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Lest Bankers Forget: Extensions of 'Threatened' Mortgages Trigger Appraisals

As residential and commercial property values generally continued northward through the latter part of the 1990s and much of the 2000s, bankers and their outside appraisers rarely had to formally calculate whether slumping collateral values threatened a financial institution's health.

Banks did keep their favorite appraisal vendors plenty busy over that borrower-friendly period, as they underwrote so many acquisition-driven mortgages. But even while originations activity declined along with property values as the Great Recession took hold, banks have continued calling on appraisers for a more ominous reason.

As a lot of bankers probably forgot during the boom years, the Financial Institutions Reform Recovery And Enforcement Act requires a new third-party collateral appraisal any time a mortgage with a "threatened" loan-to-value ratio is extended ("renewed" in regulatory terms), refinanced, or subject to a "subsequent transaction" (generally meaning defaulted or foreclosed).

The FIRREA requirement applies to property-secured loans held on portfolios of federally regulated lenders, including most Small Business Administration lenders and credit unions. Regulators' examiners generally allow banks under their care to come up with their own definitions of threatened, explains George Mann, managing director and chief appraiser with Collateral Evaluation Services LLC.

And as long as an internal evaluation determines an LTV appears to be below 95 percent (a bit lower in some cases) - and the borrower remains current with monthly payments - examiners typically wouldn't require an appraisal. However if an evaluation calculates that the LTV of a maturing loan being considered for extension or refi is more like 120 percent, the bank would necessarily categorize the credit as threatened - triggering the FIRREA appraisal requirement.

Banks also typically appraise collateral if a loan becomes subject to workout negotiations for potential modification - but that's not a FIRREA-triggered requirement.

Of course bankers aren't exactly thrilled with having to absorb additional appraisal costs (or pass them along to borrowers where viable) when so many balance sheets are out of whack. Not only are examiners pushing larger banks to beef up their evaluation staffs, "now they're also having to order dozens if not hundreds of appraisals," observes Mann, who heads CES's Midwest office in Cincinnati and conducts seminars on commercial appraisal requirements.

And while fees have generally been declining for many years, commercial appraisals still aren't exactly cheap.

Licensed pros are likely to charge in the vicinity of $2,500 to $3,000 to appraise a commercial property valued in the $5 million vicinity. Even for a $1 million commercial property, an appraisal will likely run at least $1,500, Mann continues, adding that certain complex small properties can be more challenging to appraise than larger ones.

The internal cost of an evaluation alone is typically less than $1,000, and often more like $700 or so.

In many cases where banks don't employ in-house chief appraisers or other professional appraisal staffers, they'll likely pay another $500 to $1,000 for an outside review of an appraisal, a service provided by firms such as Mann's.

With small-balance commercial loan originations down 29% sequentially during the first quarter and off nearly 60% from headier times in early 2007 according to research from Boxwood Means, Inc., appraisers are happy to see the FIRREA-driven business. Indeed at many shops appraisals tied to loan extensions, refis or foreclosures can account for 90 percent or more of current business, Mann notes.

But overall volume is still down for many appraisers, only exacerbating pressure on fees. "Bankers might not agree, but appraisals should cost more than they do," Mann concludes.

But in this uncertain valuation environment, savvy bankers pay far more attention to professional acumen than fees or turn time, says Tom Boyle, Portland-based senior vice president and chief appraiser at U.S. Bank. As slower transaction volume provides appraisers with fewer comps, estimating values of less-than-stable commercial properties requires particular expertise today, he continues.

Hence Boyle can't stress enough the need to work with highly competent appraisers, rather than shopping for bargain rates. "An appraisal is just one element of the underwriting decision, but it's an important one. And you run the risk that by saving $100 dollars, you wind up with an appraisal that might be unreasonably high or low - and just not credible.

"So this is no time to be picking the cheapest service."