Mae’s Collateral Underwriter (CU), a tool it made available to lenders and appraisal management companies in January, is going to change the way the appraisal world works, and its effects will be felt from lender to AMC to appraiser to homebuyer. While many experts are hopeful that the net effect will be improved appraisals and more access to credit, appraisers are wary that CU will likely make their jobs more difficult, their work more time consuming and further reduce their autonomy and independence as professionals.
The decision by Fannie Mae to rely on big data to assess appraisal risk is understandable given misdeeds of the past and their consequences. Not too long ago, appraisers found themselves directly answerable to the lenders who would choose them and ultimately determine their income. The mortgage broker or lender hired an appraiser to determine the value of the property (or collateral), knowing that the buyer and seller had already agreed upon a price.
According to Ed Pinto of the American Enterprise Institute, “In the lead-up to the mortgage meltdown, appraisal methodology had one input: boom-induced comparable sales prices led to a predictable output: a boom-induced value for the subject property. The appraiser is left with determining ‘the price at which a property may be sold,’ not its value or more importantly, its value for lending purposes.”
In the wake of the meltdown, the government sought to reform the appraisal process with the adoption of the Home Valuation Code of Conduct and by introducing appraisal management companies to ensure “arms-length” transactions. Despite these fixes, however, it is almost universally acknowledged that the appraisal industry still doesn’t work very well.
THE LIMITS OF ALGORITHMS
Depending on an algorithm to determine the reliability of a home value is like evaluating works of art by algorithm, according to Brian Coester, CEO of Coester VMS. “There is an intrinsic value to art that allows it to be looked at for what it is. Add too many algorithms to the appraisal and you can take away from what it is.”
And according to Coester, comparing traditional appraisals and AVMs is like comparing Warren Buffet and day traders.
“Both are right and both have their place, but there needs to be a healthy median between automation and local-market knowledge. That balance is still being worked out because the automation that’s been used in the past has actually probably been more harmful than good. I think that Collateral Underwriter has the first shot at having a legitimate chance at being complementary to the appraisal rather than harmful.”
That may be because the number of data points Fannie has at its disposal is now so large. By establishing a Uniform Appraisal Dataset and creating the Uniform Collateral Data Portal (UCDP), Fannie Mae has been able to collect over 14 million appraisals, with data on over 20 million transactions. Using that data, Fannie developed more advanced appraisal analytics, which led to the internal implementation of CU.
Leveraging an extensive database of property records, sales transactions, market data, third-party data sources, and proprietary analytic models, CU is able to generate a comprehensive analysis of the appraisal.
Along with human due diligence, CU has been used to assist Fannie Mae in the post-acquisition quality control process — flagging appraisals with a heightened risk of property eligibility or policy compliance violations, overvaluation and appraisal quality issues.
Now Fannie is giving access to CU to lenders who sell to them directly, as well as AMCs that are acting on behalf of the lenders. Since Jan. 26, 2015, CU feedback has been available through UCDP to lenders, and beginning in the first quarter of 2015, lenders will also be able to access CU through a web interface that will go beyond the Risk Score, Flags and Messages.
Fannie’s goal in releasing CU to lenders is to fix potential issues on the front end, rather than waiting until the loan is delivered to Fannie Mae. By allowing lenders to peek behind the curtain, Fannie is hoping to help lenders build their businesses with increased safety/decreased risk and make loans with increased confidence.
According to Zach Dawson, director of collateral strategy at Fannie Mae, using CU will result in “a much more proactive approach to appraisal quality and a much more proactive approach to managing collateral risk…. It makes a lot more sense to share this further up front in the process.”
Ultimately, increased confidence and certainty about repurchase risk might allow lenders to expand access to mortgage credit.
In addition to alerting lenders to potential issues earlier in the process, Fannie also hopes that CU will enable lenders to manage their workflow more effectively by segmenting appraisals by risk profile. By using data-driven, research-based analysis instead of the arbitrary guidelines and legacy checklists that many underwriters and appraisal reviewers have been using, CU may also prevent unnecessary back-and-forth by differentiating the riskier appraisals from the less risky.
Says Dawson, “Our hope is that with a tool like Collateral Underwriter, they [lenders] will make more effective requests.”
APPRAISERS ARE WARY
But while lenders welcome CU with open arms, appraisers aren’t sure what to make of it. They complain that they are receiving mixed messages as guidance is evolving and often conflicted. Anthony Roveda, a consultant with gandysoft.com, wrote recently, “On one end of the field you have an 800-pound gorilla, teamed with the loan originator getting assistance with big data analytics to back them up… and on the other end of the field is the appraiser.”
Throughout their training materials, FAQs and webcasts, Fannie is careful to say these flags, messages and warnings are just suggested areas to consider.
Coester agrees that they are only warnings, but says, “Ultimately, if Collateral Underwriter tells you to do something, you are going to do it.” While Fannie would argue that CU doesn’t “tell you to do something,” the practical effect will be the same.
As part of CU’s review of each appraisal, it will compare the submitted appraisal to other appraisals by the same appraiser, as well as similar appraisals by other appraisers. Automated checks include evaluation for plausible data (is the house really 40,000 square feet or is that an extra zero tacked on to 4,000 square feet?), consistency with data contained within appraisals submitted by peers, and consistency with other appraisals by the same appraiser.
Fannie Mae indicates it is looking for significant plausible data errors, significant differences among appraisers and appraisals, or outliers — and aren’t looking to split hairs.
But if this tool is so good, why not share the information with appraisers? Their work product is now going to be judged according to a set of criteria they don’t have access to, and the consequences can be dire. It’s easy to predict that if an appraiser has a number of flagged appraisals according to an algorithm, lenders won’t risk their reputation with Fannie Mae to keep using them.
But what that number is, or how the algorithm arrived at that score in the first place, will remain a mystery to the affected appraisers.
“Keep in mind that all the data we appraisers supplied Fannie and Freddie is now going to be used against us, yet they plan on supplying information only to the lender and NOT the appraiser,” said appraiser Johnny Osipchak.
Fannie Mae’s Dawson explains that there are a couple of practical reasons why Fannie isn’t sharing CU with appraisers. First, CU isn’t a database designed to return data when a user enters an address. It’s a program designed to analyze an appraisal once submitted. Without an appraisal submission, CU doesn’t work.
Second, Fannie was already equipped to share CU with the few thousand lenders with whom they already have a relationship, but it is not prepared logistically to open CU up to the 40,000 plus appraisers who have no direct relationship with Fannie.
“First and foremost, we don’t want to value conformity with this tool above all else, and there could be unintended consequences of appraisers having access to this information and simply choosing to agree with this automated output. We value the independent local market expert,” Dawson said.
But appraisers are questioning how the automation of rating appraisals is treating them like market experts. One of the biggest concerns among appraisers is that the 
release of Collateral Underwriter will further the professional exodus currently taking place within the appraisal industry.
With the increased regulation and lenders’ increased reliance on AMCs to act as their agents and manage their appraisal processes, appraisers have less autonomy and are working harder to earn less money. AMCs are responsible for approximately 90% of appraisals required by big banks and lenders, and many appraisers and industry observers feel that the business has become a commodity rather than a professional service.
“Many are effectively an army of what I call form-fillers,” Jonathan Miller of Miller Samuel Real Estate Appraisers said. “Like any industry, there are terrific appraisers, average appraisers and form-fillers. Post-Lehman, there are a LOT more of the latter.”
Author Hamp Thomas writes in “Where Did All the Good Appraisers Go?” that “downward pressure on fees means more experienced appraisers are leaving the business and newer appraisers are left to work for the AMCs. Since they have less experience and are perceived as less trustworthy, the system is layering bureaucracy, which takes discretion from the hands of the appraiser and gives them an ‘invisible fence.’”
Thomas contends, “the best appraisers are leaving mortgage appraising as fast as they can.” Crabtree noted in a recent discussion on housingwire.com that the end result of CU’s implementation will be “ more appraisers leaving the profession, lower appraisals and longer transaction times.”
Without additional revenue to fund AMCs, the fees that appraisers used to earn are now shared with the AMC and appraisers often earn half of what they used to. To make matters worse, some AMCs are cutting the fees they charge to gain market share.
Typically, for a process and a product that depends largely on human effort, if you want a higher quality product, you have to pay more. The best doctors, chefs, mechanics and attorneys all make more than the market average. Nevertheless, lenders, AMCs and Fannie Mae all expect appraisal quality to increase even as appraiser fees decrease.
Joan Trice, CEO and founder of Alterra Group LLC and host of Collateral Risk Network, puts it this way: “You know that triangle that says ‘Service, Quality, Price: choose any two?’'
“They somehow think they can get it in 24 hours at half the price and yet it should be better. I don’t know why everybody thinks that appraising is the exception to the rule,” Trice says.
MAINSTREET CONFUSION
At almost the same time, the Wall Street Journal ran an article entitled “Dodgy Home Appraisals Are Making a Comeback” which claimed that “home appraisers are inflating the values of some properties they assess, often at the behest of loan officers and real estate agents, in what industry executives say is returned to practices seen before the financial crisis.”
In trying to understand how Collateral Underwriter is going to impact the appraisal industry, some have compared the potential impact to another database-dependent mathematical modeling system — Automated Valuation Models (AVMs). While investors and real estate professionals have used AVMs for years because they are fast, relatively inexpensive and not prone to fraud, AVM disadvantages can often outweigh the advantages.
With no physical inspection, AVMs do not account for the characteristics of an individual property—the quality of workmanship, condition of the property, the view. Further, in neighborhoods with rapidly rising or falling home prices, AVMs generally lag the market by several months.
Collateral Underwriter is distinct from AVMs in a several ways. First, Collateral Underwriter is not designed to produce a range or a specific valuation for the property, but to determine the risk profile of an appraisal.
Second, CU is able to account for data in a rapidly rising or falling market. An appraisal that was submitted yesterday is a data point for today’s appraisal analysis. Third, CU is built on and has access to an unparalleled appraisal/transaction database that significantly improves the information and analysis it produces.
While most experts agree that the release of Collateral Underwriter will be good for Fannie Mae, lenders and appraisals as a whole, there are several potential intended and unintended consequences that may result.
On the positive side, Roveda thinks greater scrutiny will “shake out the shady characters.”
“There are always shady characters in any industry. I’ve heard rumors/seen articles that there’s been some pressure from some AMCs for appraisers to hit numbers,” Roveda said. “Collateral Underwriter’s going to shine a great big light on everybody involved so if it hurts anybody, it’s going to hurt the loan officer that’s pushing values.”
In fact, CU is currently used by Fannie Mae as part of its appraiser quality monitoring process and will likely be used by lenders and AMCs to identify potentially problematic appraisers. What lenders and AMC’s choose to do once they identify bad actors remains to be seen.
Coester posits that CU is likely to result in better appraisals. “It’s going to help the lenders, it’s going to help Fannie Mae. They’re not giving it to the appraiser, but in an indirect way it’s probably good for the appraisal industry as a whole.”
Trice suggests that CU might result in lenders and AMCs seeking to upgrade their appraisal talent pool. “With all the time-consuming aspects that it may create, it would behoove the lender and the AMC to initially engage the best appraiser for the job and not attempt to engage the cheapest appraiser.”
On the less-positive side, many suspect that the release of Collateral Underwriter will cause a significant increase in the time, effort and cost it takes to address potential issues flagged by CU and complete a good appraisal.
“There’s going to be an awful lot of back-and-forth from lender to AMC to appraiser before you finally get all the exceptions addressed, so it could potentially slow down the process,” Trice said.
Fannie Mae expects that some of the added work will be offset by cases where the lender determines it will not need to go back the appraiser with the corrections process.
“There’re certainly things that CU will identify that have not been identified before, but we also think that there are a lot of appraisals that are done very well and Collateral Underwriter will confirm that. So we think those two factors will balance each other out,” Dawson said.
Another of the unintended consequences may be the further commoditization of the appraisal industry. As appraisers are appraising with CU in the back of their minds, they are more likely to be conservative in their appraisals to avoid having to rework/refine/explain their findings.
While Fannie and lenders will likely appreciate this bias toward conservatism, such bias might keep appraisals from reflecting the most current market trends. Instead of valuing local market knowledge above all, appraisers might find themselves valuing moderation in all things and valuations regressing to the mean.
Although only a small part of the whole mortgage process, appraisals can have an outsized effect on home prices and the overall health of the mortgage market.
For Fannie Mae and lenders, CU represents a welcome risk assessment tool. For appraisers and, ultimately, homeowners — whose mortgages might get bogged down in a lengthy appraisal process — the jury is still out.
