[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
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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
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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