Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Proposed Rules 64997

1See Title XI’s Statement of Purpose. 12 U.S.C.

3331.

2See 12 U.S.C. 3350(5). 3See 59 FR 29482 (1994).

FEDERAL RESERVE SYSTEM

12 CFR Part 225

[Regulation Y; Docket No. R–0990]

Real Estate Appraisals

AGENCY: Board of Governors of the

Federal Reserve System.

ACTION: Notice of proposed rulemaking.

SUMMARY: The Board of Governors of the

Federal Reserve System is soliciting

comments on a proposed amendment to

subpart G of the Board’s Regulation Y,

Appraisal Standards for Federally

Related Transactions, to exempt any

transaction involving the underwriting

or dealing of mortgage-backed securities

from the Board’s appraisal

requirements. This amendment would

permit a bank holding company or a

nonbank subsidiary of a bank holding

company engaged in underwriting and

dealing in securities (a so-called section

20 subsidiary) to underwrite and deal in

mortgage-backed securities without

demonstrating that the loans underlying

the securities are supported by

appraisals that meet the Board’s

appraisal requirements.

The Board is proposing this

amendment to address concerns raised

by bank holding companies regarding

the inability of section 20 subsidiaries to

actively participate in the commercial

mortgage-backed securities (CMBS)

market due to the appraisal restrictions

of subpart G.

DATES: Comments must be received on

or before January 8, 1998.

ADDRESSES: Comments should refer to

Docket No. R–0990 and may be mailed

to Mr. William W. Wiles, Secretary,

Board of Governors of the Federal

Reserve System, 20th Street and

Constitution Avenue, N.W.,

Washington, D.C., 20551. Comments

addressed to Mr. Wiles may also be

delivered to the Board’s mail room

between 8:45am and 5:15pm, and to the

security control room outside of those

hours. Both the mail room and the

security control room are accessible

from the courtyard entrance on 20th

Street between Constitution Avenue and

C Street, N.W. Comments may be

inspected in Room MP–500 between

9:00am and 5:00pm weekdays, except as

provided in § 261.8 of the Board of

Governors’ Rules Regarding Availability

of Information, 12 CFR 261.8.

FOR FURTHER INFORMATION CONTACT:

Norah M. Barger, Assistant Director

(202/452–2402), or Virginia M. Gibbs,

Senior Supervisory Financial Analyst,

(202/452–2521), Division of Banking

Supervision and Regulation; or Deneen

L. Donnley-Evans, Staff Attorney (202/

736–5567), Legal Division; Board of

Governors of the Federal Reserve

System, 20th Street and Constitution

Avenue, N.W., Washington, DC 20551.

SUPPLEMENTARY INFORMATION:

Background

Title XI of the Financial Institutions

Reform, Recovery, and Enforcement Act

of 1989 (FIRREA), 12 U.S.C. 3331 et

seq., directed the federal banking

agencies (the agencies) to publish

appraisal rules for federally related

transactions within the jurisdiction of

each agency. The stated purpose of the

legislation is to provide that federal

financial and public policy interests in

real estate-related transactions will be

protected by requiring that real estate

appraisals utilized in connection with

federally related transactions are

performed in writing, in accordance

with uniform standards, and by

individuals whose competency has been

demonstrated and whose professional

conduct will be subject to effective

supervision.1

Section 1121(4) of FIRREA, 12 U.S.C.

3350(4), defines a federally related

transaction as a real estate-related

financial transaction that is regulated or

engaged in by a federal financial

institutions regulatory agency and

requires the services of an appraiser.

Section 1121(5), in turn, defines a real

estate-related financial transaction as

any transaction that involves: (1) the

sale, lease, purchase, investment in or

exchange of real property, including

interests in property, or the financing

thereof; (2) the refinancing of real

property or interests in real property;

and (3) the use of real property or

interests in real property as security for

a loan or investment, including

mortgage-backed securities (emphasis

added).2 In enacting Title XI, Congress

envisioned that competent appraisals in

these transactions would reduce the risk

of loss to the deposit insurance funds,

regulated institutions, and the

secondary markets, arising from a

financial institution’s lending activities

where real estate is taken as collateral.

In 1990, in accordance with the

mandates of Title XI, the agencies

adopted appraisal regulations for

federally related transactions within

their jurisdiction, and exempted certain

real estate-related transactions from the

appraisal requirements of Title XI. In

June 1994, several existing exemptions

to the appraisal regulation were

modified and new exemptions were

added. At that time, the agencies

clarified that a regulated institution

investing in a mortgage-backed security

or similar instrument need not obtain

new Title XI appraisals for the

underlying loans so long as the loans

met regulatory appraisal requirements

for the institution at the time the real

estate-secured loan was originated.3

This requirement also applies to the

activity of underwriting and dealing in

mortgage-backed securities.

In adopting this requirement, the

agencies did not foresee that requiring

evidence that the loans underlying

mortgage-backed securities had

appraisals would be a difficult task. The

mortgage securities market consisted of

securitized 1-to-4 family residential

loans, most of which were generated in

accordance with the agencies’ appraisal

requirements. The appraisal regulation

appears not to have hindered the

secondary market in 1-to-4 family

mortgages, for two reasons. First, the

Federal National Mortgage Association

(Fannie Mae) and the Federal National

Mortgage Corporation (Freddie Mac)

dominate the market for the

underwriting and dealing of residential

mortgage-backed securities, and neither

bank holding companies nor their

investment banking competitors have

large stakes in this market. Second,

banks and bank holding companies have

not been prevented from investing in

such securities, even though the

underlying mortgages may not have

conforming appraisals, because the

interagency appraisal regulations

contain an exemption for any

transaction that qualifies for sale to, or

involves a residential real estate

transaction in which the appraisal

conforms to the appraisal standards of,

a United States government or

government-sponsored agency,

including Fannie Mae and Freddie Mac.

However, recent developments in the

emerging CMBS market, including the

recovery of the commercial real estate

market, the wider acceptance of

collateralized securities, the significant

expansion of the CMBS market, and the

operation of the agencies’ appraisal

regulations, have worked to bar banking

organizations from actively participating

in the CMBS market’s growth.

Proposed Amendment

The Board proposes to amend its real

estate appraisal regulation to permit

bank holding companies and their

nonbank subsidiaries to underwrite and

deal in mortgage-backed securities

without demonstrating that the loans

underlying the securities are supported
64998 Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Proposed Rules

4Consistent with the Board’s policy of imposing

operating restrictions according to risk, the Board

also proposes to permit section 20 subsidiaries to

underwrite and deal in both residential and

commercial mortgage-backed securities without

demonstrating that the loans underlying the

securities are supported by appraisals that meet the

Board’s appraisal requirements. In this regard, the

Board notes that residential mortgage-backed

securities are considered far less risky than CMBS

as 1-to-4 family residential mortgages have one of

the lowest historical loss rates of any credit-related

asset class. The Board expects this exemption to

affect a relatively small number of transactions

because, as previously noted, the vast majority of

loans underlying residential mortgage-backed

securities meet the appraisal standards of Fannie

Mae or Freddie Mac, and thus qualify for an

exemption under the agencies’ appraisal

regulations. See e.g. 12 CFR 225.63(a)(10).

5Between 1992 and 1996, approximately $100

billion of CMBS were issued, all of which are still

outstanding.

6For example, of the $30 billion of new CMBS

issued in 1996, only $2.4 billion involved the

collateralization of loans underwritten by

commercial banks.

7See Title XI’s Statement of Purpose. 12 U.S.C.

3331.

8See Real Estate Appraisal Reform Act of 1988,

H.R.Rep. No. 100–101, 100th Cong., 2d Sess., pt. 1

at 19 (1988); 135 CONG. REC. H10, 709 (daily ed.

November 20, 1987) (statement of Rep. Barnard).

by appraisals that meet the Board’s

appraisal requirements. However, in

practice, the proposed amendment

would only apply to the section 20

subsidiaries because, to date, section 20

subsidiaries are the only regulatedinstitution affiliates permitted to

underwrite or deal, to a limited extent,

in corporate debt and equity securities.4

The CMBS Securities Market

The CMBS market has been in

existence since the mid-1980s, with

banking organizations, investment

banks, and insurance companies serving

as the primary underwriters of CMBS.

Recently, there has been significant

growth in new CMBS issues. In 1996,

$30 billion of new CMBS were issued,

a 50 percent increase over the $20

billion issued in 1994, and new

issuances of $25 billion to $35 billion

are expected in 1997.5 Approximately

90 percent of the tranches of new CMBS

issues are rated investment grade.

In recent years, the majority of new

CMBS issuances have involved loans

originated by nonbank financial

companies that are not subject to the

agencies’ appraisal requirements.6

While the Board has not studied

whether these companies generally

obtain appraisals conforming to Title XI

requirements upon origination of the

underlying loans, anecdotal evidence

suggests that many of the underlying

loans originated by these institutions do

not have Title XI conforming appraisals.

In addition, although commercial bank

participation as lenders and investors in

this market is expected to increase as

larger national and regional banking

organizations reenter the real estate

lending business, banking organizations

and their affiliates currently are

precluded from actively participating in

this market because the majority of the

loans underlying CMBS issuances do

not have Title XI conforming appraisals.

Policy Considerations

As noted above, Title XI’s purpose

and intent was to protect ‘‘federal

financial and public policy interest’’ in

real estate-related transactions.7 Those

‘‘federal interests’’ were described in

predecessor legislation and

accompanying Congressional reports as

encompassing the federal government’s

role as: (1) regulator and insurer of

financial institutions; (2) guarantor or

lender on mortgage loans; (3) as a direct

party itself in real estate-related

transactions; and (4) as the overseer of

financial markets and real estate-related

investments therein.8

The Board believes that permitting

section 20 subsidiaries to underwrite

and deal in mortgage-backed securities

without obtaining appraisals that meet

the Board’s appraisal requirements will

not lead to substantial losses for bank

holding companies or pose a systemic

risk to the banking system. The Board

notes that section 20 subsidiaries have

the expertise necessary to evaluate the

credit risks involved in underwriting

and dealing mortgage-backed securities.

In this regard, the Board notes that,

section 20 subsidiaries are subject to an

operational and managerial

infrastructure inspection prior to being

permitted to engage in corporate

underwriting. Periodic inspections

verify that proper underwriting and risk

management procedures are in place.

When a section 20 subsidiary serves

as lead underwriter, it is responsible for

performing adequate due diligence. In

other instances, such as the dealing of

an outstanding debt security, a section

20 subsidiary may rely on the due

diligence performed by independent

rating agencies. These due diligence

efforts often include analyses of factors

such as payment history, mortgage and

security structure, borrower’s income or

property cash flow, credit

enhancements, and seasoning. In most

CMBS transactions, the underlying

loans have demonstrated their ability to

perform over some period of time. As

the underlying commercial real estate

loans in the CMBS season, the Board

believes that appraisals obtained at

origination become increasingly less

relevant to the CMBS investment

decision because the market

assumptions upon which the appraisals

were based become obsolete. Further,

the public rating or due diligence that

must be obtained for CMBS provides

information that is at least as sufficient

for assessing risks as requiring new

appraisals if appraisals were not

obtained at loan origination. For

residential mortgage-backed securities,

the market is well established with very

clear standards for loan documentation

and underwriting. In light of the

foregoing, the Board concludes that

permitting section 20 subsidiaries to

underwrite and deal in CMBS without

demonstrating that the loans underlying

the CMBS are supported by appraisals

that meet the Board’s appraisal

requirements would not adversely affect

financial markets and real estate

investments therein.

Regulatory Flexibility Act Analysis

This proposal is not expected to have

a significant economic impact on a

substantial number of small business

entities within the meaning of the

Regulatory Flexibility Act (5 U.S.C. 601

et seq.) because, if adopted, the proposal

would not impose additional burdens

on bank holding companies or their

section 20 subsidiaries.

Paperwork Reduction Act

No collection of information pursuant

to section 3504(h) of the Paperwork

Reduction Act (44 U.S.C. 3501 et seq.)

is contained in this proposal.

List of Subjects in 12 CFR Part 225

Administrative practice and

procedure, Banks, banking, Federal

Reserve System, Holding companies,

Reporting and recordkeeping

requirements, Securities.

For the reasons set forth in the

preamble, the Board proposes to amend

12 CFR part 225 as set forth below:

PART 225—BANK HOLDING

COMPANIES AND CHANGE IN BANK

CONTROL (REGULATION Y)

1. The authority citation for part 225

continues to read as follows:

Authority: 12 U.S.C. 1817(j)(13), 1818,

1828o, 1831i, 1831p–1, 1843(c)(8), 1844(b),

1972(l), 3106, 3108, 3310, 331–3351, 3907,

and 3909.

2. In subpart G, § 225.63 is amended

by removing the word ‘‘or’’ at the end

of paragraph (a)(11), by redesignating

paragraph (a)(12) as paragraph (a)(13),

and by adding a new paragraph (a)(12)

to read as follows:

§ 225.63 Appraisals required; transactions

requiring a State certified or licensed

appraiser.

(a) * * *
Federal Register / Vol. 62, No. 236 / Tuesday, December 9, 1997 / Proposed Rules 64999

(12) The transaction involves

underwriting or dealing in mortgagebacked securities; or

* * * * *

By order of the Board of Governors of the

Federal Reserve System.

Dated: December 3, 1997.

William W. Wiles,

Secretary of the Board.

[FR Doc. 97–32160 Filed 12–8–97; 8:45 am]

BILLING CODE 6210–01–P