Single-Family Housing: HUD's Risk-Based Oversight of Appraisers Could Be Enhanced
Released: 2004-11-05T00:00:00

Letter

Background

Each year, HUD helps hundreds of thousands of Americans finance home purchases by insuring their mortgage loans. HUD insures private lenders against losses on mortgages for single-family homes—which HUD defines as structures with one to four dwelling units—and plays a particularly large role in certain market segments, including low-income borrowers and first-time homebuyers. The loan amount that HUD can insure is based, in part, on the appraised value of the home. The primary role of appraisals in the loan underwriting process is to provide evidence that the collateral value of the property is sufficient to avoid losses on loans if the borrower is unable to repay the loan. If a borrower defaults and the lender subsequently forecloses on the loan, the lender can file an insurance claim with HUD for nearly all of its losses, including the unpaid balance of the loan. After the claim is paid, the lender transfers the title of the home to HUD, which is responsible for managing and selling the property. Most of the mortgages are insured by FHA under its Mutual Mortgage Insurance Fund. To cover claims for lenders’ losses, FHA deposits insurance premiums paid by borrowers into the fund, which, historically, has been self-sufficient. Figure 1 shows the role appraisals play as part of the home-buying process.

As figure 1 indicates, the purpose of a HUD appraisal is to (1) determine the property’s eligibility for mortgage insurance on the basis of its condition and location and (2) estimate the value of the property for mortgage insurance purposes. In performing these tasks, the appraiser is required to identify any readily observable deficiencies impairing the safety, sanitation, structural soundness, and continued marketability of the property and to assess the property’s compliance with other minimum standards and requirements.

HUD maintains a roster of appraisers who have satisfied the requirements to be certified to perform HUD appraisals. Lenders underwriting mortgages to be insured by HUD must select one of the approximately 26,000 appraisers listed on the appraiser roster to prepare an appraisal of the mortgaged property. In fiscal year 2003, appraisers listed on HUD’s roster performed 902,118 appraisals for the purposes of HUD mortgage insurance.

HUD’s oversight of appraisers who appraise properties with mortgages insured by HUD is the responsibility of the Processing and Underwriting Divisions at the four homeownership centers (HOCs). The HOCs are located in Atlanta, Georgia; Denver, Colorado; Philadelphia, Pennsylvania; and Santa Ana, California. Figure 2 below shows the distribution of appraisers throughout the HOCs, each of which is responsible for a multistate region. The HOCs report directly to HUD’s Office of Single-Family Housing, which is responsible for implementing HUD’s home mortgage insurance programs and maintaining the appraiser roster.

Since the creation of the HOCs in 1998, their role with respect to HUD’s appraiser monitoring strategy has evolved. From fiscal year 1998 through 2000, HUD instructed the HOCs to perform random field reviews for at least 10 percent of all loans insured by HUD. Starting in fiscal year 2000, HUD’s Real Estate Assessment Center assumed the responsibility of performing these field reviews for the HOCs and used an automated system—the Single Family Appraiser Subsystem—to review the quality of appraisals and identify those that were poorly prepared. However, HUD discovered that the majority of the appraisals identified as poor simply had documentation errors, and the system had failed to identify poorly performing appraisers who contributed to losses to the FHA mortgage insurance fund.

In April 1999, we reported on HUD’s appraiser approval, monitoring, and enforcement efforts. We noted that HUD had limited assurance that the appraisers on its roster were knowledgeable about its appraisal requirements. We also reported that HUD was not doing a good job of monitoring the performance of appraisers and that HUD staff did not routinely visit appraised properties to determine the accuracy of field review contractors’ observations. In addition, we observed that HUD was not holding appraisers accountable for the quality of their appraisals and that HUD had not aggressively enforced its policy to hold lenders equally accountable with the appraisers they select for the accuracy and thoroughness of appraisals.

HUD Has Strengthened Its Criteria for Placing Appraisers on Its Roster, but Has Limited Assurance that These Criteria Are Being Implemented

HUD issued guidance and regulations in order to help ensure that appraisers it approves to perform appraisals under its Single-Family Mortgage Insurance programs are qualified to be placed on the appraiser roster. In 1999, the department issued guidance that required appraisers to, among other things, pass an examination on HUD appraisal methods and reporting. In 2003, HUD also issued regulations making changes to the licensing and certification requirements for the appraiser roster. Although HUD has strengthened its criteria for approving appraisers to perform appraisals, quality control over the approval process is limited.

Guidance and Regulations Are Designed to Help Ensure Competency of Appraisers on FHA’s Roster

In November 1999, HUD issued new guidance under its Homebuyer Protection Plan—which was implemented in an attempt to increase the accuracy and thoroughness of HUD appraisals performed as part of the home-buying process—for placement and retention on the appraiser roster. As noted previously, lenders underwriting HUD loans must select appraisers from those listed on the roster to perform appraisals in connection with FHA-insured mortgages. Before 1999, HUD relied largely on the states’ licensing processes to ensure that appraisers were qualified to perform appraisals. However, the states’ minimum licensing standards did not include proficiency in HUD appraisal requirements. According to HUD’s new guidance, in order to be eligible for placement on the roster, an appraiser must (1) pass an examination on HUD appraisal methods and reporting; (2) be state licensed or state certified, with credentials based on the minimum criteria issued by the Appraiser Qualifications Board of the Appraisal Foundation; and (3) not be listed on the General Services Administration’s Suspension and Debarment List, HUD’s Limited Denial of Participation List, or HUD’s Credit Alert Interactive Voice Response System.

In May 2003, HUD published a final rule making several additional changes to the licensing and certification requirements for the roster. Specifically: An appraiser who was included on the roster in June 2003, but did not meet the minimum Appraiser Qualifications Board licensing or certification criteria had 12 months to comply with these criteria and submit evidence of compliance to HUD. Failure to comply constituted cause for removal from the roster.

An appraiser whose licensing or certification in a state has been revoked, suspended, or surrendered as a result of a state disciplinary action is automatically removed from the roster.

An appraiser whose licensing or certification in a state has expired may not conduct HUD appraisals in that state.

HUD does not formally recertify appraisers whose licenses or certifications have expired or have been revoked. Instead, these functions are performed at the state level, and HUD is notified electronically, through an interface with state appraiser regulatory systems, to ensure that appraisers have passed the appropriate exams and that licenses have been renewed and through daily e-mails from the Appraisal Subcommittee to learn when licenses have been revoked. HUD is seeking to establish an electronic connection to the Appraisal Subcommittee, which would enable automatic notification when appraisers are sanctioned by states and when appraisers’ licenses or certifications need to be renewed.

Quality Control for Placement of Appraisers on Roster Is Limited

While HUD strengthened the requirements for approving appraisers for placement on the appraiser roster, quality control over approval procedures is limited. According to HUD’s guidance on placing new appraisers on the roster, HUD valuation staff are supposed to verify eligibility by checking (1) the Appraisal Subcommittee’s National Registry to ensure that the applicant is listed, (2) the General Services Administration’s Excluded Parties List System and HUD’s Limited Denial of Participation List to ensure that the applicant is not listed, and (3) the Credit Alert Interactive Voice Response System to ensure that the applicant’s social security number is not associated with any defaults or delinquencies in other federal loan programs.

We found that HUD’s quality control for approving appraisers for placement on the roster is limited. According to HUD officials, the employees responsible for appraiser approval check to ensure the applications include all relevant information, verify that applicants are eligible to participate in HUD programs, and enter applicants’ names into the Computerized Homes Underwriting Management System. They perform the eligibility verifications manually, checking the aforementioned registries and lists to ensure that the applicant is appropriately listed. HUD officials explained that they are developing a contract to establish a system that will track these verifications. In addition, while HUD officials indicated that they do perform quality control on the roster placement procedures, this quality control is limited. A HUD official conducts quality control reviews over a random sample of the approving employees’ work, but not on a routine basis. HUD does not document these quality control reviews and could not provide evidence that they were performed. HUD officials indicated that they are planning to develop and implement a quality control plan for the appraiser approval process.

HUD Focuses on Appraisers with Known Risks to FHA’s Mortgage Insurance Fund, but Weaknesses Exist in Implementing These Efforts

HUD uses a risk-based targeting approach to identify appraisers for review. HUD has shifted its focus from targeting appraisals to targeting appraisers, modifying its approach in an attempt to more effectively identify and monitor appraisers most associated with known risks to FHA’s mortgage insurance fund. The HOCs have generally reviewed the appraisers targeted during fiscal year 2003 and the first half of fiscal year 2004, but the reviews have not consistently met HUD’s criteria for completeness. In addition, HUD has not performed adequate oversight of contractors who conduct field reviews of appraisals.

HUD Uses a Risk-Based Approach to Target Appraisers for Review

HUD’s process for monitoring appraisers is risk based. In 1999, we reported that HUD’s guidance called for random reviews of 10 percent of all appraisals. HUD modified this approach and now targets for review appraisers who are associated with known risks to FHA’s mortgage insurance fund, including those associated with a large number of defaulted loans, those who perform a large volume of appraisals, and those who appraise properties for loans with characteristics that are associated with high default and claim rates, including loans made under the 203(k) rehabilitation program, loans with nonprofit mortgagors, and loans for properties with multiple (three to four) units. HUD’s new approach is intended to identify poorly performing appraisers rather than poorly prepared appraisals. The goal of this approach is to remove from the appraiser roster appraisers who have not complied with HUD requirements and therefore pose a risk to FHA’s mortgage insurance fund, disqualifying them from doing business with HUD.

The “early default rate” is the primary factor that HUD uses to identify poorly performing appraisers. On a quarterly basis, each HOC first identifies appraisers with the highest percentage of early defaults over the last 12-month period. Early defaults are defined as those that occur within 12 months of loan origination and represent a delinquency—which occurs when the borrower is unable to honor the mortgage obligation—of 90 days or greater. Each HOC next identifies, from the pool of appraisers associated with high early default rates, those appraisers who performed 10 or more appraisals and who performed appraisals for five or more defaulted mortgages. To do this, HUD uses its Neighborhood Watch Early Warning System—a Web-based software application that displays loan performance data for lenders and appraisers by loan types and geographic areas using FHA-insured single-family loan information—which was enhanced to include summary and loan level appraiser data to enable the targeting of appraisers for review. The system not only helps HUD target appraisers associated with a high rate of early defaults but also provides HUD the ability to identify and analyze patterns—by appraiser, geographic area, or originating lender—in loans that go into early default.

According to HUD’s guidance, each HOC must develop a target list of appraisers to be reviewed based on the targeting criteria. They also must review at least 30 appraisers each quarter, but these do not necessarily need to be pulled from the target lists. In addition to selecting appraisers using the targeting criteria, the HOCs also may review appraisers for other reasons. For example, HOC officials informed us that they also include on the targeting lists appraisers who have recently been sanctioned and have completed their sanction period. The officials indicated that this helps them to ensure that recently sanctioned appraisers have corrected their relevant deficiencies and do not repeat past performance problems. However, because this targeting criterion is not required, there is no assurance that it will be used consistently. The HOCs may also review appraisers based on complaints from homebuyers and referrals from other HUD offices.

To help identify appraisers to be placed on the target lists, HUD has recently implemented a statistical risk-based appraiser-sampling algorithm. This algorithm helps to identify appraisers for desk and field reviews, focusing on those who are more likely to be associated with adverse outcomes, including (1) early default of an FHA insured loan, (2) large dollar amount of claims on the FHA mortgage insurance fund, or (3) severity of the net dollar loss on the FHA mortgage insurance fund. The algorithm also incorporates risk factors statistically related to these adverse outcomes, including appraiser workload, performance in high-risk programs, and geographical area. According to HUD, this enhanced and automated targeting helps to ensure the efficient use of resources for field reviews.

Because the HOCs do not maintain a permanent record of the data used to identify appraisers for review each quarter, we could not verify that the appraisers they placed on their target lists were actually those that met HUD’s criteria. The HOCs maintain general information about the reasons why appraisers are targeted for review, specifically labeling the reasons appraisers are targeted as “high default rate,” “high volume,” or high-risk loans or properties. However, they do not maintain specific early default rate information for the appraisers targeted, even though early default rate is the primary factor behind HUD’s targeting approach. The Neighborhood Watch Early Warning system allows HUD officials to maintain this information. For example, HUD uses this system to target lenders participating in its Single-Family Mortgage Insurance programs for review and maintains targeted lenders’ early default information. However, according to HOC officials, once the appraiser target lists are created, the HOCs do not maintain the targeted appraisers’ early default information. Without the specific default rate information, we were unable to determine whether the HOCs reviewed those targeted appraisers who posed the greatest risk based on high default rate. More importantly, in the absence of this information, HUD is unable to monitor the HOCs to ensure that the appropriate appraisers were targeted and reviewed based on its criteria and may be unable to determine the effectiveness of its targeting criteria in reducing risk to the mortgage insurance fund.

HUD Reviewed Most Targeted Appraisers, but Reviews Were Not Always Complete

Overall, the HOCs reviewed 730 (almost 78 percent) of the 936 appraisers who were placed on the target lists during fiscal year 2003 and the first half of fiscal year 2004. However, as shown in figure 3, the percentage varied among the HOCs. Each HOC exceeded the goal of reviewing 30 appraisers per quarter. Specifically, they reviewed a total of 2,055 appraisers over this period, or an average of more than 85 appraisers per HOC per quarter. (In addition to the 730 appraisers who were reviewed because they were on the target lists, the HOCs reviewed 1,325 appraisers who were not on the target lists but were reviewed based on other reasons, including complaints from homebuyers and referrals from other HUD offices, for a total of 2,055 appraisers reviewed.) HOC officials explained that they are not always able to conduct reviews of the appraisers within the quarter targeted because of resource constraints, but indicated that they eventually perform reviews of all targeted appraisers.

HUD’s guidance calls for the HOCs to conduct desk reviews of 10 appraisals prepared by each appraiser identified for review through the targeting methodologies. The HOCs are to use a standard set of desk review criteria, the focus of which is to identify deficiencies in the content and format of the reported data. The appraisal report is to be analyzed for reasonable and logical conclusions of value to determine if the appraisal data are consistent with FHA requirements.

However, the HOCs did not review every appraiser to the extent called for in the guidance. The HOCs performed, on average, about 5.6 desk reviews for each appraiser reviewed during fiscal year 2003 and the first half of 2004. As shown in figure 4, the Philadelphia HOC was the only HOC that conducted almost 10 desk reviews for each appraiser reviewed during this period. Officials from the other HOCs explained that an appraiser might have conducted fewer than 10 appraisals, and so the HOCs would be unable to perform the required number of desk reviews. However, as noted earlier, HUD’s targeting criteria provide that from the pool of appraisers associated with high early default rates, those appraisers performing 10 or more appraisals and with five or more defaulted cases should be targeted.

HOC officials also told us that they attempt to perform desk reviews of appraisals that were conducted no more than one year prior to the time of the review and that, if possible, they try to perform these reviews on the appraisers’ 10 most recent appraisals. While this approach is not required, HOC officials explained that it helps them to ensure that an appraiser’s most recent work is being reviewed and that appraisals are not outdated at the time of review.

HUD Conducted Limited Oversight of Field Review Contractors

According to HUD guidance, if a desk review concludes that an appraisal is inconsistent or unacceptable, then a field review is warranted on up to five appraisals prepared by that appraiser. HUD uses contractors and HUD employees who are qualified as appraisers to conduct field reviews. The review consists of a comprehensive inspection of the subject property’s interior and exterior, with the reviewer reporting any readily observable defective conditions (whereby the property does not meet minimum property standards as laid out in HUD’s guidance). The reviewer also must perform an exterior inspection of the comparable properties—other recently sold properties with similar features used to help the appraiser estimate the value of the subject property—submitted in the original appraisal and must verify all data reported by the original appraiser for the subject property and comparables.

We found that HUD staff do not routinely visit appraised properties to verify the work of the field review contractors. According to HUD guidance, on-site monitoring reviews by HUD staff are essential for high-risk program participants to the extent practicable. HUD officials explained that they are constrained by limited travel resources and so are not able to make on-site visits to properties. HUD officials agreed contract oversight is important but indicated that it is often not cost efficient to send employees on site to review contractors’ work because many of the department’s contractors are responsible for reviewing only a few properties. However, HUD officials indicated that they are planning to develop a cost-efficient oversight mechanism.

HUD Has Expanded the Authority of the HOCs and Developed an Appraisal Scoring System to Facilitate Enforcement Actions

Expanded authority giving HOCs the ability to sanction appraisers has provided the HOCs with additional enforcement options. According to HUD officials, by expanding their ability to sanction appraisers and by focusing oversight on appraisers instead of appraisals, they are able to effectively and efficiently impose sanctions on appraisers. HUD reviews and quantifies appraisers’ work by using a Web-based tool, the Appraisal Review Process, a system that scores each appraiser on several appraisals, weighting the scores to capture violations that pose the greatest risk to FHA’s mortgage insurance fund. According to HUD, the system helps to make the process of sanctioning appraisers more consistent. In addition, HUD has issued a final rule to hold lenders accountable for poor appraisals. Lenders who submit appraisals that do not meet HUD requirements are now subject to the imposition of sanctions by the department.

Devolution of Authority and Risk-Based Targeting Assist HOCs in Sanctioning Appraisers

In 2000, a HUD regulation expanded its ability to sanction appraisers at the national level by giving the HOCs the authority to remove appraisers from the roster. As figure 5 illustrates, for the 1,004 appraisers field reviewed by HUD in fiscal year 2003 and the first half of fiscal year 2004, 620 sanctions were imposed, with 180 appraisers having been removed from the appraiser roster. Prior to receiving this expanded authority, the only enforcement tool at the HOCs’ disposal was issuance of limited denials of participation. However, the HOCs needed to refer limited denials of participation to headquarters, and the sanctions were only effective in the particular HOC’s jurisdiction for a year. Currently, the sanctions available to the HOCs include removal from the roster for 6 to12 months, removal from the roster in conjunction with education for 6 to12 months, education for up to 90 days, notices of deficiency, and limited denials of participation. Other sanctions available to HUD through headquarters include suspension—often used as a temporary measure to stop an appraiser from doing business with HUD until a more serious action can be taken—for up to 12 months or until the conclusion of legal or debarment proceedings; debarment, which removes an appraiser from the FHA roster, generally for up to 3 years; and civil and criminal penalties. In fiscal year 2003 and first half of fiscal year 2004, HUD reports that it suspended 14 appraisers from the roster and did not debar or impose civil or criminal penalties on any appraisers. HUD officials stated that these sanctions are harder to use and less timely so they focus their efforts on those sanctions they can use at the HOC level. Figure 5 illustrates the extent to which the department has made use of each type of enforcement action available, as reported by HUD.

In addition, HUD officials explained that by changing the oversight approach to focus targeting efforts on appraisers instead of appraisals they can now better focus oversight efforts on appraisers with known risks. Specifically, they reported that they can now review a smaller number of appraisers and use sanctions more effectively and efficiently. For example, HUD reports that since 1998, the number of removal actions taken by the department has increased, while the number of field reviews and the cost to the agency have decreased, as shown in table 1.

Risk-Based Appraisal Scoring System Is Designed to Help Ensure Consistency within and across HOCs

In 2002, HUD developed a monitoring and enforcement tool called the Appraisal Review Process, a risk-based appraisal scoring system that scores appraisers who are field reviewed. (Field-reviewed appraisers include those targeted and field reviewed by HUD on a quarterly basis as well as those who were not necessarily targeted but may have been field reviewed for a variety of reasons, including complaints from home buyers and referrals from other HUD offices.) In an attempt to ensure consistency within and across HOCs, HUD designed this tool to (1) weigh each field review question used to assess appraiser performance and (2) recommend actions to be taken against appraisers. The tool provides the rater with a systematic way of thoroughly examining the written appraisal and carrying out the corresponding field review. Based on the desk and field review data, the system yields a recommendation of removal, education, or notice of deficiency. For example, questions associated with appraisal factors that are considered to be of greater risk to the fund—such as the accuracy of market value of the property and characterization of repair conditions—receive a higher weight and automatically result in a removal recommendation if the appraisal exceeds the maximum allowable points.

The Appraisal Review Process tool allows HUD to review appraisers and impose sanctions on them in a systematic way. In 1999, we reported that HUD was not holding appraisers accountable for the quality of their appraisals and that the primary reason for HUD’s inability to pursue enforcement actions against poorly performing appraisers was poor record keeping. According to HUD officials, the Appraisal Review Process’s systematic approach to reviewing appraisers’ work and maintaining electronic records of appraisers’ performance has helped the HOCs maintain better documentation. The data manager at each HOC orders cases for each of the targeted appraisers and assigns them to a desk reviewer. Based on the results of the desk review, the desk reviewer can decide that a field review for a particular appraisal is warranted or that no further action is necessary. If a field review is warranted, the appraisal is assigned to a contractor or HUD employee, who measures the quality and accuracy of appraisers’ performance in the completion of the desk-reviewed appraisal and up to four other appraisals prepared by the targeted appraiser and inputs the results electronically into the Appraisal Review Process. Based on the desk and field review data, the system yields a recommendation of removal, education, or notice of deficiency. A HUD rater then looks at the field review score generated by the system, factors in past performance and results from other appraisals, and recommends a proposed action. The branch chief must concur before the appraiser is notified of the action, at which point the appraiser has 20 days to appeal. Figure 6 portrays the major steps of the Appraisal Review Process.

According to HUD’s guidance, once a recommended action is affirmed, the appraiser roster is updated to reflect the change. If the appraiser is removed from the roster, lenders cannot assign cases to the appraiser until the appraiser is reinstated. Further, if the appraiser violated any of the laws in the state in which the appraiser is licensed, then the appropriate state regulatory agency is notified.

Recent Rule Is Designed to Hold Lenders Accountable for Poor Appraisals

In 1999, we recommended that HUD determine its authority to hold lenders accountable for poor-quality HUD appraisals performed by the appraisers they select from the roster and issue policy guidance that sets forth the specific circumstances under which and actions by which HUD may exercise this authority. In July 2004, HUD issued a final rule clarifying lenders’ accountability for the quality of appraisals on properties securing FHA-insured mortgages. Specifically, the rule provides that lenders who submit appraisals that do not meet HUD requirements are subject to the imposition of sanctions by the department. The rule applies to both sponsor lenders, who underwrite loans, and loan correspondents, who originate loans on behalf of sponsor lenders. HUD believes these changes will help ensure better compliance with appraisal standards and ensure that homebuyers receive an accurate statement of appraised value.

Conclusions

The importance of accurate appraisals to HUD’s Single-Family Mortgage Insurance programs underscores the need for effective appraiser oversight. HUD relies on appraisals to ensure that the billions of dollars in mortgage loans it insures annually accurately reflect the value of the homes being mortgaged. Since our April 1999 report, HUD has taken a number of steps designed to ensure the qualifications of appraisers on its roster; improve the efficiency and effectiveness of its oversight, specifically by revising its guidance to focus on appraisers (rather than appraisals) and incorporating a risk-based monitoring approach; and facilitate enforcement actions by empowering HOCs and developing a scoring system to promote consistency. However, certain weaknesses in implementing these initiatives limit their ability to (1) lower HUD’s risk of insuring properties that are overvalued and (2) minimize potential losses to FHA’s mortgage insurance fund. Thus, opportunities exist to enhance HUD’s appraiser approval and monitoring efforts.

HUD’s process for verifying that appraisers meet all relevant criteria when applying for placement on its roster lacks effective quality control. An effective control process is essential for HUD to systematically assure and demonstrate that all eligibility criteria are verified with respect to appraisers applying for placement on the roster so they can perform appraisals in connection with HUD’s Single-Family Mortgage Insurance programs.

Further, while HUD’s guidance specifies criteria for targeting appraisers based on a set of known risk factors, it does not require the HOCs to target for review appraisers who have been recently sanctioned, even though the HOCs sometimes do so in order to ensure that the problem for which the appraiser was sanctioned has been resolved. Requiring this criterion for targeting appraisers for review could help assure that sanctioned appraisers will not repeat past performance problems. Similarly, HUD does not require that the HOCs maintain historical information, particularly data on the associated default rates of loans, used to target and select appraisers for review. Without this information, HUD cannot demonstrate that the appropriate appraisers are being systematically targeted and reviewed based on its criteria and may be unable to determine the effectiveness of its targeting criteria in reducing risk to the mortgage insurance fund.

HUD rarely verifies the work of its field review contractors through on-site evaluations, weakening the department’s ability to ensure that contracted work is actually performed and to accurately assess the quality of the appraisals used to support the loans the department insures. While it entails costs, on-site monitoring is an essential part of any monitoring process and is an important way to verify that work is actually being conducted and to accurately assess the quality of appraisals.

Recommendations for Executive Action

To reduce the financial risks assumed by HUD and to further enhance its oversight of appraisers participating in HUD’s Single-Family Mortgage Insurance programs, we recommend that the Secretary of HUD direct the Assistant Secretary for Housing-Federal Housing Commissioner to institute reasonable controls on the process of placing appraisers on the appraiser roster to ensure that applicants’ conformance to eligibility criteria is verified; consider a requirement to include, when targeting appraisers for review, those appraisers who have recently completed a sanction period in order to ensure that these appraisers have corrected their relevant deficiencies; maintain the historical information, particularly early loan default information, used to target appraisers for review in order to ensure that the HOCs target and review appraisers based on the criteria in HUD guidance; and implement a cost-effective field review contractor oversight process that includes on-site monitoring.

Agency Comments

We provided a draft of this report to HUD for its review and comment. In written comments from HUD’s Assistant Secretary for Housing–Federal Housing Commissioner, HUD agreed with three of our four recommendations, but disagreed with our presentation of its accomplishments as well as some of our findings. The full text of HUD’s comments appears in appendix II.

HUD agreed with three of our recommendations. Specifically, it agreed to consider a requirement to include, when targeting appraisers for review, those appraisers who have recently completed a sanction period. Also, the department agreed to modify its system to archive quarterly reports in response to our recommendation that it maintain the historical information used to target appraisers for review. Further, it agreed to consider implementing a cost-effective field review contractor oversight process that includes on-site monitoring.

However, HUD disagreed with our recommendation that it institute reasonable controls on the process of placing appraisers on the appraiser roster. HUD commented that our report inaccurately stated that HUD does not document all verifications of appraisers’ eligibility for the roster and has limited quality control over the approval process, noting that the department has a paper record of the application review process whereby each applicant’s eligibility is verified and documented. HUD also noted that we did not review its paper records of the application review process. We modified the report to clarify that our primary concern was quality control, in general, and not solely documentation. We did not review the paper files because it was not our objective to test whether or not specific verifications had been performed, but rather to examine the overall verification and documentation procedures HUD relies on to ensure that appraisers meet its criteria. In doing so we observed a control weakness and we modified the report to clarify this weakness. Specifically, a HUD official conducts quality control reviews over a random sample of the approving employees’ work, but not on a routine basis. Also, HUD does not document these quality control reviews and could not provide evidence that they were performed. At a meeting to discuss the results of our review, HUD’s acting Deputy Assistant Secretary for Single-Family Housing and the Director of the Office of Single-Family Program Development agreed that they do not systematically document that all of the verifications have been conducted and explained that they are developing a contract to establish a system that will track these verifications. They also indicated that they are planning to develop and implement a quality control plan for the appraiser approval process. We modified the recommendation to emphasize that HUD should institute reasonable quality controls on the process of placing appraisers on the appraiser roster.

HUD commented that while we acknowledged that it implemented policy and procedural changes, we did not recognize the significance of these changes, and that it is appropriate and necessary for our report to clearly present and highlight these significant achievements. While we agree that HUD has made significant improvements, our objectives concern HUD’s appraiser oversight as it currently exists, regardless of past weaknesses. Nevertheless, we noted a number of specific improvements in the draft report. Specifically, we noted that the number of removal actions taken by the department has increased, while the number of field reviews and the cost to the agency have decreased, as represented in table 1. With respect to HUD’s adoption of a new risk-based approach for monitoring appraisers, we reported that HUD’s process for monitoring appraisers is risk based and that HUD modified its approach to target for review appraisers who are associated with known risks to FHA’s mortgage insurance fund. In addition, we reported that the department issued guidance that required appraisers to, among other things, pass an examination on HUD appraisal methods and reporting. We also noted that HUD issued several rules and mortgagee letters to strengthen its oversight and control of appraisers and improve appraisal quality.

HUD also disagreed with the accuracy of some of our findings. Specifically, HUD characterized as inaccurate our statement that in the absence of historical early default rate information, the department may be unable to determine the effectiveness of its appraiser targeting criteria in reducing risk to the mortgage insurance fund. HUD explained that its system directly targets the appraisers that pose the greatest risk to the fund. We concur that HUD’s process is designed to so target, and our draft characterized the approach as risk based and described the specific criteria HUD’s process calls for to target appraisers for review. However, because the HOCs do not maintain a permanent record of the data showing which appraisers met the criteria in each quarter, we could not verify that the appraisers the HOCs placed on their target lists were actually those that met HUD’s criteria. Similarly, without these records, HUD is unable to determine whether the HOCs reviewed those appraisers who met the criteria. In turn, this limits HUD’s ability to determine, over time, the effectiveness of its targeting criteria in reducing risk to the mortgage insurance fund. HUD went on to say that FHA would modify its system to archive quarterly reports in order to maintain the historical targeting records.

In addition, HUD disagreed that it conducted limited oversight of field review contractors and that such efforts are affected by limited travel resources. HUD explained that it conducts a 100 percent review of contractors’ work and that the HOCs do not conduct on-site reviews (which may require travel resources) because the 100 percent review method serves as an appropriate and effective risk-control measure. As we noted in our report, HUD’s guidance states that on-site monitoring reviews by HUD staff are essential for high-risk program participants to the extent practicable. Further, HOC officials told us that they are constrained by limited travel resources and so are not able to make on-site visits to properties. At a meeting to discuss the results of our review, HUD’s acting Deputy Assistant Secretary for Single-Family Housing and the Director of the Office of Single-Family Program Development agreed that contract oversight is important but indicated that it is often not cost efficient to send employees on site to review contractors’ work because many of the department’s contractors are responsible for reviewing only a few properties. However, as we reported in our draft, these officials indicated that they are planning to develop a cost-efficient oversight mechanism.

Finally, HUD disagreed with our conclusion that weaknesses in implementing its appraiser oversight initiatives limit the department’s ability to (1) lower its risk of insuring properties that are overvalued and (2) minimize potential losses to FHA’s mortgage insurance fund. HUD also stated that our recommendations would not affect FHA’s risk. As we stated in the draft report, we did not attempt to estimate the impact that HUD’s appraiser oversight has on the financial health of FHA’s mortgage insurance fund. While we agree that HUD’s new targeting methodology is intended to reduce risks to FHA, our concern is whether the methodology is operating as intended. Our recommendations relate to the implementation of processes that are directed at controlling and minimizing risk and we continue to believe that opportunities exist to enhance HUD’s appraiser approval and monitoring.

We are sending copies of this report to the Secretary of HUD. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov.

Should you or your staff have questions or comments on matters discussed in this report, please contact me at (202) 512-6878 or woodd@gao.gov, or Paul Schmidt, Assistant Director, at (312) 220-7681 or schmidtpj@gao.gov. Major contributors to this report are listed in appendix III.

Scope and Methodology

To examine how HUD ensures that appraisers it approves to perform appraisals under its Single-Family Mortgage Insurance programs are qualified to be placed on the appraiser roster, we reviewed pertinent HUD regulations and policy guidance and the minimum licensing criteria established by the Appraiser Qualifications Board of the Appraisal Foundation. In addition, we discussed this information with officials from HUD’s Single-Family Housing Office of Program Development. Further, we met with the staff member responsible for maintaining the FHA appraiser roster and observed the process for adding approved appraisers to the roster.

To assess the extent to which HUD uses a risk-based approach when monitoring appraisers, we interviewed officials at the four HOCs and observed a demonstration of their quarterly targeting procedures. We reviewed HUD’s risk-based targeting guidance and obtained data for fiscal year 2003 through the first half of fiscal year 2004 from each of the HOCs. We then compared each of the HOCs’ appraiser target lists to their desk and field review lists to determine the number of targeted appraisers that were actually reviewed. Further, from each of the HOCs’ desk review lists, we calculated the numbers of desk reviews performed by the HOCs on each appraiser reviewed in order to assess whether the HOCs have been following HUD’s guidance.

To examine HUD’s efforts to take enforcement actions against appraisers it identifies as not complying with its requirements, we reviewed HUD’s guidance regarding enforcement actions taken against poorly performing appraisers. We also discussed enforcement issues with officials from HUD’s Office of Single-Family Housing and the Departmental Enforcement Center. At the HOCs, we discussed the Appraisal Review Process and the HOCs’ ability to sanction appraisers. We obtained data generated from the Appraisal Review Report on HUD’s sanctions imposed between fiscal year 2003 and the first half of fiscal year 2004 and compared this data to the number of field reviews conducted during the same time period. We focused this analysis on removals because removals are the strongest type of action that can be taken at the HOC level.

We assessed the reliability of the HUD data we used by reviewing information about how the data were collected, and we interviewed HUD officials to determine the completeness and accuracy of the data provided. We performed electronic testing on the data elements used for our analysis to detect obvious errors in completeness and reasonableness. We determined that these data were sufficiently reliable for the purposes of this report.

Finally, we discussed appraiser oversight issues with officials from the Appraisal Subcommittee, the Appraisal Foundation, the Appraisal Institute, the Federal Home Loan Mortgage Corporation, and the Federal National Mortgage Association.

We performed our work from December 2003 through August 2004 in accordance with generally accepted government auditing standards.

Comments from the Department of Housing and Urban Development

GAO Contacts and Staff Acknowledgments

GAO Contacts

Staff Acknowledgments

Staff members who made key contributions to this report include Eric Diamant, Mark Egger, Harold Fulk, Nadine Garrick, Curtis Groves, John McGrail, Mark Molino, Josephine Perez, David Pittman, Terry Richardson, and Paige Smith.