If you talk to a professional risk manager working in the home finance industry, they’ll tell you that risk is hiding everywhere. While they may be overstating it, they aren’t doing it by much.
This is why federal regulators require banks to do such rigorous stress testing, proving that they can respond appropriately to any risk they may face. We saw a great deal of this in the years following the Great Recession, but over the last year or two we’ve heard much less about stress testing.
This might come as a surprise, given the pressures COVID-19 put on our industry. The truth is that the processes lenders put in place over the past decade are working really well. They have a much better understanding of the risks their institutions face and have plans for mitigating them.
Professional risk managers have learned what levers to move and what knobs to push to effectively mitigate their risk. But they still see risk pretty much everywhere.
When it comes to the appraisal report, there are five primary risks lenders are working to mitigate. Here’s a brief look at valuation risk through the eyes of a lender or an Appraisal Management Company.
Risk 1: Appraiser risk
Banks are required by regulation to use licensed and certified appraisers. Fannie and Freddie may offer regulatory exceptions, but in general they require it. When lenders or AMCs are ordering and reviewing appraisal reports and when they deliver loan packages, they must be certain that all appraisers working on the deal are credentialed, credible and reliable and the reports were completed competently. It’s a standard investors require all parties to meet.
Risk 2: Collateral risk identification
It’s important for lenders to know how a particular piece of real estate both fits into its marketplace and about any risk it presents to lenders or investors. The former is about the larger market and the latter is about the actual condition of the real estate. This isn’t just about the structure, but also about how close it is situated to an airport or railway or other potentially adverse influence, and whether the owner the lender thinks is occupying the home actually lives there.
Risk 3: Valuation risk
This is the risk most appraisers are most familiar with and it involves the lender’s ability to get sufficient value out of selling a property that it must take back in foreclosure. This involves a full assessment of market risk in all of its dimensions.
Risk 4: Transaction risk
This risk has more to do with the type of transaction the lender is considering and less to do with the appraiser working on the deal. Some deals are just inherently more risky, like super jumbo loans where a lender may order multiple appraisals to be as certain as possible about the value of the property.
Risk 5: Fair Lending Risk
This has always been a risk lenders face, but never has it seemed more important to government regulators than today. Lenders are required by law to avoid bias and they must be prepared to demonstrate to regulators and investors that they aren’t making this mistake.
In light of all of this, it should be clear that the appraisal report is not just about a number. The appraiser’s opinion of value is still a core requirement for the lender, but as you can see the appraiser’s expertise can also help the lender mitigate a number of other risks.
No appraiser can arrive at a credible value without first assembling all the data. You cannot really understand a piece of real estate without it. Even more importantly, you cannot help your lender clients mitigate their risk without it.
Fortunately, most lenders know this and continue to put a high value on the appraisal industry and consider hard working appraisers valuable partners in the loan origination process.