Interim Final Rule on Real Estate Appraisals

BRIEF SUMMARY

On October 18, 2010, the Federal Reserve Board ("Board") issued an interim final rule to implement the appraisal independence provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"). The interim final rule also implements the provisions of the Dodd-Frank Act that require creditors and their agents to pay customary and reasonable fees to fee appraisers. This client alert summarizes the Board's rule and discusses its ramifications for mortgage lenders.

HISTORY AND SCOPE

Section 1472 of the Dodd-Frank Act added a new Section 129E to the federal Truth-in-Lending Act ("TILA") to impose appraisal independence requirements for a consumer credit transaction secured by the principal dwelling of the consumer. A detailed discussion of Section 1472 is found in our Dodd-Frank Residential Mortgage User Guide. See http://www.mofo.com/files/Uploads/Images/ResidentialMortgage.pdf . Regulations, interpretive guidelines, and statements of policy under Section 129E of TILA relating to appraiser independence ultimately may be jointly issued by the Board, Comptroller of the Currency ("OCC"), Federal Deposit Insurance Corporation ("FDIC"), National Credit Union Administration, Federal Housing Finance Agency ("FHFA"), and Bureau of Consumer Financial Protection. In the meantime, Section 129E directed the Board to issue interim final regulations within 90 days following the enactment of the Dodd-Frank Act (i.e., by October 19, 2010) to define the acts and practices that violate appraisal independence. These interim final regulations are deemed to be regulations issued by the larger group of federal agencies noted above. A number of existing provisions of law mandate appraisal independence, including Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"); the appraisal regulations of the various federal banking agencies (e.g., 12 C.F.R. §34.41, et seq., in the case of the OCC); and the Uniform Standards of Professional Appraisal Practice ("USPAP"). Section 129E itself, as well as the Board's interim final regulation, are modeled on, and expand upon, the Board's existing regulation at Section 226.36(b) of Regulation Z (12 C.F.R. §226.36(b)), which took effect on October 1, 2009. Section 226.36(b) applies to any closed-end consumer credit transaction secured by the consumer's principal dwelling. In contrast, the Board's interim final regulation applies to all consumer credit transactions secured by the consumer's principal dwelling, both closed-end and open-end (collectively, "Covered Transactions"). Covered Transactions include, among others, purchase loans, refinancings, closed-end home equity loans, home improvement loans, debt consolidation loans, reverse mortgages, and home equity lines of credit. The appraisal independence provisions of the Board's interim final regulation apply to all creditors and settlement service providers (collectively, "Covered Persons") that are involved with a Covered Transaction. Covered Persons include creditors, appraisal management companies ("AMCs"), appraisers, mortgage brokers, real estate brokers and agents, title insurers, and other settlement service providers (as defined in the Real Estate Settlement Procedures Act ("RESPA") and HUD's Regulation X) Covered Persons do not include the consumer him/herself, a guarantor, or a person residing in the consumer's home who is not liable on the loan In contrast, the provisions of the interim final regulation requiring the payment of customary and reasonable fees to fee appraisers, and the provisions requiring the reporting of certain compliance failures, are limited to appraisers subject to state agencies' jurisdiction The valuations ("Valuations") covered by the appraisal independence provisions of the new regulation include formal appraisals performed by licensed or certified appraisers, broker price opinions ("BPOs"), or any other estimate of value prepared by a natural person. Pictures and other information included with the estimate of value are treated as part of the Valuation. A Valuation does not include an estimate of value prepared solely by an automated valuation model ("AVM") However, an estimate of value prepared by a natural person that is based, in whole or in part, on information from an AVM will be a Valuation The Home Valuation Code of Conduct ("HVCC") was announced by the FHFA on December 23, 2008. The HVCC imposed additional appraisal independence requirements for loans purchased by Fannie Mae and Freddie Mac. The HVCC also had a variety of unintended consequences. Section 129E(j) of TILA states that the HVCC will have no force or effect on the date that the Board's interim final regulation is promulgated. Note that Section 1476 of the Dodd-Frank Act requires the General Accounting Office to prepare a study on the HVCC, leaving open the possibility that elements of it may return at some point. The Board's interim final regulation was published in the Federal Register on October 28, 2010, and will be effective on December 27, 2010. Comments regarding any aspect of the regulation may be submitted to the Board through that date. Compliance with the interim final regulation is optional through March 31, 2011. Compliance becomes mandatory on April 1, 2011 The Board's existing appraisal independence regulation at Section 226.36(b) of Regulation Z is removed effective on April 1, 2011. Parties subject to Section 226.36(b) may comply with either Section 226.36(b) or new Section 226.42 (discussed below) through March 31, 2011, and if those persons comply with Section 226.42 they will be deemed to comply with Section 226.36(b) The Board's interim final regulation does not address other appraisal matters governed by the Dodd-Frank Act, such as appraisal report portability under Section 129E(h) of TILA. This will await subsequent rulemaking. A violation of Section 129E of TILA subjects the violator to the "enforcement provisions" referred to in Section 130 of TILA. In addition, violators are subject to a civil penalty of up to $10,000 per day for the first violation, and up to $20,000 per day for subsequent violations. The civil penalties are to be assessed by the federal agencies with administrative enforcement authority under TILA. HIGHLIGHTS OF THE INTERIM FINAL RULE AND ANALYSIS

Use of Coercion to Affect Valuations (Section 226.42(c)(1) of Regulation Z) A Covered Person may not directly or indirectly cause, or attempt to cause, a Valuation to be based on any factor other than the independent judgment of the person preparing the Valuation This prohibits the use of coercion, extortion, inducement, bribery, intimidation, compensation, or collusion to influence the person who performs the Valuation or performs the valuation management functions described below. Paragraph 226.42(c)(1)-1 of the Federal Reserve Commentary to Regulation Z ("Commentary") states that the terms "coercion," etc., are to be defined by applicable state law or contract The interim final regulation provides the following examples of violations: Seeking to influence a person that prepares a Valuation to report a minimum or maximum value Withholding, or threatening to withhold, timely payment because the value does not come in at or above a certain amount Implying to a person that prepares a Valuation that current or future retention of the person will depend on the amount of the Valuation of a particular property Excluding a person that prepares a Valuation from consideration of future engagements because the amount of the Valuation of a particular property did not come in at or above a certain level Conditioning payment to a person who prepares a Valuation on whether the transaction is consummated Applying any coercion or other prohibited act against an AMC or other person that performs valuation management functions, or any of their affiliates. In this regard, it is irrelevant whether the AMC or any such other person falls within the definition of an "appraisal management company" under Section 1473 of the Dodd-Frank Act Threatening to withhold future business from a title company affiliated with an AMC unless the AMC's appraiser values a property at or above a certain level These examples are illustrative, not exhaustive. For example, the following acts also are prohibited: Agreeing to employ a relative or friend in return for having the Valuation come in at a particular value Providing gifts of money or other consideration in return for having the Valuation come in at a particular value It is irrelevant whether the coercive act is designed to cause the person who prepares a Valuation to come in at or above a specific value, below a specific value, or within a certain range of values. All of these are impermissible Mischaracterization of Value (Section 226.42(c)(2) of Regulation Z) A person who prepares a Valuation may not materially misrepresent the value of the property. The Commentary provides the following example: An appraiser estimates a value of $250,000 when applying USPAP, but then assigns a value of $300,000 for the property in the Uniform Residential Appraisal Report A misrepresentation is "material" if it is likely to significantly affect the value assigned to the property. This means that a misrepresentation is "material" even if it does not affect the creditor's decision to make the loan or the credit terms In practice, it will be prudent to regard virtually any misrepresentation of value as material A bona fide error is...