed in this issue’s lead article, there’s now increased scrutiny on banks’ assessments of the adequacy of their ALLL. In addition, regulators are taking a closer look at the currency and accuracy of commercial real estate appraisals when the repayment of these loans is dependent on the real estate.

Regulators also want to confirm that banks are ordering, administering and reviewing appraisals properly, given today’s uncertain credit and real estate environment. During examinations, regulators are digging deep to make sure that banks are adhering to Section 323 of the FDIC’s Rules and Regulations regarding real estate appraisals (visit http://fdic.gov and enter “section 323” in the search box for more details).

When to Reappraise

Banks have experienced a significant increase in real estate losses in the past couple of years, making historical loss rates one part of the ALLL analysis that’s under enhanced scrutiny from regulators. The question: What is the appropriate lookback period for formulating the loss rates that should be used for determining ALLL adequacy?

Environmental Factors

In light of declining property values, regulators expect banks to re-examine the current market value of CRE held as collateral by reappraising property using assumptions that more realistically reflect current market conditions. This value directly impacts the calculation of the adequacy of the bank’s ALLL and testing for loan impairment as directed by FAS 114, making it doubly important.

The main thing regulators want to determine is whether or not banks have current appraisals on file. The next question, then, is how “current” is current enough?

There’s no single answer, but to get an idea, ask yourself if you’re confident that the value of the property today is close to or the same as it was when you made the loan. If you’re not confident, it’s a good idea to consider a new appraisal.

It’s not enough to have current appraisals on file: You also need a policy in place for monitoring the value of CRE held as collateral and ordering reappraisals as necessary.

This policy should be reviewed and approved by your board of directors and adhered to for all CRE property appraisals. Failing to do so is an invitation for a Section 323 violation citation from a bank examiner.

Back to Basics

Many regulators today are taking a back-to-basics approach to appraisal examinations, asking questions like:

  • Is the appraisal ordering process appropriate?
  • Do you have a current list of potential appraisers that’s approved by your board of directors?
  • How qualified are the appraisers on your list? Don’t just rely on state licensing or certification to assess their competence: Make sure your appraisers use all three approaches in determining the value of CRE as applicable (cost, market and discounted cash flow analyses).
  • Is the person(s) who orders and reviews appraisals independent of the credit approval process, with no potential influence over the appraiser?

While not required by Section 323, you may choose to use a management company when ordering appraisals.

Doing so segregates appraisal ordering even more. For example, a management company may perform the appraisal review for you.

Note that the new Home Value Code of Conduct does not apply to CRE loan appraisals. Be sure to rely on the guidance found in Section 323.

For more details on regulators’ expectations for real estate appraisals and evaluation, refer to the Inter-agency Appraisal and Evaluation Guidelines that were issued by the FDIC in late 2008. These guidelines can help clarify the risk management principles and internal controls necessary to ensure that banks’ residential and CRE appraisals are accurate and reliable from a regulatory standpoint.

 

Compliments of:

Porter Keadle Moore, LLP (PKM) is a full service accounting firm based in Atlanta, Georgia. PKM offers audit, tax and systems services to clients throughout the country. The firm focuses its efforts on companies registered with the Securities and Exchange Commission (SEC), community banks, the insurance industry, technology and life sciences companies and the real estate/construction industry.

Follow this link to learn more about PKM's banking practice.
 

To discuss this article contact Tim Messman, CPA with Porter Keadle Moore, LLP at tmessman@pkm.com.

Tim provides accounting and auditing services to financial institutions as well as clients in the construction, service, technology/life sciences and manufacturing/distribution industries. He routinely works with companies registered with the Securities and Exchange Commission; privately-owned companies and S Corporations. He has experience with Initial Public Offerings (IPOs), Mergers and Acquisitions, Sarbanes-Oxley compliance and internal control consulting.

 

Pat has over 23 years of experience in public accounting. He has worked with clients ranging from individuals to international Fortune 50 companies in a variety of tax consulting and compliance areas. He is most active in the real estate and banking industries, serving numerous clients across the Southeast. Pat has led PKM’s tax practice since 2003. Prior to joining PKM he was a partner with KPMG, where he spent 17 years of his professional career. You can contact Pat at ptuley@pkm.com.