Part one of this series on the subject of Appraisal Review provided an overview of the risk management concepts used by many lenders today to manage risk associated with real estate lending. Distinctions were made between the quality control and quality assurance functions as they pertain to risk management.
This installment in the series will discuss the methods and processes used to execute both quality control and quality assurance.
Quality Control: Manual vs. Automated
Quality control processes in use today include a wide array of options, ranging from tried and true labor-intensive manual processes to fully automated processes. Both ends of the spectrum have their advantages and disadvantages. With manual processes, time spent repeating mundane processes can lead to slow and inconsistent results. Fully automated processes can be great time savers on getting the results needed as they rely on standardized processes and rule sets. However, real estate is far from standardized and often presents situations and issues that are complex, requiring expertise and sound judgment to gain a complete understanding of identified and potential issues that are to be effectively managed.
Ideally, a customized risk tool that can provide solutions for each and every stakeholder that is nimble enough to adjust for risk tolerances through the lifecycle line of a real estate loan that gives a clear picture of existing and anticipated risks, will achieve optimal results. But any expectation that such a robust tool can be developed and utilized effectively is neither feasible nor plausible.
The most effective approaches are those that use a combination of automation and manual process to effectively identify relevant risk, and then initiate processes to properly address the risk. To paraphrase an influential regulator that offered a guiding hand to many Bank appraisal managers through the mortgage crisis, “Automated rules are a great starting point to understanding the appraisal, the true understanding comes when you have qualified people who can understand what actions need to be taken with the automated results.”
Expectations and practices in the marketplace have evolved in the past five years to where the lender leverages a combination of technology and in-house expertise to manage appraisal and collateral risk.
Available tools in the marketplace, including those developed and managed by Fannie Mae and Freddie Mac, have extremely robust appraisal risk measurement tools that many lenders leverage in their review processes. The risk teams at both Fannie Mae and Freddie Mac and many mortgage originators are strong advocates of developing robust appraisal review quality control processes to identify and manage appraisal-related risk. In fact, in the Fannie Mae FAQ published in June of 2021 for their proprietary Collateral Underwriter System, the answer to question 26 on how lenders can have informed conversations with their appraisers using the CU feedback, the response is that Fannie Mae expects lenders to use human due diligence in combination with the automated CU findings, and lenders are encouraged to carefully review appraisal reports, including all commentary before seeking clarification from the appraiser. Appropriately used, these tools can be effective in not only identifying risk, but assisting a lender with developing effective paths of resolution, with or without the need for follow-up with the appraiser.
Quality Assurance: Audit Management Process
Where does Quality Assurance fit in? As a part of any effective risk management program, risk assessment does not stop at the quality control check point. Stakeholders and regulators will require a Quality Assurance process for loan files, including analysis of the appraisal decision process. Most Quality Assurance processes are built on the principles of practices of audit management. For example, many states require that an appraisal management company develop and institute a Quality Assurance Program that samples the appraisals of their panel of appraisers to ensure USPAP standards are upheld. These processes often occur after the loan decision is made, and care must be taken to not impact a prior lending decision. While technology tools can assist and augment the process, most Quality Assurance processes are manual and require a person to read the appraisal and any appraisal review documentation to ensure both the Appraisal and Appraisal Review requirements are upheld.
Feedback and measurements from both Quality Control and Quality Assurance processes are utilized by both lenders and appraisal management companies to develop approaches to manage the appraisers and valuation service providers for their appraisal and valuation needs. This is not only a regulatory expectation but a marketplace expectation.
Consistency of a documented process is paramount to success and will stand up to scrutiny by any third party observer or auditor (the Third Line of Defense). Technology advancements will continue to assist lenders and appraisal management companies with identifying and managing collateral and appraisal-related risks. Machine learning advancements are creating outputs that are becoming increasingly reliable and effective tools for identifying when human intervention is required, and will be at the cornerstone of process improvements. But at the end of the day, no automated algorithm can fully replace the deep learning of the human brain, held by both the experienced appraiser or the the experienced reviewer, to ensure that independence and equitable treatment remains an integral part of the process.