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Mortgage lenders using Automated Valuation Models (AVMs) to speed loan processing and reduce costs will soon meet quality control standards, including proof that the use of AVMs does not violate the Fair Lending Act. Implementation may be required.
Following lawmakers’ direction, six federal agencies Thursday released proposed rules aimed at protecting the “reliability and integrity” of valuation models used in real estate.
of Proposed standardIn a request for comment, the regulator said random sample testing and reviews were “designed to ensure a high degree of confidence in the estimates produced by AVM” to prevent data manipulation, conflicts of interest and violations of the Fair Lending Act. and asked for comment.
“AVM is being used as part of the property valuation process, driven in part by advances in database and modeling technology and the availability of larger property datasets,” the agency said in a statement. joint press release. “Although advances in AVM technology and data availability may contribute to lower costs and faster loan cycle times, financial institutions using AVMs are not It is important that we take action.”
AVM’s proposed quality control standards would also apply to Fannie Mae and Freddie Mac, which have fully embraced the use of AVM to approve loans to some homebuyers without evaluation. Lenders that rely on Fanny and Freddy’s automated ratings will not be subject to the new standard.
The rule applies only to mortgage originators making credit decisions, servicers making loan modification decisions, and secondary market issuers such as Fannie Mae and Freddie Mac who use AVMs to value collateralized homes. be done.
Other uses of AVMs, such as portfolio monitoring, “are not within the scope of the proposed rule because they do not involve determining collateral values,” the agency said.
This standard does not apply to the use of AVM to generate an appraisal by a certified or licensed appraiser, or to the review of already completed appraisals.
The Federal Reserve and five other government agencies are asking for comments on the draft standard for 60 days. There will be at least 12 months between the publication of the final rule and its implementation.
Some of the dozens of questions the regulator is seeking guidance on before issuing the final rule relate to finer details. However, the proposal to make non-discrimination a quality control element is expected to continue to provoke controversy.
Regulators enabling a flexible approach
The regulator says it has no plans to specify how agencies must structure their AVM quality management policies and practices, so companies subject to the rule will have flexibility in their approach. Ultimately, regulators expect their approach to quality control of AVMs to vary depending on the size of the financial institution, the risk and complexity of the transactions in which AVMs are used.
Asked for comment on the proposed rule, the regulator said, “The agency considered whether to propose more prescriptive requirements for the use of AVMs, but decided not to do so.” “Different policies, practices, procedures, and control systems may be appropriate for financial institutions with different business models and risk profiles, and more prescriptive rules may be appropriate for financial institutions to set their risk management practices accordingly. It could unduly limit our efforts.”
As is often the case in technology, once the AVM quality control rules are finalized, smaller companies may have a harder time implementing them than their larger competitors.
The Federal Deposit Insurance Corporation (FDIC), one of the regulators involved in drafting the proposed rule, estimates that the nearly 2,300 smaller financial institutions it oversees could be subject to the rule. But experts believe it accounts for only about 10% of all financial institutions supervised by the FDIC. He uses AVMs for mortgage originations, loan modifications, and securitization decisions.
Another regulator, the Office of the Comptroller of the Currency (OCC), which oversees national banks and the Federal Savings Association, estimates that about 600 of the smaller banks it supervises will be affected. The OCC estimates that it will cost small banks about $21,600 a year to comply with the rule.
Nondiscrimination as a quality control element
It has been years since the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 mandated increased oversight of AVMs.
The Consumer Financial Protection Bureau (CFPB) last year convened an advisory panel to gather feedback from small businesses on AVM quality control standards. Many say it will take 12 months or more before they are ready to introduce stricter quality control standards, especially if they have to prove that their AVMs are non-discriminatory.
Small businesses “do not have the ability to validate the algorithms used by AVM providers, making it impractical to assess AVM’s fair lending performance,” the CFPB told the CFPB. May 2022 report We summarized the panel’s findings. As a small institution, some firms complained that they “did not have the staff, data or scales to meaningfully evaluate the results of AVM models”, prompting the regulator to focus instead on his AVM provider. I suggested.
In passing the Dodd-Frank Act, lawmakers directed regulators to require AVMs to meet quality control standards aimed at:
- Ensuring high confidence in the estimates generated by AVMs
- Protect against data tampering
- avoid conflicts of interest
- Random sample testing required
Congress also gave government agencies the authority to “determine appropriate” and “consider such other factors” for qualified administration. In addition, the proposed rule would require lenders using AVMs to adopt quality control standards to ensure compliance with laws prohibiting discriminatory lending when making credit decisions. become.
“While existing anti-discrimination laws apply to the use of AVMs by financial institutions, financial institutions should implement a fifth quality control element on non-discrimination to increase lender awareness of the applicability of anti-discrimination laws to AVMs. ,” the regulator said of the proposed rule.
However, the regulator is open to further discussion on this matter and seeks feedback on questions such as:
- What are the advantages and disadvantages of specifying a fifth quality control element on promiscuity?
- What, if any, alternative approaches should agencies consider?
Richard Jones, president and CEO of Minnesota-based Randall State Bank, told the CFPB last year that “AVM complies with specific quality control standards and It is important to rely on data that does not create inadvertent discrimination based on “
However, “requiring financial institutions, especially smaller entities like myself, to evaluate and evaluate their models for potential fair lending concerns before using them is unreasonable and redundant. , is going to be very costly,” Jones warned.
Lenders are already subject to the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act, Jones said, adding that “the potential for additional fair lending requirements to apply to AVM valuations would be particularly redundant and onerous. As a result, more regional banks are likely to choose not to lend.” You should either use AVM or get out of the mortgage business altogether. “
Increased AVM regulation may incur additional costs, but those costs may ultimately be outweighed by savings from reduced workloads and faster approvals.
Joan Todd, chairman of the Northeast Family Federal Credit Union, based in Manchester, Connecticut, told the CFPB that if the new standard achieves its goals without significantly increasing costs, the bank will expand its use of AVMs. said it could be done.
“AVM provides a reasonable guarantee of collateral value and we use AVM for loans that can absorb some of the risk of valuation discrepancies. For these reasons, we expect continued use of AVM. We are,” Todd said in a statement to the CFPB last year. “If the proposed quality control standards improve the reliability and accuracy of our evaluations while maintaining low cost and speed, we welcome the improvements and feel more confident in our evaluations, hence the use of AVMs. AVM usage is currently limited to mortgages under $200,000 and less than 80%. [loan-to-value ratio]”
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