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Ron D'Vari, CEO, NEWOAK CAPITAL LLC

New Regs Suggest Need for Independent Collateral Valuation
Thursday, March 10 2011 | 11:09 AM
Ron D'Vari
CEO, NEWOAK CAPITAL LLC

While much attention and scrutiny has been given to the effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act on the financial services industry, other recent regulatory changes will also have profound effects on the way financial institutions do business. One key trend: the need for independent collateral valuation, particularly regarding complex or hard to value collateral, such as many asset-backed securities, whole loans, real estate, pools of receivables and leases.

The motivation behind the new regulations is a perceived need for independent, conflict-free, professional judgment, without influence or pressure that could possibly be exerted by parties having an interest in the transaction. Driving this perception has been the massive federal loss exposure in the aftermath of the subprime financial crisis.

The portfolio valuation requirements of the 2010 Interagency Appraisal and Evaluation Guidelines[1] (which replace the 1994 guidelines) flesh out the new federal expectations; these changes will have application to a wide variety of institutions, including: federally chartered banks and those accepting FDIC insured deposits; fund managers and others who make representations about collateral to public investors; investment bankers; and rating agencies.

Given the regulatory trend, it appears certain to us that the Agencies will follow the lead of the Financial Services Authority in the United Kingdom, which has required financial services firms to engage outside experts to provide independent, conflict-free valuation and risk analysis. This requirement provides an institution with a defendable (i.e., independent) valuation of the portfolio components.

Pursuant to the Guidelines, each financial institution must maintain policies and procedures which establish standards for obtaining current collateral valuation information. The institution may employ a variety of techniques for monitoring the effect of collateral valuation trends on portfolio risk associated with its lending practices.

Changes in market conditions underscore the importance of following sound collateral valuation practices and monitoring when originating or modifying real estate loans and evaluating portfolio risk.
The Agencies implicitly are addressing three major risk exposures that drive the government’s interest in objective third-party collateral validation practices:

1. The FDIC scheme of depository insurance, which depends crucially upon the soundness of bank lending practices.

2. Agency guarantees on mortgage-backed securities provided by Ginnie Mae, Fannie Mae and Freddie Mac.

3. The potential government responsibility to bail out financial institutions deemed “too big to fail.”

The drafting of the Guidelines is a joint effort of the Office of the Comptroller of the Currency, Treasury; Board of Governors of the Federal Reserve System; Federal Deposit Insurance Corporation; Office of Thrift Supervision, Treasury; and National Credit Union Administration (collectively, the “Agencies”). The Agencies have committed to work together to ensure that real estate lending is conducted in a safe and sound manner.

Note: Contributors to this blog post include members of the NewOak Capital team.
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