Six federal regulatory agencies today requested PUBLIC COMMENT on a proposed rule designed to ensure the credibility and integrity of models used in real estate valuations. In particular, the proposed rule would implement quality control standards for automated valuation models (AVMs).

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by Dismal-Jellyfish

https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20230601a1.pdf

Under the proposed rule, the agencies would require institutions that engage in covered transactions to adopt policies, practices, procedures, and control systems to ensure that AVMs adhere to quality control standards designed to ensure the credibility and integrity of valuations. The proposed standards are designed to ensure a high level of confidence in the estimates produced by AVMs; help protect against the manipulation of data; seek to avoid conflicts of interest; require random sample testing and reviews; and promote compliance with applicable nondiscrimination laws.

AVMs are used as part of the real estate valuation process, driven in part by advances in database and modeling technology and the availability of larger property datasets. While advances in AVM technology and data availability have the potential to contribute to lower costs and reduce loan cycle times, it is important that institutions using AVMs take appropriate steps to ensure the credibility and integrity of their valuations. It is also important that the AVMs institutions use adhere to quality control standards designed to comply with applicable nondiscrimination laws.

The Proposed Rule

  • The agencies are inviting comment on a proposed rule to implement quality control standards for the use of AVMs that are covered by this proposal.
  • The agencies’ proposed rule would require that mortgage originators and secondary market issuers adopt policies, practices, procedures, and control systems to ensure that AVMs used in certain credit decisions or covered securitization determinations adhere to quality control standards designed to meet specific quality control factors.
  • The proposed rule would not set specific requirements for how institutions are to structure these policies, practices, procedures, and control systems. This approach would provide institutions the flexibility to set quality controls for AVMs as appropriate based on the size of the institution and the risk and complexity of transactions for which they will use AVMs covered by this proposed rule. As modeling technology continues to evolve, this flexible approach would allow institutions to refine their policies, practices, procedures, and control systems as appropriate.
  • The agencies’ existing guidance related to AVMs would remain applicable.
  • The quality control standards in section 1125 of title XI apply to AVMs “used by mortgage originators and secondary market issuers to determine the collateral worth of a mortgage secured by a consumer’s principal dwelling.”
  • The proposed rule would implement the statute by applying the quality control standards when an AVM is being used to make a determination of collateral value, as opposed to other uses such as monitoring value over time or validating an already completed valuation. Determinations of collateral value are generally made in connection with credit decisions or covered securitization determinations as defined in this proposed rulemaking, for example when determining a new value before originating a purchase-money mortgage or placing a loan in a securitization pool. Other uses of AVMs, such as for portfolio monitoring, do not involve making a determination of collateral value, and thus are not within the scope of the proposed rule.
  • The agencies are further proposing that the rule would not cover the use of AVMs in the development of an appraisal by a certified or licensed appraiser, nor in the review of the quality of already completed determinations of collateral value (completed determinations).
  • The proposed rule would cover the use of AVMs in preparing evaluations required for certain real estate transactions that are exempt from the appraisal requirements under the appraisal regulations issued by the OCC, Board, FDIC, and NCUA, such as transactions that have a value below the exemption thresholds in the appraisal regulations.
  • Section 1125(c)(1) provides that compliance with regulations issued under this subsection shall be enforced by, “with respect to a financial institution, or subsidiary owned and controlled by a financial institution and regulated by a Federal financial institution regulatory agency, the Federal financial institution regulatory agency that acts as the primary Federal supervisor of such financial institution or subsidiary.”
  • Section 1125(c)(1) applies to a subsidiary of a financial institution only if the subsidiary is (1) owned and controlled by a financial institution, and (2) regulated by a Federal financial institution regulatory agency. Section 1125(c)(2) provides that compliance with regulations issued under this subsection shall be enforced by, “with respect to other participants in the market for appraisals of 1-to-4 unit single family residential real estate, the Federal Trade Commission, the Bureau of Consumer Financial Protection, and a State attorney general.”
  • The proposed rule would define “covered securitization determination” to mean a determination regarding (1) whether to waive an appraisal requirement for a mortgage origination in connection with its potential sale or transfer to a secondary market issuer, or (2) structuring, preparing disclosures for, or marketing initial offerings of mortgage-backed securitizations. Monitoring collateral value in mortgage-backed securitizations after they have already been issued would not be covered securitization determinations.

Rules on AVMs used in connection with making credit decisions:

The proposed rule would apply to AVMs used in connection with making a credit decision. The proposed rule would define “credit decision,” in part, to include a decision regarding whether and under what terms to originate, modify, terminate, or make other changes to a mortgage. The scope provision of the proposed regulatory text would expressly exclude the use of AVMs in monitoring the quality or performance of mortgages or mortgage-backed securities. The use of AVMs solely to monitor a creditor’s mortgage portfolio would not be a credit decision under the proposed rule because the lending institution has already made the credit decision. The scope of the proposed rule would include, for example, decisions regarding originating a mortgage, modifying the terms of an existing loan, or renewing, increasing, or terminating a line of credit. The proposed rule uses the term “credit decision” to help clarify that the proposed rule would cover these various types of decisions. The proposal to limit the scope of the rule to credit decisions and covered securitization determinations reflects the statutory definition of AVM, which focuses on the use of an AVM “by mortgage originators and secondary market issuers to determine the collateral worth of a mortgage secured by a consumer’s principal dwelling.”23 The proposed rule would distinguish between using AVMs to determine the value of collateral securing a mortgage and using AVMs to monitor, verify, or validate a previous determination of value (e.g., the proposed rule would not cover a computerized tax assessment used to verify the valuation made during the origination process).24 The proposed rule focuses on those aspects of mortgage and securitization transactions where the value of collateral is typically determined. Loan modifications and other changes to existing loans. The proposed rule would cover the use of AVMs in deciding whether to change the terms of an existing mortgage even if the change does not result in a new mortgage origination, as long as a “mortgage originator” or “secondary market issuer,” or servicers that work on the originator’s or secondary market issuer’s behalf, uses the AVM to determine the value of a mortgage secured by a consumer’s principal dwelling. For example, the proposed rule would cover AVMs used in making decisions to deny a loan modification or to confirm collateral values, such as when there is a request to change or release collateral. In relevant part, section 1125 provides that an AVM is “any computerized model used by mortgage originators and secondary market issuers to determine the collateral worth of a mortgage . . . .”25 The agencies’ view is that the phrase “determine the collateral worth” broadly covers instances where mortgage originators and secondary market issuers use AVMs in connection with making credit decisions. Under the proposal, the agencies consider mortgage originators and secondary market issuers or servicers that work on their behalf to be using AVMs in connection with making a credit decision when they use AVMs to modify or to change the terms of existing loans.

How I understand it:

  • The rule would cover a range of decisions such as mortgage origination, modification, or termination, and uses “credit decision” as a blanket term to simplify this. Think of it as the umbrella under which all these different decisions take shelter.
  • The rule would differentiate between using AVMs for deciding the value of collateral securing a mortgage and using them to check, validate, or affirm a previous value determination. In short, it’s not about looking back and second-guessing, but rather about making fresh valuation decisions.
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AVMs used by secondary market issuers:

The language of section 1125 includes not only mortgage originators, but also secondary market issuers. Given that the statute refers to secondary market issuers and the primary business of secondary market issuers is to securitize mortgage loans and to sell those mortgagebacked securities to investors, the proposed rule would cover AVMs used in securitization determinations. In addition, covering AVMs used in securitizations could potentially protect the safety and soundness of institutions and protect consumers and investors by reducing the risk that secondary market issuers will misvalue homes. For example, misvaluation by secondary market issuers could in turn incentivize mortgage originators to originate misvalued loans when making lending decisions Such misvaluations could pose a risk of insufficient collateral for financial institutions and secondary market participants and could limit consumers’ refinancing and selling opportunities.

How I understand it:

  • The proposed rule would also apply to AVMs used in securitization decisions, because secondary market issuers are typically busy bundling up these mortgages for selling to investors.
  • By extending to securitizations, the rule could help protect the safety of institutions, consumers, and investors by reducing the risk of misvaluing homes. So, it’s like a security guard keeping watch over the valuation process.
  • Misvaluation by secondary market issuers could encourage mortgage originators to originate misvalued loans, a domino effect we don’t want to see in the lending decisions….
    • Such misvaluations could pose a risk of insufficient collateral for financial institutions and secondary market participants and could limit consumers’ refinancing and selling opportunities.

Appraisal waivers:

The proposed rule would define “covered securitization determination” to include determinations regarding, among other things, whether to waive an appraisal requirement for a mortgage origination (appraisal waiver decisions).

Under the proposal, a secondary market issuer that uses AVMs in connection with making appraisal waiver decisions would be required to have policies, practices, procedures, and control systems in place to ensure that the AVM supporting those appraisal waiver decisions adheres to the rule’s quality control standards. In contrast, a mortgage originator that requests an appraisal waiver decision from a secondary market issuer would not need to ensure that the AVM used to support the waiver meets the rule’s quality control standards because the secondary market issuer would be using the AVM to make the appraisal waiver decision in this context, not the mortgage originator.

For example, both GSEs have appraisal waiver programs and are the predominant issuers of appraisal waivers in the current mortgage market. To determine whether a loan qualifies for an appraisal waiver under either GSE program, a mortgage originator submits the loan casefile to the GSE’s automated underwriting system with an estimated value of the property (for a refinance transaction) or the contract price (for a purchase transaction). The GSE then processes that information through its internal model, which may include use of an AVM, to determine the acceptability of the estimated value or the contract price for the property. If the GSE’s analysis determines, among other eligibility parameters, that the estimated value or contract price meets its risk thresholds, the GSE offers the lender an appraisal waiver. In this example, when the GSEs use AVMs to determine whether the mortgage originator’s estimated collateral value or the contract price meets acceptable thresholds for issuing an appraisal waiver offer, the GSEs would be making a “covered securitization determination” under the proposed rule. As a result, the proposed rule would require the GSEs, as secondary market issuers, to maintain policies, practices, procedures, and control systems designed to ensure that their use of such AVMs adheres to the rule’s quality control standards. On the other hand, when a mortgage originator submits a loan to determine whether a GSE will offer an appraisal waiver, the mortgage originator would not be making a “covered securitization determination” under the proposed rule because the GSE would be using its AVM to make the appraisal waiver decision in this context. As a result, the mortgage originator would not be responsible for ensuring that the GSEs’ AVMs comply with the proposed rule’s quality control standards.

How I understand it:

  • Defining “Covered Securitization Determination”: This term would include decisions about waiving an appraisal requirement for a mortgage origination, also known as appraisal waiver decisions.
  • If these issuers use AVMs for making appraisal waiver decisions, they need to have policies and control systems in place to ensure that the AVMs adhere to the rule’s quality control standards.
  • Mortgage originators requesting an appraisal waiver from a secondary market issuer wouldn’t have to ensure that the AVM used meets the rule’s quality control standards.
    • This responsibility would rest with the secondary market issuer, not the originator.
  • GSEs as an Example: When GSEs (like Fannie Mae and Freddie Mac) use AVMs to decide whether the mortgage originator’s estimated collateral value or the contract price meets thresholds for issuing an appraisal waiver, they would be making a “covered securitization determination”. As such, GSEs would need to ensure AVM adherence to the rule’s quality control standards.
    • When a mortgage originator submits a loan to see if a GSE will offer an appraisal waiver, the originator is not making a “covered securitization determination”, so they don’t need to ensure GSEs’ AVMs comply with the proposed rule’s quality control standards.
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Other uses by secondary market issuers:

The proposed rule would define “covered securitization determination” to include determinations regarding, among other things, structuring, preparing disclosures for, or marketing initial offerings of mortgage-backed securitizations. Monitoring collateral value in mortgage-backed securitizations after the securities have already been issued would not be a covered securitization determination. The proposed rule would cover AVM usage if and when a secondary market issuer uses an AVM as part of a new or revised value determination in connection with covered securitization determinations. For example, the GSEs use the origination appraised value or the estimated value in appraisal waivers when issuing mortgage-backed securities. Hence, AVMs are not used by the GSEs to make a new or revised value determination in connection with MBS issuances. However, because the GSEs provide guarantees of timely payment of principal and interest on loans that are included in an MBS, they are obligated to purchase loans that are in default from MBS loan pools. The GSEs may modify such loans and subsequently re-securitize them as new MBS offerings. In these instances, the GSEs may use an AVM to estimate collateral value for investor transparency and disclosure. AVMs used in this manner by the GSEs would be considered covered securitization determinations because there are new or revised value determinations. As discussed in part II.A.3 of this SUPPLEMENTARY INFORMATION, the proposed rule distinguishes between secondary market issuers using AVMs to determine the value of collateral securing a mortgage versus using AVMs solely to review completed value determinations. For example, AVMs used solely to review appraisals obtained during mortgage origination would not be covered by the proposed rule.

How I understand it:

  • “Covered Securitization Determination”: This term would include decisions about structuring, preparing disclosures for, or marketing initial offerings of mortgage-backed securities.
    • However, monitoring collateral value after securities issuance wouldn’t fall under this definition.
  • The rule would apply if a secondary market issuer uses an AVM for new or revised value determination in relation to covered securitization determinations.
  • Although GSEs don’t use AVMs for new or revised value determinations for MBS issuances, they do use them when re-securitizing defaulted and modified loans for new MBS offerings.
    • In these cases, AVMs are used for estimating collateral value for investor transparency, and these instances would be considered covered securitization determinations.
  • The proposed rule differentiates between using AVMs to determine collateral value and using them only for reviewing completed value determinations.
    • For instance, using AVMs solely to review appraisals obtained during mortgage origination wouldn’t be covered by this rule.

AVM uses not covered by the proposed rule

Uses of AVMs by appraisers. The proposed rule would not cover use of an AVM by a certified or licensed appraiser in developing an appraisal. This approach reflects the fact that, while appraisers may use AVMs in preparing appraisals, they must achieve credible results in preparing an appraisal under the Uniform Standards of Professional Appraisal Practice (USPAP) and its interpreting opinions.33 As such, an appraiser must make a valuation conclusion that is supportable independently and does not rely on an AVM to determine the value of the underlying collateral. The agencies also note that it may be impractical for mortgage originators and secondary market issuers to adopt policies, procedures, practices, and control systems to ensure quality controls for AVMs used by the numerous independent appraisers with which they work.

Who watches the watchmen though?

How to comment:

Commenters are encouraged to submit comments through the Federal eRulemaking Portal. Please use the title “Quality Control Standards for Automated Valuation Models” to facilitate the organization and distribution of the comments. You may submit comments by any of the following methods:

  • Federal eRulemaking Portal – Regulations.gov: Go to https://regulations.gov/. Enter “Docket ID OCC-2023-0002” in the Search Box and click “Search.” Public comments can be submitted via the “Comment” box below the displayed document information or by clicking on the document title and then clicking the “Comment” box on the top-left side of the screen. For help with submitting effective comments, please click on “Commenter’s Checklist.” For assistance with the Regulations.gov site, please call 1-866- 498-2945 (toll free) Monday-Friday, 9am-5pm ET, or e-mail regulationshelpdesk@gsa.gov.
  • Mail: Chief Counsel’s Office, Attention: Comment Processing, Office of the Comptroller of the Currency, 400 7th Street, SW, suite 3E-218, Washington, DC 20219.
  • You must include “OCC” as the agency name and “Docket ID OCC-2023- 0002” in your comment.
  • In general, the OCC will enter all comments received into the docket and publish the comments on the Regulations.gov website without change, including any business or personal information provided such as name and address information, e-mail addresses, or phone numbers. Comments received, including attachments and other supporting materials, are part of the public record and subject to public disclosure.
  • Do not include any information in your comment or supporting materials that you consider confidential or inappropriate for public disclosure.

TLDRS:

  • The proposal discusses the use of automated valuation models (AVMs) by mortgage originators and secondary market issuers to determine a mortgage’s collateral value
  • Institutions engaged in certain credit decisions or securitization determinations would be required to adopt policies and procedures to ensure AVMs used adhere to quality control standards.
  • The proposal also aims to protect against data manipulation, avoid conflicts of interest, require random sample testing and reviews.
    • Data Manipulation: By implementing quality control standards and promoting transparency, this rule may reduce the risk of AVMs being manipulated to overestimate or underestimate a property’s value.
    • Conflicts of Interest: It may mitigate potential conflicts of interest where a party could benefit from the property’s valuation being higher or lower than its actual worth.
    • Inaccurate Valuations: The required random sample testing and reviews could catch systematic errors or biases in the AVMs that lead to inaccurate property valuations.
    • Discrimination: By requiring compliance with nondiscrimination laws, the rule could address loopholes where certain properties might be undervalued due to location in certain neighborhoods or other discriminatory practices.
    • Securitization Risks: The rule could help reduce the risk of mispriced mortgage-backed securities, by ensuring that the underlying assets (i.e., the properties) are properly valued. This is particularly crucial because undervaluation or overvaluation of properties could result in financial instability.
  • How does this relate to GameStop?
    • The broader economy is seeing regional banks blow up at these rates, what sort of stress will higher rates cause in the banking system with those trying to maintain their short positions for another day if they can’t tip the scale on valuations on items that have become linchpins of their collateral down the line?