Automated Valuation Models, a sophisticated risk management tool.

In a span of less than 20 years Automated Valuation Models (AVMs) have evolved from an inexact technology tool used primarily to determine risk for collateralized loan purchases to a sophisticated analytical product widely used throughout the originating, investing and servicing industries. Current uses for AVM and AVM Cascade products include appraisal review, portfolio review and analysis, prequalification screening, RMBS and ABS securitization, loan underwriting (as outlined in the Interagency Appraisal and Evaluation Guidelines), as well as various loan servicing and asset management applications.

Lina Piedrahita of Resolute Asset Management uses AVMs along with a second opinion BPO to validate their market value. She states that the AVM, “gives us a broader outlook of the market conditions, which we use to compare to the agent’s valuations and support our marketing recommendation.”

AVMs are a sophisticated risk management tool that can streamline the lending process, assist with reconciling value discrepancies and help mitigate fraud risk, but the product does have its limitations. Without knowing the current condition of the property the AVM value assumes ‘average’ condition for the area; this is an obvious drawback with properties in fair to poor condition, non-conforming properties or in neighborhoods with a large range of values. AVM values are most accurate in urban and suburban homogenous neighborhoods. Without the eyes and ears of a professional it is impossible to adjust for important locational factors that can exist within a one mile radius. A property’s view, proximity to commercial buildings or railroad tracks and the pride of ownership in the immediate neighborhood, among other factors, can cause extreme value shifts within a mini-market.

Some of the advantages AVMs have over other valuation methods including appraisals and broker price opinions are their immediacy, cost effectiveness and the unbiased nature of the product; results are strictly analytical and not subject to pressure from lenders. The quality and accuracy of AVM products have been thoroughly tested by AVM producers, lenders and third party testing agencies.

The more recent addition of AVM ‘cascade’ and ‘hybrid’ products have further expanded and strengthened the product’s footprint. An AVM cascade provides the end user with the highest rated report pulled from multiple products, improving accuracy and hit rate. Hybrid products typically include an exterior or interior inspection or BPO with the AVM, providing the crucial property condition component to the AVM product.

Regulatory agencies first referenced analytical tools in a 2000 OCC bulletin; AVMs themselves were first mentioned in OCC bulletins in 2004 and 2005. However it was not until the 2010 Interagency Appraisal and Evaluation Guidelines that federal agencies validated the expanded use of AVM products. These guidelines, revised from the 1994 rules and Issued by the OCC, FRB, FDIC, OTS & NCUA, lay out the framework for the appropriate use of appraisal and evaluation products. According to the Interagency Guidelines, “ An AVM may be used for a transaction provided the resulting evaluation meets all of the supervisory expectations in the ‘Evaluation Development’ and ‘Evaluation Content’ sections in the guidelines, is consistent with safe and sound banking practices, and produces a credible market value conclusion.”

However the Evaluation Development section of the Guidelines warns against using a product that does not provide sufficient information and analysis to support the value conclusion; “A valuation method should address the property’s actual physical condition and characteristics as well as the economic and market conditions that affect the estimate of the collateral’s market value. It would not be acceptable for an institution to base an evaluation on unsupported assumptions, such as a property is in average condition, the zoning will change, or the property is not affected by adverse market conditions.” Additionally, the Evaluation Content section specifies that among other things, an Evaluation must identify the location of the property, provide a description and its current and projected use, and describe the method used to confirm the physical condition of the property and the extent to which the inspection was performed.

The responsibility for determining an appropriate collateral valuation method and determining the risks associated with those methods lies squarely on the financial institution. It is important that each institution establishes internal policies and procedures governing appraisal, BPO and AVM use and what supplemental products are required or recommended with each.

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