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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   July 2005

Insured-value opinions lower commercial-loan risks

The residential-lending and valuation arena has long been ahead of the commercial world in terms of automated-valuation models (AVMs), electronic submission of reports and insured-value opinions. With the advent of commercial-property AVMs and the availability of lender-purchased insured values on a deal-by-deal basis, that is about to change.

Although AVMs generally are riskier for lenders than are conventionally prepared appraisals from an “on-the-ground” appraiser, they do have advantages. AVMs present significant cost savings, faster turnaround and increased reliability, as more data becomes available.

The U.S. Office of the Comptroller of the Currency’s Bulletin on Risk Modeling from May 2000 says computer models “are playing a progressively more important role in the banking industry. The tools are now routinely used for credit scoring, asset-liability management, trading-risk management and for valuation estimates of financial instruments.” Only so much risk can be underwritten by a lender, and inevitably, some borrowers will default on their loans regardless of the value placed on the security by an AVM or appraisal.

If a problem loan was based upon a faulty, negligent or unsupported value opinion at the loan’s inception, lenders historically sought restitution from the appraisal company through their errors and omissions insurance (E&O). As those familiar with this process can attest, it can be lengthy, uncertain and depending on the outcome, costly. Many claims against appraisers through their E&O carriers end up in courts or in binding arbitrations.

Valuation professionals in the commercial-appraisal market now are working to bridge deficiencies between E&O and the actual protection lenders need to minimize risks on commercial loans.

Commercial-real-estate valuation firms, for example, have gained the opportunity to add an option for a lender to purchase an insured-value opinion on its evaluation products or traditional

appraisal services. Each valuation is insured separately for five years from the original date of value. Loans eligible for insured-value coverage have a maximum property value of $5 million and must be one of the following property types: industrial/warehouse, retail, office, multifamily (more than four units) or special-purpose land, such as agricultural.

Premiums for insured-value-opinion coverage are affordable, in part because of the low default rate on small commercial loans nationwide. Typically, that rate is between 1 percent and 1.5 percent. This provides positive results for lenders and appraisers, as their conventional E&O premiums should

decline as the insured-value opinion gains acceptance in the marketplace. Through an insured-value policy, a lender may file a claim at several stages:

  • After the loan has been foreclosed upon;
  • When all efforts to collect any portion of the balance owed on a default loan have been exhausted;
  • When the lender has made every reasonable attempt to collect or mitigate the deficiency; and/or
  • When there is a written determination that the loan is “commercially uneconomic” to foreclose upon and the lender has charged off the loan.

The appraisal firm is expected to prepare an accurate appraisal/evaluation that complies to Uniform Standards of Professional Appraisal Practices (USPAP) and/or regulatory guidelines for evaluations as of the effective date of value and within a stated nominal percentage allowance or variance. If the valuation is not compliant, a lender may file a claim based on the nominal allowance or the difference between the original value opinion and the value established by a retrospective

appraisal, less the deductible — whichever is less. A claim also can be based on the lender’s actual financial loss, minus the nominal deductible, or by a set limit that the lender selects and pays for.

The lender must still obtain a retrospective appraisal of the property. The appraisal must reflect the same date of value and physical condition as on the original valuation. Additionally, the lender is required to submit proof of loss. The appraiser can dispute the claim or the retrospective appraisal.

There also are provisions for the selection of a mutually acceptable appraisal firm to perform a second retrospective appraisal. Unlike many E&O claims, the value opinion of the second retrospective appraisal is binding upon both parties. The insurance company must pay the appropriate claim within 30 days.

Insured-value opinions give small-business and small-property lenders the opportunity to reduce their risk greatly at a nominal cost. Another major benefit is the prescribed, simple means to process claims on eligible loans that have been foreclosed upon to regain considerable portions of financial losses. This kind of coverage is beneficial to the lender and the appraisal firm.


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