[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