COVID-19 has caused financial institutions to have difficulty obtaining appraisals for additional extensions of credit or changes to existing note terms.
In an effort to prevent the spread of COVID-19, federal, state and municipal governments have established strict restrictions on businesses deemed nonessential.
These government mandated orders have caused borrowers to not be allowed to operate, nor receive interior appraisals.
However, despite difficulties of obtaining appraisals, federal bank regulators are encouraging institutions to work with borrowers suffering as a result of COVID-19.
On April 14, 2020, bank regulators issued an interim final rule which was effective-immediately (“interim appraisal rule”).
This ruling allows financial institutions to defer requirements to obtain an appraisal for up to 120 days following the closing of certain real estate transactions, excluding transactions for acquisition, development and construction of real estate (“ADC”).
This deferral applied to both residential and commercial real estate related financial transactions that are not otherwise ADC.
The temporary deferral sunsets on December 31, 2020 (unless extended by the agencies), but will apply to any non-ADC loans otherwise requiring appraisals or evaluations that close on or before December 31, 2020.
The rule provides only for a deferral of appraisal and evaluation requirements because a waiver would require legislative action.
Commercial Real Estate: The Impact of the 2020 Interim Rule on Appraisals
Institutions extending credit to struggling borrowers with repayment issues on real estate collateral dependent loans are usually required to obtain an appraisal reflecting the current value of the collateral in connection with the extension or modification of credit.
It seems that credit decisions could be risky minus a meaningful estimate of the current value of the collateral, particularly in a stressed economic environment.
The interim appraisal rule states institutions that defer appraisals are still expected to conduct their lending activity consistent with safety and soundness standards and real estate lending standards focused on the borrower’s ability to repay.
Due to the interim appraisal rule financial institutions have three avenues for modifying loans secured by real estate collateral:
- Determine that the modifications to the loan do not require appraisals. The appraisal regulations of federal banking agencies provide at least 14 exceptions to appraisal requirements, certain of which were set forth in the interagency statement issued with the interim appraisal rule.
- Rely on existing appraisals. The interagency statement issued with the interim appraisal rule recognizes that institutions may use an existing appraisal or evaluation for subsequent transactions on an existing loan, provided that the underlying appraisal or evaluation remains valid.
- Obtain an appraisal within 120 days of the loan date. As per the interim appraisal rule, appraisals consistent with safe and sound banking principles must be obtained before the end of the deferral period.
Regardless of the avenue chosen, the institution should document each borrower-specific determination as well as humanly possible.
Despite the deferral provided in the interim appraisal rule, the preamble to the rule provides that “[r]egulated institutions should make best efforts to obtain a credible valuation of real property collateral before the loan closing, and otherwise underwrite loans consistent with the principles in the agencies’ Standards for Safety and Soundness and Real Estate Lending Standards.”
That directive, along with concerns that regulators will quickly forget their concessions as soon as the immediate crisis passes and the difficulty mitigating risk if the deferred appraisal comes back lower than expected, may temper the practical use of deferrals by financial institutions.
In situations where a temporary deferral is relied upon, institutions should carefully document the assessment of collateral value at the time of the loan or refinancing, together with management and board monitoring of any interim credit policies and related exceptions.