[Federal Register Volume 62, Number 236 (Tuesday, December 9, 1997)]
[Proposed Rules]
[Pages 64997-64999]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-32160]
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 /
Proposed Rules
[[Page 64997]]
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FEDERAL RESERVE SYSTEM
12 CFR Part 225
[Regulation Y; Docket No. R-0990]
Real Estate Appraisals
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Board of Governors of the Federal Reserve System is
soliciting comments on a proposed amendment to subpart G of the Board's
Regulation Y, Appraisal Standards for Federally Related Transactions,
to exempt any transaction involving the underwriting or dealing of
mortgage-backed securities from the Board's appraisal requirements.
This amendment would permit a bank holding company or a nonbank
subsidiary of a bank holding company engaged in underwriting and
dealing in securities (a so-called section 20 subsidiary) to underwrite
and deal in mortgage-backed securities without demonstrating that the
loans underlying the securities are supported by appraisals that meet
the Board's appraisal requirements.
The Board is proposing this amendment to address concerns raised by
bank holding companies regarding the inability of section 20
subsidiaries to actively participate in the commercial mortgage-backed
securities (CMBS) market due to the appraisal restrictions of subpart
G.
DATES: Comments must be received on or before January 8, 1998.
ADDRESSES: Comments should refer to Docket No. R-0990 and may be mailed
to Mr. William W. Wiles, Secretary, Board of Governors of the Federal
Reserve System, 20th Street and Constitution Avenue, N.W., Washington,
D.C., 20551. Comments addressed to Mr. Wiles may also be delivered to
the Board's mail room between 8:45am and 5:15pm, and to the security
control room outside of those hours. Both the mail room and the
security control room are accessible from the courtyard entrance on
20th Street between Constitution Avenue and C Street, N.W. Comments may
be inspected in Room MP-500 between 9:00am and 5:00pm weekdays, except
as provided in Sec. 261.8 of the Board of Governors' Rules Regarding
Availability of Information, 12 CFR 261.8.
FOR FURTHER INFORMATION CONTACT: Norah M. Barger, Assistant Director
(202/452-2402), or Virginia M. Gibbs, Senior Supervisory Financial
Analyst, (202/452-2521), Division of Banking Supervision and
Regulation; or Deneen L. Donnley-Evans, Staff Attorney (202/736-5567),
Legal Division; Board of Governors of the Federal Reserve System, 20th
Street and Constitution Avenue, N.W., Washington, DC 20551.
SUPPLEMENTARY INFORMATION:
Background
Title XI of the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 (FIRREA), 12 U.S.C. 3331 et seq., directed the
federal banking agencies (the agencies) to publish appraisal rules for
federally related transactions within the jurisdiction of each agency.
The stated purpose of the legislation is to provide that federal
financial and public policy interests in real estate-related
transactions will be protected by requiring that real estate appraisals
utilized in connection with federally related transactions are
performed in writing, in accordance with uniform standards, and by
individuals whose competency has been demonstrated and whose
professional conduct will be subject to effective
supervision.1
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\1\ See Title XI's Statement of Purpose. 12 U.S.C. 3331.
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Section 1121(4) of FIRREA, 12 U.S.C. 3350(4), defines a federally
related transaction as a real estate-related financial transaction that
is regulated or engaged in by a federal financial institutions
regulatory agency and requires the services of an appraiser. Section
1121(5), in turn, defines a real estate-related financial transaction
as any transaction that involves: (1) the sale, lease, purchase,
investment in or exchange of real property, including interests in
property, or the financing thereof; (2) the refinancing of real
property or interests in real property; and (3) the use of real
property or interests in real property as security for a loan or
investment, including mortgage-backed securities (emphasis
added).2 In enacting Title XI, Congress envisioned that
competent appraisals in these transactions would reduce the risk of
loss to the deposit insurance funds, regulated institutions, and the
secondary markets, arising from a financial institution's lending
activities where real estate is taken as collateral.
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\2\ See 12 U.S.C. 3350(5).
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In 1990, in accordance with the mandates of Title XI, the agencies
adopted appraisal regulations for federally related transactions within
their jurisdiction, and exempted certain real estate-related
transactions from the appraisal requirements of Title XI. In June 1994,
several existing exemptions to the appraisal regulation were modified
and new exemptions were added. At that time, the agencies clarified
that a regulated institution investing in a mortgage-backed security or
similar instrument need not obtain new Title XI appraisals for the
underlying loans so long as the loans met regulatory appraisal
requirements for the institution at the time the real estate-secured
loan was originated.3 This requirement also applies to the
activity of underwriting and dealing in mortgage-backed securities.
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\3\ See 59 FR 29482 (1994).
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In adopting this requirement, the agencies did not foresee that
requiring evidence that the loans underlying mortgage-backed securities
had appraisals would be a difficult task. The mortgage securities
market consisted of securitized 1-to-4 family residential loans, most
of which were generated in accordance with the agencies' appraisal
requirements. The appraisal regulation appears not to have hindered the
secondary market in 1-to-4 family mortgages, for two reasons. First,
the Federal National Mortgage Association (Fannie Mae) and the Federal
National Mortgage Corporation (Freddie Mac) dominate the market for the
underwriting and dealing of residential mortgage-backed securities, and
neither bank holding companies nor their investment banking competitors
have large stakes in this market. Second, banks and bank holding
companies have not been prevented from investing in such securities,
even though the underlying mortgages may not have conforming
appraisals, because the interagency appraisal regulations contain an
exemption for any transaction that qualifies for sale to, or involves a
residential real estate transaction in which the appraisal conforms to
the appraisal standards of, a United States government or government-
sponsored agency, including Fannie Mae and Freddie Mac. However, recent
developments in the emerging CMBS market, including the recovery of the
commercial real estate market, the wider acceptance of collateralized
securities, the significant expansion of the CMBS market, and the
operation of the agencies' appraisal regulations, have worked to bar
banking organizations from actively participating in the CMBS market's
growth.
Proposed Amendment
The Board proposes to amend its real estate appraisal regulation to
permit bank holding companies and their nonbank subsidiaries to
underwrite and deal in mortgage-backed securities without demonstrating
that the loans underlying the securities are supported
[[Page 64998]]
by appraisals that meet the Board's appraisal requirements. However, in
practice, the proposed amendment would only apply to the section 20
subsidiaries because, to date, section 20 subsidiaries are the only
regulated-institution affiliates permitted to underwrite or deal, to a
limited extent, in corporate debt and equity securities.4
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\4\ Consistent with the Board's policy of imposing operating
restrictions according to risk, the Board also proposes to permit
section 20 subsidiaries to underwrite and deal in both residential
and commercial mortgage-backed securities without demonstrating that
the loans underlying the securities are supported by appraisals that
meet the Board's appraisal requirements. In this regard, the Board
notes that residential mortgage-backed securities are considered far
less risky than CMBS as 1-to-4 family residential mortgages have one
of the lowest historical loss rates of any credit-related asset
class. The Board expects this exemption to affect a relatively small
number of transactions because, as previously noted, the vast
majority of loans underlying residential mortgage-backed securities
meet the appraisal standards of Fannie Mae or Freddie Mac, and thus
qualify for an exemption under the agencies' appraisal regulations.
See e.g. 12 CFR 225.63(a)(10).
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The CMBS Securities Market
The CMBS market has been in existence since the mid-1980s, with
banking organizations, investment banks, and insurance companies
serving as the primary underwriters of CMBS. Recently, there has been
significant growth in new CMBS issues. In 1996, $30 billion of new CMBS
were issued, a 50 percent increase over the $20 billion issued in 1994,
and new issuances of $25 billion to $35 billion are expected in
1997.5 Approximately 90 percent of the tranches of new CMBS
issues are rated investment grade.
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\5\ Between 1992 and 1996, approximately $100 billion of CMBS
were issued, all of which are still outstanding.
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In recent years, the majority of new CMBS issuances have involved
loans originated by nonbank financial companies that are not subject to
the agencies' appraisal requirements.6 While the Board has
not studied whether these companies generally obtain appraisals
conforming to Title XI requirements upon origination of the underlying
loans, anecdotal evidence suggests that many of the underlying loans
originated by these institutions do not have Title XI conforming
appraisals. In addition, although commercial bank participation as
lenders and investors in this market is expected to increase as larger
national and regional banking organizations reenter the real estate
lending business, banking organizations and their affiliates currently
are precluded from actively participating in this market because the
majority of the loans underlying CMBS issuances do not have Title XI
conforming appraisals.
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\6\ For example, of the $30 billion of new CMBS issued in 1996,
only $2.4 billion involved the collateralization of loans
underwritten by commercial banks.
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Policy Considerations
As noted above, Title XI's purpose and intent was to protect
``federal financial and public policy interest'' in real estate-related
transactions.7 Those ``federal interests'' were described in
predecessor legislation and accompanying Congressional reports as
encompassing the federal government's role as: (1) regulator and
insurer of financial institutions; (2) guarantor or lender on mortgage
loans; (3) as a direct party itself in real estate-related
transactions; and (4) as the overseer of financial markets and real
estate-related investments therein.8
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\7\ See Title XI's Statement of Purpose. 12 U.S.C. 3331.
\8\ See Real Estate Appraisal Reform Act of 1988, H.R.Rep. No.
100-101, 100th Cong., 2d Sess., pt. 1 at 19 (1988); 135 CONG. REC.
H10, 709 (daily ed. November 20, 1987) (statement of Rep. Barnard).
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The Board believes that permitting section 20 subsidiaries to
underwrite and deal in mortgage-backed securities without obtaining
appraisals that meet the Board's appraisal requirements will not lead
to substantial losses for bank holding companies or pose a systemic
risk to the banking system. The Board notes that section 20
subsidiaries have the expertise necessary to evaluate the credit risks
involved in underwriting and dealing mortgage-backed securities. In
this regard, the Board notes that, section 20 subsidiaries are subject
to an operational and managerial infrastructure inspection prior to
being permitted to engage in corporate underwriting. Periodic
inspections verify that proper underwriting and risk management
procedures are in place.
When a section 20 subsidiary serves as lead underwriter, it is
responsible for performing adequate due diligence. In other instances,
such as the dealing of an outstanding debt security, a section 20
subsidiary may rely on the due diligence performed by independent
rating agencies. These due diligence efforts often include analyses of
factors such as payment history, mortgage and security structure,
borrower's income or property cash flow, credit enhancements, and
seasoning. In most CMBS transactions, the underlying loans have
demonstrated their ability to perform over some period of time. As the
underlying commercial real estate loans in the CMBS season, the Board
believes that appraisals obtained at origination become increasingly
less relevant to the CMBS investment decision because the market
assumptions upon which the appraisals were based become obsolete.
Further, the public rating or due diligence that must be obtained for
CMBS provides information that is at least as sufficient for assessing
risks as requiring new appraisals if appraisals were not obtained at
loan origination. For residential mortgage-backed securities, the
market is well established with very clear standards for loan
documentation and underwriting. In light of the foregoing, the Board
concludes that permitting section 20 subsidiaries to underwrite and
deal in CMBS without demonstrating that the loans underlying the CMBS
are supported by appraisals that meet the Board's appraisal
requirements would not adversely affect financial markets and real
estate investments therein.
Regulatory Flexibility Act Analysis
This proposal is not expected to have a significant economic impact
on a substantial number of small business entities within the meaning
of the Regulatory Flexibility Act (5 U.S.C. 601 et seq.) because, if
adopted, the proposal would not impose additional burdens on bank
holding companies or their section 20 subsidiaries.
Paperwork Reduction Act
No collection of information pursuant to section 3504(h) of the
Paperwork Reduction Act (44 U.S.C. 3501 et seq.) is contained in this
proposal.
List of Subjects in 12 CFR Part 225
Administrative practice and procedure, Banks, banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
For the reasons set forth in the preamble, the Board proposes to
amend 12 CFR part 225 as set forth below:
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
1. The authority citation for part 225 continues to read as
follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1828o, 1831i, 1831p-1,
1843(c)(8), 1844(b), 1972(l), 3106, 3108, 3310, 331-3351, 3907, and
3909.
2. In subpart G, Sec. 225.63 is amended by removing the word ``or''
at the end of paragraph (a)(11), by redesignating paragraph (a)(12) as
paragraph (a)(13), and by adding a new paragraph (a)(12) to read as
follows:
Sec. 225.63 Appraisals required; transactions requiring a State
certified or licensed appraiser.
(a) * * *
[[Page 64999]]
(12) The transaction involves underwriting or dealing in mortgage-
backed securities; or
* * * * *
By order of the Board of Governors of the Federal Reserve
System.
Dated: December 3, 1997.
William W. Wiles,
Secretary of the Board.
[FR Doc. 97-32160 Filed 12-8-97; 8:45 am]
BILLING CODE 6210-01-P