[Federal Register Volume 63, Number 228 (Friday, November 27, 1998)]
[Rules and Regulations]
[Pages 65530-65532]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-31602]


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FEDERAL RESERVE SYSTEM

12 CFR Part 225

[Regulation Y; Docket No. R-0990]


Appraisal Standards for Federally Related Transactions

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Board of Governors of the Federal Reserve System has 
approved an amendment to Subpart G of the Board's Regulation Y, 
Appraisal Standards for Federally Related Transactions, which exempts 
from the Board's appraisal requirements transactions involving the 
underwriting or dealing of mortgage-backed securities. This amendment 
permits bank holding company subsidiaries engaged in underwriting and 
dealing in securities (so-called section 20 subsidiaries) 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.

EFFECTIVE DATE: December 28, 1998.

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 Mark Van Der Weide, Attorney (202/452-2263), Legal 
Division; Board of Governors of the Federal Reserve System, 20th Street 
and Constitution Avenue, NW, Washington, DC 20551.

SUPPLEMENTARY INFORMATION:

Background

    The Board is adopting an amendment to its appraisal regulation that 
exempts from the Board's appraisal regulation transactions involving 
the underwriting or dealing of mortgage-backed securities. The 
amendment is designed to address the concerns raised by bank holding 
companies regarding the extent to which the Board's appraisal 
regulation restricts the ability of section 20 subsidiaries to actively 
participate in the commercial mortgage-backed securities (CMBS) market.
    In 1990, the Board adopted its appraisal regulation pursuant to the 
requirements of Title XI of the Financial Institutions Reform, 
Recovery, and Enforcement Act of 1989 (12 U.S.C. 3331 et seq.). Title 
XI directed the federal banking agencies (the agencies) to publish 
appraisal rules for federally

[[Page 65531]]

related transactions \1\ within the jurisdiction of each agency. The 
stated purpose of the legislation is to protect federal financial and 
public policy interests in real estate-related financial transactions 
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.\2\ In their appraisal regulations, the agencies 
exempted certain categories of real estate-related financial 
transactions that do not require the services of an appraiser in order 
to protect federal financial and public policy interests or to satisfy 
principles of safe and sound banking.
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    \1\ 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\ See Title XI's Statement of Purpose. 12 U.S.C. 3331.
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    In June 1994, several existing exemptions to the agencies' 
appraisal regulations were modified and new exemptions were added. At 
that time, the agencies clarified that a regulated institution 
investing in, underwriting, or dealing in a mortgage-backed security or 
similar instrument need not obtain new Title XI appraisals for the 
underlying real estate-secured loans so long as the loans met 
regulatory appraisal requirements for the institution at the time the 
loans were originated.\3\
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    \3\ See 59 FR 29482 (1994).
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    When the agencies adopted the 1994 amendments to their appraisal 
rules, the mortgage-backed securities market consisted of securitized 
1-to-4 family residential loans, most of which were generated in 
accordance with the agencies' appraisal requirements. Since 1994, the 
commercial real estate market has recovered and a market in CMBS has 
emerged and expanded significantly with the wider acceptance of 
collateralized securities. Because many commercial mortgages are 
originated by non-regulated institutions, they often do not fully meet 
the agencies' appraisal regulations. As a result, banking organizations 
have effectively been restricted in their ability to participate in the 
CMBS market.
    In December 1997, the Board issued a proposal 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 by appraisals that meet the Board's appraisal 
requirements.\4\ In issuing this proposal, the Board acknowledged that 
the amendment would affect only section 20 subsidiaries because section 
20 subsidiaries are the only nonbank entities subject to the Board's 
appraisal regulation that are permitted to underwrite or deal in 
mortgage-backed securities.
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    \4\ See 62 FR 64997 (1997).
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Summary of Comments and Description of the Final Rule

    The Board received eleven comments on the proposed amendment to the 
appraisal regulation: four from banking associations, one from a bank 
holding company, one from a professional appraiser association, and 
five from Federal Reserve Banks. Ten of the commenters strongly favored 
the proposed amendment. The professional appraiser association did not 
express support for the proposal and urged the Board to consider 
whether a uniform due diligence standard should be developed for the 
CMBS market before adopting this amendment.
    Several of the commenters stated that the appraisal regulation made 
it difficult for bank holding companies and their section 20 
subsidiaries to participate in the CMBS market. As one commenter 
stated, the amendment would strengthen the competitiveness of bank 
holding companies by placing their section 20 subsidiaries on a more 
equal footing with nonbank competitors. Ten commenters stated that the 
public rating and due diligence required by the market for mortgage-
backed securities provided sufficient information for the regulated 
institution to assess risks. One commenter noted that the rating 
agencies perform sophisticated stress tests of mortgage-backed 
securities, which examine the ability of the real estate collateral to 
meet the associated debt obligation under adverse market conditions, to 
ensure the soundness of their rating.
    One commenter contended that the CMBS market attributed little 
value to appraisals and that other characteristics of the CMBS market, 
such as public ratings and due diligence requirements, typically 
provide more protection to investors than the appraisal requirement. 
Another commenter stated that obtaining appraisals is a costly and 
time-consuming process that is impossible to complete in the time 
constraints applicable to underwriting and dealing in CMBS.
    One commenter suggested that the Board consider adopting additional 
exemptions from the appraisal regulation for transactions involving: 
(1) the investment in investment-grade CMBS by bank holding companies 
and their bank and nonbank affiliates and (2) the warehousing of 
commercial real estate loans by bank holding companies and their 
nonbank affiliates for the purpose of packaging and selling them as 
CMBS.
    In contrast, the comment letter from the professional appraiser 
association contended that federal oversight and underwriting criteria, 
as well as due diligence procedures used by market participants, may 
not adequately address all safety and soundness issues that exist in 
the CMBS market. The commenter expressed concern that without guidance 
from the agencies regarding due diligence standards for CMBS, federally 
insured institutions could assume undue or unacceptable risk. Further, 
this commenter contended that many of the underwriting criteria and 
investment decisions involving CMBS require that an appraisal be 
performed to check the validity, quality, and quantity of cash flow 
from the underlying property. The commenter also expressed concern that 
increased competition in the commercial real estate market may lead to 
increased risk taking and raised concern about the use of federally-
insured deposits to fund CMBS activity.
    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 is not likely 
to create significant additional risks for bank holding companies or 
pose a systemic risk to the banking system. The Board notes that bank 
holding companies have substantial expertise in analyzing the risks 
associated with loans secured by residential and commercial real 
estate, and that section 20 subsidiaries have developed the necessary 
procedures to evaluate the credit risks involved in underwriting and 
dealing in mortgage-backed securities. In addition, section 20 
subsidiaries that seek to underwrite or deal in CMBS are subject to an 
operational and managerial infrastructure inspection prior to being 
permitted to engage in such activities. Periodic inspections by the 
Federal Reserve verify that proper underwriting

[[Page 65532]]

and risk management procedures are in place at section 20 subsidiaries.
    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. Due diligence efforts conducted by a section 20 
subsidiary or an independent rating agency 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 a period of time. As the 
underlying commercial real estate loans in a CMBS pool season, 
appraisals obtained at origination become increasingly less relevant to 
an investor's decision to purchase the related CMBS because the market 
assumptions upon which the appraisals were based may have become 
obsolete. Further, the public rating or due diligence that must be 
obtained or conducted for CMBS provides investors with sufficient 
information to assess the risks associated with the CMBS. A majority of 
the commenters agreed with this assessment of the CMBS market.
    In response to the concerns expressed by one commenter that 
exempting CMBS transactions from the appraisal regulation would pose 
undue or unacceptable risk to federally-insured depository 
institutions, the Board notes that the proposed amendment relates 
solely to section 20 subsidiaries of bank holding companies and would 
not affect the appraisal requirements applicable to any federally-
insured depository institution. In addition, transactions between a 
federally-insured depository institution and an affiliated section 20 
subsidiary would continue to be subject to applicable restrictions in 
section 23A and 23B of the Federal Reserve Act (12 U.S.C. 37k, 37k-1). 
At this time, the Board is not considering any additional exemptions 
from the appraisal regulation for other transactions related to the 
CMBS market. Further, since the agencies have uniform appraisal 
regulations, any proposal to exempt CMBS-related transactions for 
federally-insured depository institutions would be addressed on an 
interagency basis.

Regulatory Flexibility Act Analysis

    This amendment 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 this amendment will only affect bank holding companies that 
have section 20 subsidiaries, which generally are among the largest 
bank holding companies. Further, the amendment is not expected to 
impose any additional burdens on regulated institutions.

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 
rulemaking.

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 amends 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, 3331-3351, 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) * * *
    (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: November 20, 1998.
Robert deV. Frierson,
Associate Secretary of the Board.
[FR Doc. 98-31602 Filed 11-25-98; 8:45 am]
BILLING CODE 6210-01-P