As 2024 gets off the ground, federal regulators are continuing their focus on fair lending issues. In February, the Federal Financial Institutions Examination Council (FFIEC) released a statement on examination principles related to valuation discrimination and bias in residential lending. Around the same time, the FFIEC's Appraisal Subcommittee (ASC) held a hearing on appraisal bias that focused on ways to reduce instances of unfair property valuations. Taken together, it's clear federal regulators are continuing to focus on fair lending issues in 2024.
FFIEC Statement on Examination Principles Related to Valuation Discrimination and Bias in Residential Lending
The FFIEC's statement announces new examination principles tailored to consumer compliance examinations and safety and soundness examinations related to valuation principles in residential lending. In promulgating the statement and examination principles, the FFIEC seems concerned with the potential consumer harm stemming from discrimination in residential real estate valuations, such as "consumers being denied access to credit for which they may be otherwise qualified, offered credit at less favorable terms, or steered to a narrower class of loan products."
The FFIEC's new consumer compliance examination principles will have examiners focus on the following topics when assessing the risks arising from potential valuation discrimination or bias:
- Board and Senior Management Oversight—Examiners will evaluate whether the board of directors and management have ensured that the institution has implemented appropriate compliance management systems, including third-party oversight systems commensurate with the institution's residential real estate lending risk profile, including information provided to the board communicating the strength of the consumer compliance program.
Examiners will also evaluate the institution's oversight of residential real estate valuation of third parties' consumer compliance-related policies, procedures, and internal controls for compliance with applicable law. Additionally, examiners will evaluate training programs as well as the institution's due diligence and ongoing monitoring of third parties, including those preparing valuation reports, third-party appraisers, and appraisal management companies to assess compliance with consumer protection laws and regulations, including anti-discrimination laws.
- Consumer Compliance Program—Examiners will assess an institution's consumer compliance program to determine whether:
- Policies and procedures assess the institution's collateral valuation review function for identifying potentially discriminatory valuation practices or results.
- Training programs appropriately address identification of potential discrimination in residential real estate lending and collateral valuation programs, whether internally identified or from consumer complaints and inquiries.
- The institution adheres to its policies and procedures designed to identify and address potential discrimination.
- The institution's system or processes for reviewing, documenting, tracking, addressing, monitoring, and handling collateral valuation complaints, including those that allege potential discrimination, are appropriate to identify potential discrimination. This includes handling complaints from various channels and sources (such as letters, phone calls, in person, regulators, third-party service providers, emails, and social media).
The FFIEC's new safety and soundness examination principles will have examiners focus on the following topics when assessing the risks arising from potential valuation discrimination or bias:
- Consumer protection issues, such as considering consumer compliance examination findings, including feedback through discussions with compliance examiners, and reviewing other examination planning information to identify consumer complaint, litigation, and other matters related to valuation discrimination or bias.
- Risk assessment, such as considering the materiality of the institution's residential real estate lending in relation to the institution's overall lending activities, size, complexity, and risk profile.
- Governance, such as assessing the institution's policies, processes, staff organization and resources, control systems, and management information systems for residential real estate collateral valuations.
- Collateral valuation program, such as evaluating an institution's practices for selecting, retaining, and overseeing independent, qualified, and competent individuals that have the ability to render unbiased and credible opinions of collateral value.
- Third-party risk management, such as evaluating the institution's oversight of valuation-related third parties and their review functions, including the institution's understanding of how these third parties identify, monitor, and manage risks related to valuation discrimination or bias.
- Valuation review function, such as an assessment of the institution's valuation review function for identifying potentially discriminatory or biased valuation results.
- Credit risk review function, such as assessing the institution's credit risk review function for residential real estate loan portfolios for appropriate consideration of potentially discriminatory or biased valuations.
- Training program, including an assessment of the institution's training program intended to provide staff with the knowledge and skills to identify and resolve valuation discrimination or bias.
The FFIEC's statement and examination principles for residential lending provide supervised institutions with a glimpse into the supervisory priorities for members of the FFIEC and provide a compliance management framework for supervised entities, including the importance of third-party oversight.
FFIEC Appraisal Subcommittee Meeting
A day after the FFIEC released its statement, the FFIEC's ASC held its fourth hearing on appraisal bias. The ASC is composed of seven members, one person from each of seven federal agencies that make-up the ASC. The ASC is comprised of the Consumer Financial Protection Bureau (CFPB), Department of Housing and Urban Development (HUD), Federal Deposit Insurance Corporation (FDIC), Federal Housing Finance Agency (FHFA), Federal Reserve Board, National Credit Union Administration (NCUA), and Office of the Comptroller of the Currency (OCC).
The recent hearing was the last of a series of ASC hearings focused on appraisal bias. Previous meetings were held in January, May, and November of 2023. Throughout the four meetings, the ASC members asked questions of various witnesses to identify causes for appraisal bias and specific steps that could be taken to combat appraisal bias.
When asked by ASC members about causes of appraisal bias, a witness pointed to the fact that the appraisal industry lacked diversity (over 90 percent of all appraisers are white, according to the U.S. Bureau of Labor Statistics) and that current property valuation methods, particularly the sales comparison approach, were perpetuating unfair valuations. ASC members also asked witnesses about ways to detect appraisal bias. Witnesses suggested scanning appraisal reports for key words that indicate bias, using automated valuation models, or other technology to reduce subjectivity in appraisals and publishing large appraisal datasets so that over—or under—valuations can be more easily detected by statistical analysis. Last fall, FHFA published, for the first-time, appraisal data at the appraiser level as part of its Uniform Appraisal Dataset (UAD). Previously, the UAD only contained aggregated data.
Members of the ASC also looked at ways to reduce barriers to entry into the appraisal profession, with the hope of increasing the number of new diverse appraisers joining the industry. In particular, the witnesses identified the current supervisor/trainee model for training aspiring appraisers as costly and problematic. New training models, such as the Practical Applications of Real Estate Appraisal (PAREA), were discussed with the intent of lowering both the financial and practical barriers to entry.
Additionally, CFPB Director Rohit Chopra appeared critical of the current governance structure for the Appraisal Foundation, a private organization authorized by Congress to set standards for appraisals and qualifications for appraisers. In several hearings, Director Chopra questioned witnesses about how the Appraisal Foundation collects its fees and whether its Board of Trustees are incentivized to govern the organization in the public interest.
Members of the ASC also explored the role that lenders play in preventing appraisal bias. Specifically, ASC members asked whether lenders should inform borrowers that they may ask for a reconsideration of value if an appraisal valuation is lower than expected. Witnesses were also asked whether it would be appropriate to hold banks responsible for appraisal bias. In response, a witness representing a bank trade organization explained that placing responsibility on banks would be inappropriate, as banks are not in the best position to detect bias unless an appraiser includes bias in their remarks and appraisal narrative reports. Members of the ASC pushed back, however, and asked whether it was consistent with current law, in particular, the Interagency Guidance on Third-Party Relationships, for banks to shift responsibility for biased appraisals to others, such as state regulators.
Although no more ASC hearings on appraisal bias are scheduled, it would be safe to assume that the ASC and its member regulatory agencies will continue to investigate how it should respond to appraisal bias. Companies that use appraisal reports to make lending decisions would also be advised to consider how it can reduce the effect of appraisal bias in its operations.
What Does this Mean for Supervised Entities?
FFIEC supervised entities should take heed of both the FFIEC's statement on examination principles related to fair lending as well as the FFIEC's appraisal subcommittee meetings. The FFIEC's examination principles serve as both an important blueprint to what FFIEC member entities will be examining relative to appraisals in residential lending as well as a guide to shaping and ensuring that compliance management systems are in-line with regulators' expectations. The appraisal subcommittee meetings are also an important source of clarity for supervised entities because, although regulators are providing more informal guidance through questioning witnesses, the regulators are also tipping their hand when it comes to their regulatory, supervisory, and enforcement priorities.