NCUA Board Member Todd M. Harper Statement on the Final Rule – Real Estate Appraisals

Like almost everyone in this room, I lived through the Great Recession and I remember the destruction and pain it created for millions of American families, for tens of thousands small businesses, and for thousands of insured depository institutions.  Inaccurate and deliberately misleading appraisals and evaluations contributed to that debacle, and while residential loans were the principal problem, commercial real estate could be the major problem in the next downturn – as it was in the 1980s.

Key provisions within the Dodd-Frank Act set forth new rules for real estate appraisals and appraisal oversight.  As a staff member of the House Financial Services Committee at that time, I devoted considerable time to these matters.  I am, therefore, very familiar with appraisal policy issues.

As such, I can say that there is much in this rule that I approve of, such as restructuring the rule to make it easier to understand what is required and incorporating into the rule the exemption for rural areas provided under S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act.

But I cannot support the overall rule, for three main reasons:

• The magnitude of the increases in the appraisal thresholds;
• The lack of consistency with rules issued by other federal financial institutions regulators – and the possibility that creates for regulatory arbitrage; and
• The impact it ultimately may have on important consumer protection safeguards for small business owners – particularly unsophisticated consumers of modest means – and on the safety and soundness of individual credit unions.

This rule quadruples the threshold for a certified appraisal of commercial real estate loans made by credit unions from $250,000 to $1 million.  It raises the threshold for both “Qualified Business Loans” – where the comparable threshold for commercial banks has long been $1 million – and for non-QBL loans where the threshold for commercial banks was only raised last year from $250,000 to $500,000 – half the threshold in this proposed rule for credit unions.

There’s an old adage that says that you should learn to crawl before you walk, and learn to walk before you run.  With this final rule, we’re not just running before we walk, we’re actually leapfrogging over the other federal financial institutions regulators.

Additionally, using data from the Costar group, the NCUA staff estimates that under this rule the percentage of exempted transactions will more than double from 27 percent to 66 percent.  The percentage of real estate market dollars exempted is estimated to increase more than seven-fold – from 1.8 percent to 13 percent.  To be fair, the NCUA staff also notes:

• that commercial real estate is only 4 percent of credit union assets,
• that the majority of that 4 percent is already exempt, and
• that commercial loans and commercial real estate are a much larger percentage of the balance sheets of banks than of credit unions, as well as a much larger percentage of their capital.

But we don’t know that will always be the case, and one of the reasons the old adage tells us we should learn to walk before we run is to reduce the risk of falling and failing.

In general, banks have a longer history of making commercial real estate loans, and they have larger staffs with more expertise in this area.  They are already walking.

And today, nearly half of federally insured credit unions are not subject to the member business lending cap.  As these uncapped credit unions gain greater experience in commercial lending they may increase their risk appetites and the system’s exposure to commercial real estate losses.  While an increase in our existing $250,000 threshold may be justified at this time, it would have been, in my view, more prudent to move in a smaller, incremental step.

In reading the comments on the proposed rule, the letter of CU Business Group, stood out.  CUBG expressed the opinion that this rule goes too far.  They said:

“After years of fighting to obtain parity with other financial institutions, credit unions finally made great strides with the 2016 revision to Part 723.

“It would be unfortunate for this traction to be reversed with the creation of a new inequity that could start another round of political turmoil with other financial institutions.

“The data in the Proposed Rule shows that the proposed revision will have a positive impact based on the number of transactions that will be affected by the change.

“However, CUBG does not believe the number of loans impacted is the best measurement.

“Based on our experience and the opinion of several of our credit unions, a $1 million appraisal threshold for commercial real estate investment property loans is too high.

“While $1 million would be considered a small loan in markets like Southern California or New York, it would be a sizable loan in other markets, where $1 million could represent significant exposure if the property value is not properly supported by an appraisal.

“CUBG believes the $500,000 threshold granted to banks would also be the most appropriate threshold for credit unions.”

In deliberating with me on this rulemaking, staff has asserted that, “Non-QBL loans are not necessarily more risky than QBL [loans]” to justify the size of the threshold increase.  I appreciate that perspective, but I would have been more persuaded if we had data demonstrating that non-qualified business loans have similar or better delinquency rates, or charge-off rates, than QBLs.

It also seems counterintuitive to me that we should quadruple the non-QBL threshold as we approach what is more likely to be the end of a decade-long upward economic cycle, than the beginning.  To be prepared for the next downturn, we need to be forward-looking by strengthening our supervisory stance, not loosening it.

My second major concern is that this rule is inconsistent with the thresholds adopted by other federal banking regulators.  I raised this point when answering a question during my confirmation hearing.

To prevent a race to the bottom, Congress created the Federal Financial Institutions Examination Council to foster cooperation, collaboration, and consistency among federal financial institutions regulators.  As such, the FFIEC works to promote uniformity by issuing and maintaining uniform principles and standards for the examination and supervision of financial institutions.

Therefore, my question for staff is whether we were invited to be part of the other agencies’ prior rulemakings in this area, especially the recent non-QBL appraisal threshold final rule, and if not, why not, and if so, why we declined to join them?

Thank you for those insights.

By leapfrogging the other regulators on the threshold for non-QBL loans we raise the risk of potential regulatory arbitrage, in my view.  We invite people who have loans that might not pass muster with a certified appraiser in a bank transaction to bring them to a credit union where only a written estimate is performed.

I know that many people contend that a written estimate can be just as rigorous as a certified appraisal – and it can – but it doesn’t have to be.  The standards for written estimates are significantly different than those for certified appraisals.  And the statutory independence standards for certified appraisals are much higher in my view.

Therefore, there is a much higher degree of certainty that a certified appraiser is offering a truly independent analysis.  That’s why the marketplace often mandates certified appraisals even when they are not required by law.

It is also why it is significant to me that the National Association of Realtors expressed concerns about raising the threshold for certified appraisals in its comment letter on this rulemaking.  I expected that credit unions and their trade associations would support raising the threshold, and that banks and appraisers and their trade groups would oppose raising the threshold.  But it is significant to me that the Realtors, who want to get real estate deals done to get paid, said “removing the appraisal element when it could be the most reliable factor in evaluating a transaction is concerning.”

I should also note, for the record, that it wasn’t just the Realtors who were concerned about the increase in the threshold; more than three-quarters of the comments we received on this issue opposed raising the threshold to $1 million.

My third and final concern with this final rule is the impact this change may have on individual credit union members and individual credit unions.  Certified appraisals are done to protect both credit union members and their credit unions.  They are an essential element of consumer protection.

While the recent problems in taxi medallion lending had many different attributes from commercial real estate lending, they also have some similarities.  Like taxi medallion loans, non-QBL loans of less than $1 million are often made to relatively unsophisticated borrowers.  We have seen the hardships that are created when credit union members are allowed to get in over their heads.  A certified appraisal, in my view, is an important consumer safeguard designed to protect relatively inexperienced borrowers.

We also know that even though it is a different type of commercial loan, the amount of the average taxi medallion loan was for less than the $1 million threshold contained in this rule.  Loans of this size can destroy the finances and lives of individual credit union members as we saw after the taxi medallion market meltdown.

Furthermore, the experiences of the Great Recession demonstrate that when the same mistake is repeated many times, even for relatively small loans, it can have a dramatic impact on both individual borrowers and individual financial institutions.  In response to the Great Recession, Congress required the Government Accountability Office to study the issue of appraisals.  The 2012 report of the GAO in this area noted that appraisals play a critical role in underwriting by providing evidence that the market value of a property is sufficient to help mitigate losses if a borrower is unable to repay a loan.

That same report also documented how many small loans without appraisals can create a virtual house of cards.  We should heed that advice today when considering this rule.

In conclusion, the magnitude of these threshold increases, at this point in the economic cycle, combined with the inconsistency they create with the thresholds adopted by other federal financial institutions regulators, and our need to prioritize both safety and soundness and provide consumer protection to persons of modest means, compel me to oppose this final rule.

Accordingly, I will vote “no” on this matter.