NORTH ISLAND BUSINESS LENDING PROCEDURE MANUAL

Transcription

1 1700 VALUATION PROCEDURES FOR COMMERCIAL/CONSTRUCTION LOANS The valuation of property securing a commercial real estate loan is a fundamental source of information about a commercial real estate property and its competitive marketplace. Decisions regarding the extension of credit, portfolio monitoring, asset classification and/or asset disposition all require complete property and market information, for an informed decision to occur. The Credit Union will use a valuation method that is appropriate for a particular transaction and situation and complies with the regulatory agencies guidelines. Valuation standards are split into three levels, Appraisals, Evaluations, and Updates: Appraisals provide a written statement independently and impartially prepared by a qualified approved appraiser setting an opinion as to the market value of a property as of a specific date, supported by the presentation and analysis of relevant market information. Evaluations provide an opinion as to the market value of a property as of a specific date and are presented in a comprehensive written statement, performed by an experienced and qualified party with the conclusion supported through research and analysis of current market conditions, property characteristics, condition and zoning. Updates are performed in conjunction with the monitoring of the portfolio collateral risk and are performed to update a previously established market value based on market analysis and market trends. This category of Valuation is more thoroughly discussed in MBL CRE Loan Reviews and Portfolio Monitoring. This section outlines the real estate appraisal management and valuation procedures for commercial and construction loans to ensure the Credit Union is operating in a safe and sound manner consistent with regulations and integrity in the valuation process. The Credit Union can originate both construction and commercial real estate loans. Even though all underwriting is based predominately on character and cash flow of the sponsor, the Credit Union also understands that a comprehensive valuation, establishing a fair market value of the subject property, is critical to the loan valuation process. In a down market, One Form of Action Rules can limit collection efforts and reliance on collateral can become critical. In addition mark to market; portfolio valuation and allowance calculations are often highly dependent on reliable collateral valuations. Special Notation: Construction lending is currently suspended until further action from regulating authorities. The Credit Union requires all appraisals to comply with NCUA regulations and to generally accepted appraisal standards as evidenced by the Uniform Standards of Professional Appraisal Practice (USPAP), or FNMA/FHLMC appraisal guidelines. Page 1

2 Objectives The Credit Union's valuation process is designed to: Safeguard the Credit Union from loss in discerning the need for valuation analysis and appraisal documentation in the Credit Union's real estate related decisions. Ensure that appraisers produce sound, market driven conclusions that appropriately represent the value of the Credit Union's real estate related assets. Establish criteria for the appropriate use, content and documentation of evaluations consistent with safe and sound banking practices. Ensure that the valuation process is consistent with USPAP as promulgated by The Appraisal Foundation. Follow the valuation process as required by federal and state financial institution regulations. Quality Control The Credit Union will consistently employ aggressive quality control measures on an ongoing basis. The essential elements of this effort are: Clear direction and controls for the selection and engagement of the independent fee appraiser, which is handled by the Credit Union s Loan Administration Department. Prudent and professional engagement, instruction and compensation policies relative to contractual procedures involving independent fee appraisers. Documented, comprehensive appraisal procedures and processes that meet and/or exceed the USPAP requirements and comply fully with applicable regulatory criteria. Professional and comprehensive appraisal review process that encompasses all externally produced appraisal reports. Closely scrutinized independent fee appraisers competent to appraise specific property types in specific geographic areas and insure they are licensed or certified by the state as required. Documented, evaluation procedures and processes that monitor the independence of the person performing an evaluation and comply with applicable regulatory criteria. Page 2

3 Ordering Appraisals or performing Evaluations on loans subsequent to funding if it is determined that the market area or property itself is deteriorating APPRAISER APPROVAL PROCESS The Credit Union utilizes fee appraisers meeting strict qualifications. The appraiser package is thoroughly reviewed by the Commercial RE Underwriter who has the training and expertise in appraisal review, and is independent of the selection and engagement process, and is independent of any loan approval authority. A second review and the appraiser approval is performed by either the Department Head of Business Services or Chief Credit Officer then placed on an Approved Appraiser List. Individual appraisers, not appraisal companies, are approved by the Credit Union with any addition of new appraisers communicated to the Officer s Loan Committee. One of the appraisal firm's principals must be on our Approved Appraiser List before his or her associates can be added to our list. If an unapproved associate member of the appraisal firm performs the Appraisal, the approved appraisal firm s principal must sign the Appraisal Report as the Review Appraiser. The associate appraiser need not be on North Island's Approved Appraiser List. The Review Appraiser will be recognized as the responsible appraiser, not the associate appraiser. Appraisers must have the appropriate experience, knowledge and understanding of the marketplace and geographical location. Appraisers must be certified and in good standing with the State where the property being appraised is located. Appraisers should hold a valid State Certified General Appraiser License (AG) for multifamily and commercial properties, or a valid State Certified Residential Appraiser License (AR) for single family, 2-4 properties. Candidates for approval and addition to the Credit Union s Approved Appraiser List will provide documentation for review including: Resume detailing their appraisal background and education. Copy of their current State License or Certification. List of references with contact persons and phone numbers. Although not a condition for approval, evidence of MAI designation, when applicable. Page 3

4 Sample of a Self-Contained Narrative Appraisal Report on a commercial or a multi-family property that meets the requirements of Rule 2-2(a). Sample of a Summary Appraisal Report on a multi-family or commercial property that meets the requirements of Rule 2-2(b). If a Self-Contained Report is provided for the commercial property, a Summary Report should be provided for the multi-family example, or vice versa. The samples should contain all applicable exhibits and must be performed by the appraiser undergoing approval. Current Price List, if available. Copy of their current Errors and Omissions Liability Insurance Policy with a minimum coverage of $1,000, A statement regarding whether he/she, or their firm, have been sued by a regulatory agency or a financial institution for fraud or negligence involving an appraisal report. The appraiser must also report the outcome of any such lawsuit ANNUAL APPRAISER REVIEW PROCESS North Island will continually evaluate the quality of the appraiser's work through the normal on-going review of all new appraisal reports. In addition, on an annual basis, the Credit Union will perform a due diligence review and re-approval of all commercial appraisers on the Approved List. The Commercial RE Underwriter maintains a master file for each appraiser. The annual review process will include: The Commercial RE Underwriter will request and review any information necessary to update each appraiser master file and provide a summary of performance covering the prior twelve months for each approved appraiser. The Department Head of Business Services or Chief Credit Officer will review the summary of performance along with information detailing the number of appraisals submitted by the appraiser during the prior twelve months. Following this review, the Department Head of Business Services or Chief Credit Officer will determine whether or not the appraiser should remain on the Approved Appraiser List, which determination will be fully supportable and not related to values not meeting expectation. The reevaluated appraiser list will be provided to the Loan Committee for Page 4

5 reaffirmation, and also identify which individuals were removed from the approved list for cause, as applicable. The Credit Union will file a complaint with the appropriate State appraiser regulatory authorities when it is suspected that a licensed or certified appraiser violates USPAP, applicable Federal or State law, or engages in other unethical or unprofessional conduct. The Credit Union will file a suspicious activity report (SAR) with the Financial Crimes Enforcement Network of the Department of the Treasury (FinCEN) when suspecting fraudulent activity APPRAISAL QUOTES, APPRAISER SELECTION AND ENGAGEMENT Obtaining the appraisal fee quotes, selecting an appraiser and preparing the engagement letter are functions performed by the Credit Union s Loan Administration Department, which is independent of loan originations of the Business Services Department. When obtaining fee quotes, the Administrator will provide the appraiser with a description of the subject property such as the type, size, location and appraisal format required. Also if there are any unusual circumstances that would need to be taken into consideration for the appraiser to provide an appropriate fee quote. Under no circumstances will a Credit Union employee communicate a predetermined, expected, or qualifying estimate of value, or a loan amount or target loan-to value ratio to the appraiser. The Approved Appraiser list contains qualified, competent and independent appraisers that have gone through the Credit Union s approval process, which evaluated the education, expertise, experience, licensing and work product. The Administrator is responsible for selecting one of the appraisers from the approved list and is not inappropriately influenced by the lowest fee quote or speed of delivery. To request the services of an appraiser, the Administrator uses a written engagement letter that states the users of the report, identifies the subject property and includes a definition of the minimum appraisal requirements, specific appraisal requirements, report format and fiduciary relationship. The Credit Union s appraisal quotes, selection and engagement process includes: The Loan Administrator will obtain bids from several of the approved appraisers and select an appraiser for the appraisal assignment. The Loan Administrator will advise the Loan Officer of the selected appraiser, applicable fee and turn-around time. The Loan Officer will obtain the appraisal fee from the prospective borrower and request the Loan Administrator to engage the appraiser. Page 5

6 The Loan Administrator will prepare the engagement letter obtaining specific verbiage from the Loan Officer or Commercial RE Underwriter in identifying the appraisal problem or critical issues and include supporting property information relative to the valuation assignment, which may include a current rent roll, historical income and expenses and if a sales transaction, a copy of the sales contract. A copy of the Engagement Letter is retained in the loan file. Upon the Loan Administrator s receipt of the Appraisal Report and Invoice, they will be provided to the Commercial RE Underwriter for thorough review/analysis. To insure prudent safeguards and maintain independence, the Commercial RE Underwriter will not perform in a Relationship Officer/Loan Officer capacity, will not have any lending approval authority and will not receive compensation based on loan production results. The Interagency Guidelines recognize that it is not always possible or practical to separate the collateral review process from the loan production staff and provides some flexibility as long as safeguards are in place that will prevent a conflict of interest. In 2008 the Credit Union s appraisal review process was reviewed and approved by the NCUA Examiner in Charge and the MBL Specialist APPRAISAL FEE PAYMENT If the Credit Union has engaged the appraiser, the Business Services Department is responsible for paying the appraisal firm for services rendered. The borrower may not pay the appraiser directly MINIMUM APPRAISAL AND EVALUATION STANDARDS North Island follows the regulatory agencies' guidelines for federally regulated transactions. "Federally Related Transactions" are any real estate related financial transaction in which the agencies engage, contract for, or regulate, and that requires the services of an appraiser. A. For the federally related transactions, all Self-Contained and Summary Appraisals shall at a minimum: Conform to the Uniform Standards of Professional Appraisal Practice ("USPAP") adopted by the Appraisal Standards Board of the Appraisal Foundation and contain sufficient disclosure to allow intended users to understand the scope of work performed. The appraiser must certify that he/she has complied with USAP. Page 6

7 Contain sufficient information and analysis to support the institutions decision to engage in the transaction, with a level of detail sufficient to understand the appraiser s analysis and opinion. Disclose any steps taken that were necessary or appropriate to comply with the Competency Rule of the USPAP. Be based upon the definition of market value as set forth in NCUA Title 12 CFR; Part Definitions. The report may include separate value opinions such as going concern value, value in use or a special value to a specific property user as long as they are clearly identified and disclosed and not used as the appraiser s market value. Contain sufficient disclosure of the nature and extent of inspection and research performed. Provide an as is estimate of market value that considers the property s actual physical condition, use and zoning as of the effective date of the appraiser s opinion of value. State the real property interest being appraised. Include disclosure if the appraiser previously appraised the property. When developing an opinion of the value of a leased fee estate or a leasehold estate, provide analysis of the effect on value, if any, of the terms and conditions of the lease(s). Be written and presented in a narrative format or on forms that satisfy all requirements, and provide: Sufficient documentation with all pertinent information reported so that the appraiser s logic, reasoning, judgment and analysis in arriving at a conclusion indicate to the reviewer the reasonableness of the market value supported. Detail and depth of analysis that reflect the complexity of the real estate appraised. Describe the highest and best use both As If Vacant and As Improved representing the highest marketable use of the appraised property. Analyze and report in reasonable detail any prior sales of the property being appraised that occurred within three years preceding the date when the appraisal was prepared. Analyze and report data on current revenues, expenses, and vacancies for the property if it is and will continue to be income producing. Page 7

8 List significant deferred maintenance items and estimate the cost to cure. Analyze and report a reasonable marketing period for the subject property. Analyze and report on current market conditions and trends that will affect projected income or the absorption period, to the extent they affect the value of the subject property. Analyze and report appropriate deductions and discounts for any proposed construction, renovation, partially leased or leased at other than market rents as of the date of the appraisal, or any tract developments with unsold units. Include in the certification required by the USPAP an additional statement that the appraisal assignment was not based on a requested minimum valuation, a specific valuation, or the approval of a loan. Appraisers must state their independence in all appraisals. Race or racial composition of the neighborhood should not be considered as a reliable factor in the appraisal. Include the parcel number(s) of the subject property, in addition to the description required by the USPAP. Include the age and remaining economic life of the subject property. Identify and separately value any personal property, fixtures, or intangible items that are not real property, but are included in the appraisal, and discuss the impact of their inclusion or exclusion on the estimate of market value. Follow a reasonable valuation method that addresses the direct sales comparison, income and cost approaches to market value, reconciles those approaches, and explains the elimination of each approach not used. Disclose the name of the person(s) that made a personal inspection of the subject property and the name of any person(s) that provided significant assistance to the person signing the appraisal report. B. Appraiser Independence Although allowed by USPAP, the regulatory agencies' appraisal regulations do not permit an appraiser to appraise any property in which the appraiser has an interest, Page 8

9 direct or indirect, financial or otherwise. The Credit Union will follow the regulatory agency guidelines. C. Non Discriminatory Appraisal and Underwriting The Credit Union will not rely upon an appraisal of a dwelling, which appraisal the Credit Union knows, or reasonably should know, is discriminatory on the basis of the age or location of the dwelling, or is discriminatory per se or in effect under the Fair Housing Act of 1968, the Equal Credit Opportunity Act or the March 20, 1995 FNMA memo entitled "Fair Lending and the Appraisal Process." D. Unavailability of Information If information required or deemed pertinent to the completion of an appraisal is unavailable, that fact shall be disclosed and explained in the appraisal. E. Borrower s Right To Receive Copy of Appraisal Report It is the Credit Union's procedure to provide the borrower with a copy of the appraisal report used in connection with the application for credit. F. Code Violations All appraisers are required to report major code violations discovered during the appraisal process. G. Appraisal Exemptions There are certain real estate related financial transactions that do not require the services of an appraiser and are exempt from the appraisal requirement. However, for transactions with higher risk characteristics, which include loan size, atypical location, and complexity of the loan or collateral, refer to the Subsequent Transaction Risk Chart in this procedure to determine the appropriate valuation method. Appendix A of the Interagency Appraisal and Evaluation Guidelines dated December 2, 2010 includes several exemption categories. For the Credit Union s commercial real estate new loan originations and subsequent transactions, one of the following three may apply: Appraisal Threshold Exemption A loan transaction where the amount of the loan or extension of credit is $250,000 or less. To identify the appropriate type of valuation, refer to the Valuation Format Requirements for New Loan Originations discussed later in this procedure. Page 9

10 o If there are multiple properties that will secure a loan transaction that are not a part of a tract development, the estimate of value for each individual property will determine whether an appraisal or evaluation is required. If the individual property value is $250,000 or less the Exemption applies regardless of the loan amount. If the individual property value is over $250,000 the Appraisal Threshold Exemption does not apply. Abundance of Caution Exemption A lien on real property that has been taken as collateral through an abundance of caution and where the terms of the transaction as a consequence have not been made more favorable than they would have been in the absence of a lien. The loan must be fully supported by the primary and secondary repayment sources, without consideration of the real estate taken as an abundance of caution. No valuation method is required as long as the credit analysis documents the adequacy and reliability of the repayment sources and concludes that knowledge of the market value of the real estate being taken as an abundance of caution is unnecessary in making the credit decision. Subsequent Transaction Exemption 1 Updating collateral valuations is an essential part when considering a subsequent transaction. Under certain circumstances transactions for renewals, modifications, loan assumptions and rate and term refinances of existing credit union loans may be supported by Evaluations rather than Appraisals. In some cases loan workouts may also be considered under the subsequent transaction exemption. Refer to the specifics per transaction type in this procedure. A subsequent transaction may be exempt from the appraisal requirement if: i. There is no advancement of new monies, other than funds necessary to cover reasonable closing costs, and 1 This section, as written, is consistent with our interpetation of the various regulations and interagency guidance documents; however, we have been advised otherwise by our governering authorities. Until such time as the NCUA reviews and revises section 722, we will practice a more conservative approach. Renewals (extenstion of the maturies) for loans in excess of $250,000 will always require compliant appraisal reports. Strictly market based modifications, for fully quallified borrowers where the LTV is under 80% the updated collateral value may be documented with an Evaluation. These are defensive, portfolio protection transactions where the Credit Union is adjusting the rate to prevent the loss of qualified loan to a competing financial instituion. If there is any weakness with the credit, cash flow or collateral value, the credit union must obtain a new appraisal before proceeding with the transaction. Page 10

11 ii. There is no obvious and material change in market conditions or physical aspects of the property that threaten the adequacy of the Credit Union s real estate collateral protection after the transaction. At first glance, NCUA (a)(5)(i) and (ii) (points i and ii above) would lead one to believe that a material change in the market value of the property or region would require the credit union to obtain a new appraisal for the renewal, refinance, rollover or modification of an existing Member Business Loan even if no new monies are advanced in the transaction. However, the Interagency Appraisal and Evaluation Guidelines (Evaluation Guidelines) issued jointly by the NCUA and other financial institution regulators on December 2, 2010, further helps us to understand the intent of 722.3(a)(5)(ii). Appendix A Section 7 of the Evaluation Guidelines specifically states: To satisfy the condition for no obvious and material change in market conditions or the physical aspects of the property, the current or planned future use of the property should be consistent with the use identified in the existing appraisal or evaluation. For example, if a property has reportedly increased in value because of a planned change in use of the property resulting from rezoning, an appraisal should be performed unless another exemption applies. What this helps us to understand is that the regulation is not referring to changes in market value, but changes in the actual condition and/or use of the subject property itself. As long as the current or planned use of the property is the same as that indicated in the original appraisal, and there are no new monies advanced, the transaction is specifically exempted from requiring a new appraisal and an evaluation is acceptable. If there are higher risk characteristics in the loan and the subsequent transaction causes the credit union s collateral protection to be adversely affected, refer to the Subsequent Transaction Risk Chart in this procedure to determine the appropriate valuation method. H. Evaluation If an appraisal exemption applies, an Evaluation in lieu of an Appraisal is an acceptable method for determining the market value of a property. Written evaluations may be performed by a qualified Commercial RE Underwriter, Credit Analyst, Loan Officer or the Department Head of Business Services or Chief Credit Officer as long as the individual performing the evaluation is independent of the approval process and can neither approve nor vote as a committee member on proposed new, renewed or modified loans. Evaluations are reviewed by a qualified and experienced individual, which includes the Business Services Loan Officers, Underwriters, Department Head or the Chief Credit Officer as long as they were not a party to the completion of the Evaluation and are independent of the approval process. The reviewer will confirm the rationality of the analysis, assumptions and calculations that were used to prepare the Evaluation and sign, date and provide comments Page 11

12 as applicable directly on the Property Evaluation Form. In addition, the quality of the Evaluations is monitored through the loan approval process and through the on-going independent audit of the commercial real estate loans. The Evaluation will contain sufficient information and analysis to support the value conclusion and address the property s actual physical condition and circumstances due to the current market conditions. If there is not sufficient information to adequately perform an Evaluation, an Appraisal, either updated or new, is required to determine market value. If there is sufficient information to adequately perform an Evaluation, the Property Evaluation Form is completed, reviewed and maintained in the loan file with the supporting documentation. At a minimum the Evaluation will include: A description of the property including the current use and location. An inspection or research to determine the property s actual physical condition and exterior photos of the property. Information on current economic conditions and local market trends. Description of the analysis performed and supporting information used in valuing the property. For evaluation purposes, a minimum of two of the following methods will be employed and the narrative must reconcile and opine any differences. The following valuation methods are also used for portfolio monitoring (refer to MBL-2800 CRE Loan Reviews and Portfolio Monitoring) where in that instance one method may suffice to provide a valuation. The various methods are: Direct Capitalization Method: For an income producing property, utilization of the actual income and expense figures. The analysis will include application of a market vacancy factor after taking into consideration the occupancy level represented in the income figure, and a capitalization rate based on a market trend analysis performed by a reputable commercial real estate brokerage firm or contained in recently reviewed new appraisal reports. If the income and expense figures used in this analysis reflect items such as high vacancy, considerable short term rent concessions and non-recurring one-time expenses, another valuation method may be considered. Sale Listings and Comparables: For additional support in an evaluation, the property sales or listings of similar product, zoning, size, age and location made available through reliable sources such as a reputable commercial real estate brokerage firm, online information services provider, recorded sales or an appraiser on the Credit Union s Approved list may be utilized. Adjustments may be warranted due to the property characteristics, transaction date, physical condition and condition of sale. Page 12

13 Portfolio Stress Test Model: For existing loans where an appraisal report was obtained at loan origination, utilization of the Credit Union s Portfolio Stress Test Model may be an effective tool in valuing a property. The Model takes into consideration the market changes that have occurred since the date of the appraisal report and was developed with the assistance of one of our approved appraisers and a reputable commercial real estate brokerage firm. Broker Price Opinion: For existing loans on owner user properties, or for loans with a potential for additional risk, a Broker Price Opinion, based on current market conditions may be used to develop a market valuation. If the loan transaction contains higher risk characteristics, an evaluation may not be sufficient to determine market value. Refer to the Subsequent Transaction Risk Chart in this procedure to determine the appropriate valuation method. I. Valuation Format Requirements for New Loan Originations There are three appraisal formats utilized for multi-family and commercial property: Restricted Use Report: This format provides a capsulated report. A Restricted Use Report should state the appraisal procedures followed, the value opinion and the conclusion reached. Supporting details are maintained in the appraiser s files. Summary Report: This format presents the information in a condensed manner. Summary Reports at a minimum should summarize the information analyzed, appraisal procedures followed and include the reasoning that supports the appraiser s analysis, opinions and conclusions. Self-Contained Report: This format provides the most detail. Self Contained Reports should include sufficient supporting documentation with all pertinent information reported so that the Appraiser's logic, reasoning, judgment, and analysis in arriving at a conclusion indicate to the reader the reasonableness of the market value reported. The FNMA/FHLMC Form Appraisal is acceptable for single family and 2-4 properties. The valuation format listed in the following chart reflects minimum requirements for new loan originations and may be upgraded based on the risk, size and complexity of the loan and the collateral. Amount LTV Appraisal Report Format Page 13 Comments/Alternate Valuation Documentation $250,000 or Less 50% or less None At a minimum, Lender s Drive By Inspection Report and an Evaluation

14 analysis or a Restricted Use Appraisal. $250,000 or Less Over 50% Restricted Use Restricted Use Appraisal and Lender s Drive By Inspection Report. $250,001 to $2,000,000 N/A Summary Report Appraiser will determine if a Narrative or a Form style of Summary Report is appropriate for the type of property. Over $2,000,001 N/A Self- Contained Report Or on any loan size if complex property and additional narrative would be beneficial. J. Valuation Requirements for Refinancing, and Renewing Existing Credit Union Loans If the transaction is a Non Cash Out Refinance and fits within the subsequent transaction exemption definition, an Evaluation may be used to determine the market value. If the transaction is a Cash Out Refinance, then the loan does not fit within the subsequent transaction exemption definition and a new Appraisal report is required using the Appraisal Format Requirements for New Loan Originations chart. If the transaction is a Renewal and fits within the subsequent transaction exemption definition, an Evaluation may be used to determine the market value. o The transaction is considered a Renewal if the existing credit union loan is either matured or nearing maturity (within one year) and may include bringing the loan to market rates and terms. For a Refinance or a Renewal where there are higher risk characteristics, refer to the Subsequent Transaction Risk Chart in this procedure to determine the appropriate valuation method. An existing Appraisal that has been previously reviewed and approved by the Credit Union may be used to support a subsequent transaction as long as it has been performed within the last nine months and the Credit Union s review of current market trends support the appraiser s market value of the property. A new appraisal report is not necessary if an Evaluation appropriately updates the previous appraisal to reflect current market conditions. Page 14

15 LOAN MODIFICATIONS AND WORKOUTS If the transaction is a Modification and fits within the subsequent transaction exemption definition, an Evaluation may be used to determine the market value. The transaction is considered a Modification if no hardship exists and the changes include items such as market based interest rate, term and structure and the existing maturity date has more than 12 months remaining. If the transaction is a Workout and fits within the subsequent transaction exemption definition, an Evaluation may be used to determine the market value. The restructure of a performing loan is not considered a Workout solely because the value of the underlying collateral has declined to an amount that is less than the loan balance. When a well defined weakness (hardship) exists that would jeopardize the repayment of the loan and there are lender concessions it is considered a workout situation. For a Modification or Workout where there are higher risk characteristics and/or the repayment of the loan becomes more dependent on the sale of the collateral, refer to the Subsequent Transaction Risk Chart in this procedure to determine the appropriate valuation method. For a Modification or Workout if recommended by a Loan Participant, the Credit Union may engage the appraiser to update the original report or order a new report from a different appraiser through the Credit Union s established appraiser selection, ordering and review process. The decision on selecting a new or updated report will be determined by the Loan Officer, Commercial RE Underwriter and/or Loan Participant. The final decision will be made by either the approval authority or Chief Credit Officer SUBSEQUENT TRANSACTION RISK CHART If the subsequent transaction involves higher risk characteristics which include loan size, atypical location, and complexity of the loan or collateral an alternative valuation technique may be required. Medium Risk Factors Single use property that could be converted to High Risk Factors Single use property such as church or car wash. Page 15

16 w/cash Out more generic uses with modest investment. Owner user or non arms length lease taints NOI data; however comparable sales data is available. Loan is expected to continue to pay, but there are some concerns of future deterioration. Appraisal Unique nature of property provides limited NOI and there is limited comparable sales data for analysis. Borrower is experiencing hardship and there is high probability that the loan will become collateral dependent. Appraisal No Cash Out (other than costs and fees) Loan Amount Under $250,000 Evaluation Evaluation $250M to $3.5MM See Estimated LTV See Estimated LTV Over $3.5MM See Estimated LTV Appraisal Estimated LTV (Based on an Evaluation) LTV under 50% w/high confidence Evaluation LTV under 50% w/medium confidence Evaluation LTV under 50% w/low confidence See Condition LTV under 70% w/high confidence See Condition LTV under 70% w/medium confidence See Condition LTV under 70% w/low confidence Appraisal Evaluation Evaluation See Condition See Condition Appraisal Appraisal LTV over 70% Appraisal Appraisal Condition Property/market area as good or better as from last valuation Property/market area is showing some signs of deterioration Evaluation Evaluation Evaluation Appraisal Page 16

17 Property/market has deteriorated significantly Appraisal Appraisal APPRAISALS OBTAINED FROM OTHER FINANCIAL INSTITUTIONS According to the Interagency Guidelines, the Credit Union may use an Appraisal that was prepared by an appraiser engaged directly by a federal insured financial institution. The appraisal may not be readdressed and an assignment of the appraisal is not required. Research indicates (as obtained from Banker s Compliance Group) that a letter reassigning the appraisal to North Island, provided by the original engaging financial institution, is of very little use and does not provide recourse against the appraiser. It would therefore be considered an exception to procedure to use a report not engaged by North Island and use of the report would have to be justified with mitigating conditions. Another exception to procedure would be if the appraiser performing the appraisal is not on the Credit Union s approved list. A thorough review and analysis will be performed to confirm that the appraisal complies with the appraisal regulations and Credit Union s guidelines and has sufficient information to support the loan decision. The other institution must have directly ordered the appraisal and must deliver it to the Credit Union. An appraisal ordered by the borrower or delivered to the Credit Union by the borrower is unacceptable. For the report to be considered, it must be no more than nine months old and supported by the Credit Union s review of current market trends APPRAISAL REVIEW The review of the appraisal is one of the most critical steps when considering a loan request. The value of the security for our loan is of utmost importance. We must have the safeguard that, if all else fails, we still have the property and its value. The Credit Union reserves the right to perform field reviews on any appraisals at any time. The Commercial RE Underwriter will perform a comprehensive review and analysis of the appraisal and determine whether the market value of the subject property and the market NOI are fully supported in the appraisal and meet the collateral criteria set out for the loan request, prior to final approval and loan funding. To support the Credit Union s risk focused approach to the appraisal analysis, the reviewer may implement and document a more conservative rationale resulting in a downward adjustment to the value supporting the final loan amount. Under no circumstances will there be an upward adjustment to the market value established in the appraisal report. After the appraisal review is complete, the Loan Officer is advised of the results of the appraisal review. The Commercial RE Underwriter will continue to maintain independence by not performing in a Relationship Officer/Loan Officer capacity, not having any lending approval authority and not being compensated based on loan production results. Page 17

18 All commercial real estate appraisals will be thoroughly reviewed/evaluated to determine the scope of work is appropriate for the assignment and the methodology and rationale provides sufficient support for the appraiser s opinion of the property s market value. A Non- Residential Property Appraisal Review Form will be prepared by the Commercial RE Underwriter and made part of the loan file. In addition, if the appraisal includes an income approach to value, the Underwriter will complete and include a Real Estate Valuation Model. If after the review there are items that need clarification or correction, the Commercial RE Underwriter will notify the appraiser and retain a copy of the transmission in the loan file. The approved appraiser will be expected to either justify or correct any material differences identified by the Commercial RE Underwriter prior to North Island s acceptance of the appraisal. Additionally, the approved appraiser will be expected to respond to similar questions raised by any internal or external credit review examiner as long as they are submitted by authorized North Island staff. If there are significant deficiencies in the appraisal that can not be resolved, the Commercial RE Underwriter will notify the Business Services Department Head or Chief Credit Officer, and document the loan file. A second appraisal may be ordered or an appraisal review, performed by another of the Credit Union s approved appraisers. In this situation, the appraiser s master file is notated and depending on the severity of the issue, may be removed from the Credit Union s approved appraiser list and if applicable, reported to a state appraiser regulatory official. Additionally, secondary appraisal reviews on loans over $3,000,000, or on all appraisals reviewed by a Loan Officer in the Underwriter s absence, will be performed by Risk Management/Internal Audit. If a Loan Officer performs the review in the Underwriter s absence, they can not be the same Loan Officer responsible for the transaction (the Relationship Manager) ADDITIONAL REPORTING STANDARDS - INCOME PRODUCING PROPERTY If the property being appraised is in operation, current rents, expenses, and occupancy rates must be identified, analyzed and reported in reasonable detail. Additionally, any leases that encumber the appraised property must be analyzed and described in reasonable detail. If the property being appraised has an operating history, the appraisal report must contain a summary of the property's historical financial performance as well as a forecast of its expected future performance. If there is more than a nominal difference between historical and future performance, the discrepancy must be explained in reasonable detail. Income and expense schedules are to be presented in the report to correlate previous performance levels with the present and any future projections. Correlation of the past, present and future levels should be made by the appraiser in the report itself. Page 18

19 If sale, rental or financing concessions are being used or have been used to achieve or maintain occupancy of subject, such concessions must be described and their effect on marketability and value must be quantified. All rates, ratios and multipliers used in the appraisal analysis must be supported by market evidence. The use of national surveys should be supported by local information and trends. A discounted cash flow is required for all properties that are not at stabilized occupancy or below their anticipated performance levels. First year income and expenses should reflect the property's actual circumstances. Potential gross income should reflect actual income for occupied leased space and market or obtainable rent for the unoccupied space. Deductions for excess rent, lease-up, etc. should be itemized. The appraiser should correlate the effective gross income and expenses with owner/management provided documentation. All projections for successive years should correlate with recent past performance levels and market trends. If the subject property has not achieved a stabilized level of long term occupancy, the appraiser must report the "As Is" value as well as the prospective value upon reaching stabilized occupancy ADDITIONAL REQUIREMENTS DEVELOPMENTAL PROPERTY Special Notation: Construction lending is currently suspended until further action from regulating authorities. Developmental property may consist of: Any property, the market value of which is contingent on future events and capital outlays, such as installation of on-site or off-site improvements; new construction, rehabilitation, or tenant improvements, or Any property wherein a portion of the overall real property rights or physical assets would typically be sold to their ultimate user over a future time period (subdivisions/proposed tract development /condos). Page 19

20 Completed multi-tenant buildings for which the appraisal contemplates a marketing/lease up period before stabilized occupancy can be achieved are also included in this definition. Appraisals on all properties wherein a portion of the overall real property rights or physical assets would typically be sold to their ultimate user over a future time period should report the following estimates of value: Market Value As Is On Appraisal Date - Market Value of the property appraised in the condition observed upon inspection and as it physically and legally exists without hypothetical conditions, assumptions or qualifications on the effective date of appraisal. Market Value As If Complete On Appraisal Date - Market Value of the property with all proposed construction, conversion, or rehabilitation hypothetically completed, or under other specified hypothetical conditions, as of the date of the appraisal. With regard to properties where anticipated market conditions indicate that stabilized occupancy is not likely as of the date of completion, this estimate of value shall reflect the market value of the property as if complete and prepared for occupancy by tenants. That is, the value includes the undiscounted anticipated cost of tenant improvements for the level of occupancy contemplated as of stabilized occupancy. Prospective Future Value Upon Completion of Construction - Same as Market Value As If Complete on Appraisal Date except that the prospective future value applies based upon market conditions forecast to exist as of the completion date. Appraisals on all properties for which anticipated market conditions indicate stabilized occupancy is not likely as of the date of completion should report the following estimates of value and include approximate dates indicating when achievement of prospective future values is expected: "Market Value As Is On Appraisal Date" as defined; "Market Value As If Complete On Appraisal Date" as defined; "Prospective Future Value Upon Completion Of Construction" as defined; "Prospective Future Value Upon Reaching Stabilized Occupancy On The Date Of Stabilization" as defined; and Prospective Future Value Upon Reaching Stabilized Occupancy - The prospective future value of a property as of a point in time when all improvements have been physically constructed and the property has been leased to its optimum level of long Page 20

21 term occupancy. At such point, all capital outlays for tenant improvements, leasing commissions, marketing costs and other carrying charges are assumed to have been absorbed. In arriving at Market Value As If Complete On Appraisal Date and/or Prospective Future Value Upon Completion Of Construction and/or Upon Reaching Stabilized Occupancy, the appraiser shall take into consideration and justify the anticipated pattern of revenues and expenses expected to be realized during the marketing or lease-up period, as well as additional capital outlays for such items as tenant improvements, sale or leasing concessions, and sale or leasing commissions. Appropriate deductions and discounts should be taken when arriving at such value estimates. Appropriate deductions and discounts are considered to be those that reflect all expenses associated with disposition of the property (such as sales and marketing expense), holding costs (such as taxes, insurance and overhead), cost of capital (interest or discount), and entrepreneurial profits sufficient to compensate a purchaser for the effort and business risk associated with the anticipated benefits to be received. Estimation of Prospective Future Value Upon Reaching Stabilized Occupancy does not require deductions or discounts since it is assumed that all expenses and risks of completion and marketing will have been absorbed prior to that date. Such estimates must take into consideration both existing and future competition. It is emphasized that Prospective Future Value is not Market Value because market conditions cannot be known in advance. It is expected that the appraiser cannot have the same level of confidence of such an opinion as he or she could have of an opinion of current market value, even under hypothetical conditions. Such estimates are advisory and should be viewed as one of many factors affecting discounted cash flow analysis or as an accommodation to the Loan Officer/Underwriter to aid in the scheduling of loan disbursements. They should not be viewed as either present or prospective Market Value. When the Credit Union is made aware of significant changes in plans and specifications from those on which the appraisal was based, it is the responsibility of Management to promptly request review by the appraiser to confirm or modify original value estimate. For relatively uncomplicated properties, market analysis and economic feasibility need be performed only at a level sufficient to provide the Underwriter with reasonable assurance that the proposed building will fulfill an economic demand and have a reasonable probability of success. On more complex properties, the level of market analysis and economic feasibility to be conducted should be of the highest order. Unless Management is confident the appraiser has the necessary expertise for such analysis, third party analysts should be employed. Such analysts should be screened and approved by the Department Head of Business Page 21

22 Services in the same manner as Appraisers; unusual care must be exercised to assure that the studies are objective and competent ADDITIONAL REQUIREMENTS FOR RESIDENTIAL SUBDIVISIONS Special Notation: Construction lending is currently suspended until further action from regulating authorities. All residential subdivisions developed to sell as lots or single family homes will be appraised for market value and prospective value upon completion of the first house(s) if the collateral is the build out of houses or at completion of land development improvements if the collateral is the land project only. All subdivision appraisals are to also contain: Description of the physical and legal conditions of property at date of inspection, including development density and allowable approvals. A land value estimate supported by comparisons with properties that have sold and are similar in size to the subject, contain the same bundle of rights, have the same highest and best use. Reconciliation of the builder's estimated costs. Analysis of the property by direct comparison of bulk sales where markets demonstrate sales of complete or nearly complete residential subdivision projects prior to absorption. Market abstraction techniques and cash flow analysis may be used to support sales comparison especially when sales are limited. The timing of all phases of the project (and their associated cash flows) in a discounted cash flow analysis to include the timing of land development and construction, and the cost and timing required for absorption of all completed units. Support for all assumptions in the discounted cash flow analysis including projected sales prices and absorption that recognizes market conditions anticipated at the time the product is expected to be available for sale. Page 22