Collateral still matters
Lady Justice carrying a sword and set of scales reflects a symbol of U.S. courthouses. The blindfold represents objectivity and impartiality. With the unprecedented health and economic crisis bringing marching orders to help individuals and companies get much needed funding fast; there’s a lot of uncertainly around the impact on valuations of collateral. Some fear that collateral’s role will be diminished. Many financial institutions are providing general guidelines to their commercial fee appraisers about how to discuss the potential impact of the health crisis on market conditions in their reports, which everyone agrees is a necessity for producing credible assignments. Problem is, no one really knows the medium and long-term implications. That said, I do find brokerage firms, such as CBRE’s Flash Calls to be very informative, insightful and intellectually measured.
As of today, there’s no real expectation to ascertain the pandemic’s impact on market value. Antidotally, there’s the obvious. Significant impact to restaurant tenants, personal service businesses and lodging. Any analyst would conclude that uncertainty prevails right now. Trying to nail down or quantify its impact is just too early in the process. Broad measurement, such as an 11.4% value drop (all broad property types) in the FTSE Nareit All Equity REITs (April 23, 2020), is something. However, its short-term nature may not extrapolate to accurately identify trends. Market value impacts will likely end up being on a case-by-case and locational basis.
Fee appraisers are doing their best to discuss what they think is going on, but can’t really adjust for market conditions. At least not yet. But adding disclaimers and assumptions dismissing responsibility for credible appraisal conclusions is clearly not the right thing to do. I think the best practice is to “talk” to the reader of the report in a conspicuous section about the potential short, medium and long-range implications, even if you lack the data to quantify. It helps credit ascertain potential future red flags, collateral weakness and “boots on the ground” intel from the borrower.
According to an April 14, 2020 press release by the federal banking agencies, banks can defer appraisals and evaluations for up to 120 days after closing of residential or commercial real estate loan transactions. This liquidity interim move excludes transactions involving acquisition, development and construction loans. This brings up some interesting interpretation questions. What about land development (subdivisions), proposed buildings, or buildings that require extensive renovations? It seems the authors felt these deals held the most risk and so they aren’t suitable. As the rule was being put into practice lots of questions like, if you defer the appraisal, when is the date of valuation – the loan date or post-deferment date? Does buying a home count as an acquisition? As these are being sorted out, but grey areas remain. Expect future webinars to communicate clearer expectations.
Many bank appraisal departments haven’t yet taken advantage of this deferment, while others have decided they aren’t going to. Instead, it will be business as usual for now. It’s working fairly well, especially those with appraisal workflow platforms like YouConnect. Since the intent of the deferment is to get money on the streets, while maintaining solid audit trails, having automated internal processes facilitated by workflow let’s everyone feel more confident about the accelerated process. Regulators are not all on the same page, but the general messaging about how they will address future examinations is: explain how market value was determined and document your loan file accordingly.
In the end, it comes down to having good fee appraisers. Ones you can trust. Professional appraisers rely on USPAP and Interagency Appraisal and Evaluation Guidelines to know to what degree an inspection is sufficient to develop credible assignment results. Some appraisers are being creative when they use interior pictures provided by others, using GPS location and time stamp apps.
When the dust settles, collateral will still matter. The quality and duration of the cash flow of the collateral still matter. The maintenance and proper capital expenditures of the collateral still matter. This is a good time for banks to communicate to their borrowers that the basics of maintaining positive relationships with their tenants matters. Yes, collateral matters. Lady Justice as a symbol still matters as does sound procedures and judgement. When we look back on these times, we want to do it knowing we all followed the rules we have been given to the best of our ability.