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More Science, Less Art with Revised Appraisal Guidelines: A Postscript

The U.S. financial systems suffered through various critical problems and deficiencies over the last couple of years. Perhaps the biggest issue or blind spot has involved asset quality. The revised Interagency Appraisal and Evaluation Guidelines thus concentrate on increasing transparency with policies that now elevate collateral and market monitoring to more of a science and less so an art form. The implications are none too small for our financial institutions as well as the country’s future financial and economic stability.

At the risk of sounding too cynical, there have been – and will likely continue to be – significant pressures among banks to limit vigorous programs for monitoring asset quality. After all, in the battered CRE market of 2008-2010 collateral evaluation updates were like bad medicine, often leading to write-downs and increases in capital reserves. And let’s face it: It’s not as if the risk management discipline was invented by the Dodd-Frank legislation last year. There’s a reason why loan producers make a lot more money than risk managers on Wall Street and Main Street. One might argue that the disincentives are thus deep-rooted and, until chief risk officers find a seat in the Board room, the probability that robust safety and soundness measures will survive the current stage of the credit cycle is a toss-up.

That being said, the new appraisal and evaluation guidelines are refreshing if not explicit about the requirements for keeping close tabs on collateral risk both on a loan and portfolio basis:

“Therefore, an institution should have policies and procedures that address the need for obtaining current collateral valuation information to understand its collateral position over the life of a credit and effectively manage the risk in its real estate credit portfolios.”

And the Guidelines go further than ever before in articulating if, when and how appraisals and evaluations can be employed for these purposes.

Here at SmallBalance.com we believe the Agencies have provided institutions with concrete guidance and tactical steps that will improve their identification and documentation of collateral risk, better prepare them for future economic uncertainties (and also regulatory examinations) and, last but not least, restore the public’s trust in these vital institutions.

Our own business observations are that many lending institutions are indeed undertaking serious and committed efforts to increase their preparedness and risk management focus. As a result, the banks are distancing themselves – and our communities along with them – from very challenging times.