Insights

Beginning May 1, 2009, Fannie Mae and Freddie Mac require all lenders to follow new, stringent appraisal guidelines in connection with any loans sold to them. The guidelines were published in the Home Valuation Code of Conduct - without statutory or regulatory authority. The background will provide some explanation as to why the Code came to be. An overview of the strict requirements demonstrates why lenders and brokers may have concerns about implementation of the Code.

On November 1, 2007, New York’s Attorney General, Andrew Cuomo, sued First American Corporation and an appraisal management company it owned, eAppraiseIT. eAppraiseIT was one of the principal appraisal management vendors for Washington Mutual’s residential lending business in New York. Its role was to identify qualified independent appraisers for Washington Mutual’s loans and to ensure that those appraisers would provide unbiased, industry-standard appraisals. According to Cuomo’s complaint, Washington Mutual was unhappy when it received appraisals that did not support loans in the amounts Washington Mutual wanted to make, so the lender threatened to fire the vendor unless it participated in a campaign to coerce the appraisers to produce appraisals that would support whatever loans Washington Mutual wanted to make. The complaint also alleged that First American and eAppraiseIT buckled under this pressure and allowed Washington Mutual to impose new policies that resulted in removing appraisers from the approved lists and allowing Washington Mutual to directly cajole and intimidate appraisers so that they would increase valuations beyond what would result from prudent appraisal standards. Any appraiser who did not succumb to this pressure was fired and never used again.

This behavior is unlawful under Federal appraisal laws and under the appraisal standards issued by the OTS and OCC. So, with this federal authority in mind, Cuomo apparently made the decision not to sue Washington Mutual directly because of a concern that a court would find that federal law preempts any right the state might have had to bring such a suit against a federally chartered bank.

A week after the complaint was filed, Cuomo delivered subpoenas to Fannie Mae and Freddie Mac. The Attorney General wanted to know how many loans each had purchased from Washington Mutual with fraudulent appraisals.

Within a short time, Cuomo announced that Fannie Mae and Freddie Mac had agreed to adopt a new appraisal code called the Home Valuation Code of Conduct. All approved loan sellers would be required to comply with the Code in connection with any loans sold to Fannie Mae and Freddie Mac that were originated after May 1, 2009. The Code imposes various reforms intended to eliminate a lender’s ability to exert any undue influence over the appraisal process. Cuomo, Fannie Mae and Freddie Mac did ask the public to submit comments on the Code, and they amended the Code based on these comments.

In February 2009, the National Association of Mortgage Brokers sued the Director of the Federal Housing and Finance Agency to block implementation of the Code, arguing that it was adopted in a way that did not comply with the Administrative Procedures Act. The NAMB claimed that the Code went beyond the FHFA’s authority to regulate Fannie Mae and Freddie Mac and constituted an improper delegation to the New York Attorney General of federal regulatory authority. The FHFA claimed that no court could review its decisions while Fannie Mae and Freddie Mac remain in conservatorship. The NAMB withdrew its lawsuit.

With this backdrop, it is no surprise that the Code expressly prohibits any attempt to influence an appraisal or the development, reporting, result, or review of an appraisal through coercion, extortion, collusion, compensation, instruction, inducement, intimidation, or bribery. The goal of the new Code is to ensure an independent, objective and impartial population of appraisers to avoid fraudulent appraisals. To this end, the guidelines include a laundry list of specifically prohibited conduct.

Under the new Code, the lender cannot do any of the following to influence an appraiser’s valuation: (1) withhold or threaten to withhold payment for the appraisal report; (2) threaten to deny future business or demote or terminate or threaten to demote or terminate the appraiser; (3) promise future business, promotions, or increased compensation for the appraiser; (4) condition payment or the amount of a payment on a minimum valuation in the final report or in a preliminary estimate; (5) require the appraiser to provide an estimated, predetermined, or desired valuation, or to provide estimated values or comparable sales before the appraiser completes the appraisal report; (6) provide the appraiser with an anticipated, estimated, encouraged, or desired valuation or the proposed or target amount, except that the lender may provide the appraiser with a copy of the sales contract for purchase transactions; (7) provide stock or other financial or non-financial benefits; or (8) remove an appraiser without cause or prior written notice that identifies the reason for the removal (and those reasons are further limited).

In addition to the compensation and appraiser removal limitations, lenders cannot “value shop” by ordering a second appraisal or automated valuation model unless the lender has a reasonable basis to believe that the initial appraisal was flawed or tainted and the reason is clearly and appropriately noted in the loan file. This prohibition does not impair a lender’s ability to conduct bona fide pre- or post-funding appraisal reviews or limit quality control processes.

Just in case anything was left out, the Code has a catchall prohibition – a lender cannot engage in any other act or practice that impairs or attempts to impair an appraiser’s independence, objectivity, or impartiality.

It might be easier to look and see what the Code permits a lender to do. A lender may ask an appraiser to (1) provide additional information; (2) explain the basis for a valuation; or (3) correct objective factual errors in an appraisal report.

The Code includes numerous other requirements and restrictions so that mortgage brokers and realtors do not engage in behavior to circumvent the Code to skew the value of the property. From now on, a lender must provide the borrower with a free copy of any appraisal report immediately after the appraiser completes it and at least three days before closing. Only a lender may select, retain, and pay an appraiser - not brokers or realtors (but a broker may initiate the appraisal process on behalf of the lender with a specific appraisal management company authorized by the lender so long as the broker has no role in choosing the appraisal management company). If the broker had a role in selecting, retaining, or compensating the appraiser, the lender cannot rely on that appraisal.

Not surprisingly, there are conditions on a lender’s use of in-house appraisers. A lender cannot use an in-house appraiser unless the appraiser reports to a division of the lender independent of the loan production staff; the lender does not provide the appraiser target appraisal values; and the lender has adopted written policies and procedures implementing the Code.

The Code also requires any lender with a reasonable basis to believe an appraiser is violating applicable laws, or is otherwise engaging in unethical conduct, to promptly refer the concern to the applicable State appraiser certifying and licensing agency or other regulatory bodies.

In an effort to ensure compliance with the Code, an Independent Valuation Protection Institute has been established. The Institute will monitor and study federal and state laws and regulations applicable to appraisers as well as market practices and standards. A lender must provide information to appraisers and borrowers regarding the availability of the Institute’s services, which are expected to include a telephone hotline and email address to receive any complaints concerning the improper influencing or attempted improper influencing of appraisers or the appraisal process. The Institute will also publish and promote best practices for independent valuation. The Institute has established a website at http://www.independent-valuation-protection-institute.org/ to make its services available over the Internet.

The Code represents comprehensive rules designed to prevent a lender’s influence on the home loan appraisal process in connection with loans sold to Fannie Mae and Freddie Mac. These guidelines effectively create a de facto regulation that did not have to comply with federal rulemaking procedures and that all mortgage lenders must comply with if they want to sell their loans on the secondary market. Although the Code only applies to lenders who sell to Fannie Mae and Freddie Mac, it may cause most, if not all lenders to comply to ensure that there is a market to sell their loans.

Emily Miller is an associate in the Maryland office of Hudson Cook, LLP. Basis Points readers can reach Emily at 410.865.5418 or by email at emiller@hudco.com.