Collateral Evaluation Requirements

AGENCY:

Farm Credit Administration.

ACTION:

Proposed rule.

SUMMARY:

The Farm Credit Administration (FCA, we, or our) proposes amendments updating our regulations on appraisal and evaluation requirements for property serving as collateral for loans made by the Farm Credit System (System). We propose reorganizing existing rules to remove redundancies and add clarity on the distinct valuation standards for each type of collateral. We also propose adding regulatory requirements for the use of automated valuation tools and releasing appraisal and evaluations to borrowers.

DATES:

Comments on this proposed rule must be submitted on or before July 19, 2021.

ADDRESSES:

We offer a variety of methods for you to submit comments. For accuracy and efficiency reasons, commenters are encouraged to submit comments by email or through the FCA's website. As facsimiles (fax) are difficult for us to process and achieve compliance with section 508 of the Rehabilitation Act, we do not accept comments submitted by fax. Regardless of the method you use, please do not submit your comment multiple times via different methods. You may submit comments by any of the following methods:

• Email: Send us an email at reg-comm@fca.gov.
• FCA website: http://www.fca.gov. Click inside the “I want to . . .” field near the top of the page; select “comment on a pending regulation” from the dropdown menu; and click “Go.” This takes you to an electronic public comment form.
• Mail: Kevin J. Kramp, Director, Office of Regulatory Policy, Farm Credit Administration, 1501 Farm Credit Drive, McLean, VA 22102-5090.

You may review copies of all comments we receive at our office in McLean, Virginia, or on our website at http://www.fca.gov. Once you are in the website, click inside the “I want to . . .” field near the top of the page; select “find comments on a pending regulation” from the dropdown menu; and click “Go.” This will take you to the Comment Letters page where you can select the regulation for which you would like to read the public comments. We will show your comments as submitted, but for technical reasons we may omit some items such as logos and special characters. Identifying information that you provide, such as phone numbers and addresses, will be publicly available. However, we will attempt to remove email addresses to help reduce internet spam.

FOR FURTHER INFORMATION CONTACT:

 Technical information: Darius J. Hale, Senior Policy Analyst, or Dennis K. Carpenter, Senior Policy Analyst, Office of Regulatory Policy, Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4414, TTY (703) 883-4056.

Legal information: Laura McFarland, Senior Counsel, Office of General Counsel, Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703) 883-4056.

SUPPLEMENTARY INFORMATION:

I. Objectives

The objectives of this proposed rule are to:

• Improve the organization and readability of FCA appraisal and evaluation regulations;
• Clarify expectations for internal controls in appraisal and evaluation practices;
• Expand authorities on using various sources of appraisers and evaluators as well as specifically authorizing use of automated valuation tools; and
• Update existing terminology and make other grammatical changes.

II. Background

The prevailing body of law for conducting collateral appraisals and evaluations in financial transactions is Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). Title XI of FIRREA created the Appraisal Subcommittee within the Federal Financial Institutions Examination Council (FFIEC) to provide federal oversight of state appraiser regulatory programs. Title XI of FIRREA also requires certain federally regulated lending institutions to use appraisers that are either state certified or state licensed under the Uniform Standards of Professional Appraisal Practice (USPAP). USPAP provides standards and qualifications for real estate appraisers and provides guidance on recognized valuation methods and techniques for all evaluation professionals.

The Farm Credit Act of 1971, as amended (Act) charges FCA with issuing regulations establishing loan security requirements and the manner of conducting collateral security reviews. The Act requires System direct lenders to determine the value of loan security “by appraisal under standards prescribed by the [institution] in accordance with [FCA] regulations.” FCA is further tasked with examining the quality and sufficiency of collateral used to secure System loans. Because these provisions within the Act existed before passage of FIRREA—and for other reasons—Congress exempted the System from Title XI of FIRREA, including following USPAP. However, FCA's present collateral evaluation rules are generally similar, although not identical, to FIRREA requirements.

In 1992, FCA issued subpart F of part 614, “Collateral Evaluation Requirements”, which sets forth minimum regulatory standards for performing appraisals and evaluations of collateral securing extensions of credit (lending and leasing) by Farm Credit banks and associations. The 1992 rulemaking applied many of the evaluation standards used by the banking industry under Title XI of FIRREA, including requiring the use of USPAP in certain loan transactions. In deciding to use these standards where appropriate, FCA determined the underlying policy behind Title XI of FIRREA was relevant to the System's operations, particularly for ensuring that reports on collateral values accurately reflect the current market value of collateral at the time of a credit decision and that those values be recognized as valid within the financial sector. However, our regulations differ from Title XI of FIRREA and USPAP where needed to address the unique cooperative structure of the System and to address specific provisions in the Act. For example, Title XI of FIRREA provides that no USPAP appraisal is required for a loan secured by real estate when that loan is made based on cashflow and not the value of real estate collateral (i.e., abundance of caution collateral). The System cannot use this exception for loans made under the authorities of Title I of the Act because those loans require a first lien on the real estate. Meaning those loans would never be made without consideration of the real estate collateral's value.

Collectively, subpart F of Part 614 has not been updated in over 25 years. As System institutions move toward increased use of fee appraisers and technology in loan making, we believe it is time to update our requirements for collateral appraisals and evaluations. We also believe our regulations should be updated to reflect the increased importance internal review and controls play in today's lending environment. Internal controls are an integral part of managing lending programs. Internal controls are also necessary to protect safety and soundness operations where institutions engage in credit programs using minimum information or where institutions move away from the use of staff appraisers and evaluators.

III. Section-by-Section Analysis

We discuss the specifics of our proposal below in the same order as they would appear in the regulation.

A. Organization

We propose general language changes to subpart F of Part 614 to enhance readability. We intend no change in the meaning of the affected regulatory provisions unless specifically stated in the discussions of those provisions. We also propose reorganizing existing provisions to consolidate like items, remove redundancy, and add clarity.

1. Section Consolidations

Among these proposed organizational changes are:

• Consolidating into § 614.4250 the existing basic appraisal and evaluation policies and standards of §§ 614.4245(a) and 614.4250(a) and proposing revisions to these policies and standards.
• Revising and consolidating into § 614.4255 the existing appraiser and evaluator independence requirements of §§ 614.4255, 614.4260(e), and 614.4267.
• Merging the existing contents of § 614.4266(a) and (b) into § 614.4260, to address in one section the evaluation requirements for all chattel, including personal and intangible property, while also revising the existing provisions of § 614.4266.
• Revising § 614.4250 to add a discussion of internal controls for valuing collateral.
• Consolidating the existing appraisal and evaluation requirements of §§ 614.4260, 614.4265, and 614.4266 into §§ 614.4260 and 614.4265, as appropriate for the type of collateral under discussion.
• Adding a new § 614.4270 discussing the use of appraisal and evaluation tools, including computer-based models.
• Moving to new § 614.4275 the existing contents of § 614.4260(d) regarding our authority to require appraisals and evaluations and proposing clarifications.

2. Section Removals

We propose deleting as obsolete or redundant the exiting requirements of:

• §§ 614.4250(b) and 614.4245(b), (c), and (d);
• § 614.4260(a); and
• §§ 614.4265(g) and 614.4266(d).

3. Section Headings

In keeping with proposed reorganizational changes, we propose renaming the subpart and its section headings as follows:

Subpart F—Collateral Appraisal and Evaluation Requirements

§ 614.4240 as “Definitions”;

§ 614.4245 as “General”;

§ 614.4250 as “Policies, standards, and internal controls for valuing collateral”;

§ 614.4255 as “Appraiser and evaluator qualifications and independence”;

§ 614.4260 as “Valuing business chattel, personal, and intangible property”;

§ 614.4265 as “Valuing real property”;

§ 614.4270 as “Appraisal and evaluation tools”; and

§ 614.4275 as “Reservation of authority”.

B. Definitions [Existing § 614.4240]

We propose general grammatical changes to certain terms in § 614.4240 to enhance readability. We intend no change in the meaning of the affected terms unless specifically stated. We also propose clarification, removal, or addition of certain terms as discussed below.

1. Clarifications

As a general matter, we propose adding introductory language explaining how certain terms (e.g., paper, record, provide) may be interpreted to permit the electronic equivalent if allowed under our e-commerce regulations in part 609. We add this clarification to reduce questions on how technology adaptations in daily business activities are to be treated.

We propose clarifying changes to the following definitions:

a. “Abundance of Caution”

We propose replacing the phrase “real estate” with “asset” when discussing an item taken out of an abundance of caution. We propose the change to recognize that not all collateral taken out of an abundance of caution is in the form of real estate. System lenders may hold collateral taken in an abundance of caution for real estate and non-real estate financial transactions. As a conforming change, we also propose replacing a reference to collateral required by regulations or the institution policies with a reference to assets legally required to secure the type of credit being extended. This change is intended to capture the variations in loan underwriting requirements, which allow for secured and unsecured lending in certain situations. However, the proposed clarification does not change legal requirements to take real estate as security for financing offered under Title I of the Act nor allow real estate taken as collateral for Title I lending to be considered an abundance of caution type of security.

b. “Appraisal”

We propose clarifying that the term “appraisal” means USPAP compliant valuations of real estate completed by either a state licensed or state certified appraiser. We propose this change as part of our objective to clarify our regulations by restricting the term “appraisal” to always mean a USPAP compliant real estate valuation. The proposed change would prevent using the term to identify non-USPAP valuations, including values assigned to non-real estate. We caution readers that our regulatory definition of “appraisal” is not meant to define the term as used in the Act. Instead, we believe both regulatory terms of “appraisal” and “evaluation” represent the appropriate interpretation of how the single term “appraisal” is used in the Act.

c. “Business Loan”

We propose adding cooperatives to the list of borrowing entities in recognition of lending authorities contained within Title III of the Act. In doing so, we propose changing the order of the list to aid in readability.

d. “Evaluation”

We propose clarifying changes to the meaning of “evaluation” to explain an evaluation is in writing and presents an independent and impartial opinion of market value supported by relevant information. This clarification would remove the necessity of repeating throughout subpart F that evaluations need to be in writing and prepared by independent evaluators.

e. “Evaluator”

We propose changing the existing term “qualified evaluator” to “evaluator”, using the same definition but with slight modifications. The term as proposed would explain an evaluator must always be qualified for the evaluation assignment by being trained and experienced in identifying values for the types of assets under review. For purposes of business chattel, personal and intangible property collateral evaluations, the term would continue to include eligible bank or association staff, certified public accountants, equipment dealers, grain buyers, livestock buyers, auctioneers, and other industry experts.

f. “Fee Appraiser or Fee Evaluator”

We propose clarifying the term to mean either an appraiser or evaluator of assets who is not employed by the System lender but acts as a third-party contractor. We make this change to further distinguish the term from appraisals or evaluations prepared by staff of the System lender. We also propose removing the last sentence of the existing definition that applies to personal and intangible evaluations. Instead, we propose moving that sentence to the term “evaluator.” In this definition we also propose conforming changes to use new or revised terms being proposed, such as replacing “Farm Credit System institution” with “System lender.”

g. “Highest and Best Use”

We propose clarifying changes to the term “highest and best use” to explain it means the legal use of the asset and to remove language that gives the impression the term only applies to real estate and not other collateral.

h. “Personal Property”

We propose a clarifying change to the definition of “personal property” to exclude business chattel. As proposed, the term “personal property” would refer to moveable non-real estate property that is not in the form of equipment, livestock or crops. We propose the distinction to facilitate proper valuation of business chattel, which is commonly used as security for System financing, from other forms of chattel, such as household goods, which require different valuation efforts and resources. As a conforming change, we also propose adding a new definition for “business chattel”, which is discussed in section III.B.3 of this preamble.

i. “Real Estate or Real Property”

We propose adding “or real property” to the existing term “real estate” to recognize the interchangeable use of the two terms. We also propose clarifying that the term includes fixtures, easements, rights of way, and other rights commonly attached to the land (e.g., mineral, water, gas, timber). We make this clarification to ensure appropriate identification and value adjustments for these items are part of the appraisals or evaluations of real estate. As a conforming change, we propose deleting the existing separate definition for the term “real property.”

j. “State Certified Appraiser”

We propose clarifying and conforming language to the definition of “state certified appraiser” that explains no person will be accepted as meeting the FCA definition unless that person passed a state-administered examination equivalent to those exams conducted under the jurisdiction of the FFIEC appraisal subcommittee. Currently, the definition makes a definitive statement of who is or is not a “state certified appraiser.” Because FCA does not actually certify any appraisers, we believe the clarification is necessary.

2. Removals and Relocations

First, we propose moving the terms “cost approach”, “income capitalization approach”, and “sales comparison approach” from the definitions contained in § 614.4240 and incorporating them into proposed § 614.4265, discussing real estate appraisals. This proposed movement should facilitate compliance with the requirements of real estate appraisals by keeping the definitions with the terms in the only place they are used within the rule.

Next, we propose deleting the term “Appraisal Foundation” because it is not used in the proposed rule text. We also propose removing the term “valuation” as the term has become a point of confusion. Currently, the term is defined as an evaluation that is not an appraisal. We propose removing this term and its definition, leaving only the terms “evaluation” and “appraisal”. In conformance with this proposed change, we also propose revisions to the definitions of “evaluation” and “appraisal”, drawing a distinction between the two types of reports. That proposed distinction would use the term “appraisal” only for USPAP compliance reports valuing real estate. All other reports of value, including those for business chattel, other personal property and intangible property, would be “evaluations.”

3. Additions

We propose adding six terms that would apply to all of subpart F, unless otherwise stated in the regulations. First, we propose adding a definition for “appraiser” to limit application of the term to only those persons state-certified or state-licensed under USPAP guidelines. The term as proposed would also specify that an appraiser has demonstrated experience in identifying values for real property under USPAP. We add this term as part of our efforts to differentiate USPAP required values from evaluations of non-real estate.

Second, we propose adding a definition of “automated valuation model” or AVM, explaining it means a computer-based program that estimates a property's market value based on certain factors. As proposed, the definition would also explain certain sub-set models used for particular assets. We propose adding the term to make clear what constitutes an automated model, selecting a description closely aligned with the definition used by the FIRREA agencies. We chose to use a definition similar to FIRREA agencies in recognition that vendors of most AVMs design their models to comply with FIRREA standards.

Third, we propose adding a new definition for “business chattel” that would apply to property kept for the carrying on of any agricultural activity, such as production or use in the farming of land. We believe adding the definition will help eliminate confusion with other forms of chattel not in the form of equipment, livestock or crops (i.e., household goods, personal property). We propose the distinction to facilitate proper valuation of business chattel separate from other chattel that may not be subject to a lienhold by the System lender. The new definition of “business chattel” would explain it also applies to both livestock (any creature not in the wild but regarded as an asset) used to produce food, wool, skins, fur or similar purposes, and crops (growing, harvested, or in storage) kept for production or use in the farming of land or the carrying on of any agricultural activity.

Next, we propose adding a definition for “intangible property” to clarify the term refers to valuable items that are not physical in nature (i.e., copyrights, trademarks, goodwill, brand names, etc.). As discussed earlier, this proposed change would include a conforming change to the existing definition of “personal property.”

Fifth, we propose adding a definition of “Other Financing Institutions (OFI)”, using a definition consistent with that used in other regulations. We propose specifically including the OFI definition to recognize the requirements of 12 CFR part 614, subpart P that OFIs comply with System underwriting standards, including collateral evaluation requirements.

Lastly, we propose adding a definition of “System lender”, using a definition consistent with the existing collateral evaluation regulations explaining subpart J of 12 CFR part 614 applies to any System institution engaged in lending or leasing activities secured by collateral. This proposal would add greater readability to the rule through the use of one term rather than the existing use of several terms (identifying various types of System institutions) explaining who is responsible for obtaining an appraisal or evaluation of collateral used to secure an extension of credit. We believe our proposed use of the term “System lender” is in keeping with the appraisal requirements of the Act.

B. General [Proposed § 614.4245]

We propose § 614.4245 be an all-purpose section identifying the minimum expectations applicable to every collateral appraisal or evaluation. As part of the restructure, we propose moving existing § 614.4245(a) to another section and deleting, due to redundancy, the exiting requirements of § 614.4245(b), (c), and (d), along with other proposed changes.

1. Required Appraisals and Evaluations [Proposed § 614.4245(a)]

We propose adding as new § 614.4245(a) the general rule that all collateral must be valuated via an evaluation or appraisal. This is not a new requirement, but rather a clarification of FCA's long-standing position that collateral securing a loan must be assigned a value. FCA issued an Informational Memorandum containing this clarification in 2016 after our examination staff identified some institutions held the belief no valuation was required in certain credit transactions for certain types of collateral. We recognize that non-real estate collateral may not always be a primary consideration or factor in determining creditworthiness. However, we believe that all security, including property taken out of an abundance of caution, should be properly valued. We also recognize failing to assign a market value to all collateral may negatively affect capital treatment, servicing decisions and loan classifications, as well as create borrower confusion if the property is later assigned the true market value because it has become essential to the credit. Therefore, FCA believes that whenever property is used to secure a loan, a market value must be assigned and supported by an appraisal or evaluation.

Also, we propose that, at a minimum, an appraisal or evaluation be obtained both when filing a lien against the property and when the lender expects to take liquidation actions. Ensuring an asset's value is the current market value at the identified times ensures credit decisions are using the best data available. As proposed, the rule would also require System lenders to act at other times to ensure existing values are adjusted when there are market fluctuations.

2. Format and Minimum Content Requirements [Proposed § 614.4245(b)]

We propose clarifying, reducing, and consolidating the existing minimum expectations for appraisals and evaluations into new § 614.4245(b). First, we propose adding a provision that explicitly requires appraisals to follow USPAP format requirements. Next, we propose adding language recognizing that an evaluation's format presentation will depend on the type of asset being valued and the tools and data sources used to set the value. For example, if equipment is being valued using an AVM, the evaluation format may be a computer screen shot of the recommended market value when that screen shows all the required information. Alternatively, the evaluation format may consist of several different documents with a cover synopsis. We propose this flexibility in recognition of the variety of data sources available and the different ways in which that data is obtained.

We are also proposing to establish minimum content requirements needed to support the final opinion of value. We propose using some existing content requirements and removing others in the process. The existing content provisions come from §§ 614.4245(a) and 614.4250(a). As part of this consolidation, we propose grammatical changes as well as a few additional changes. As proposed, new § 614.4245(b) would require that all appraisals and evaluations:

• Have enough details to describe the asset, including relevant characteristics;
• Provide information to aid the reader in ascertaining the reasonableness of the value; and
• Identify the data sources used for setting the value, such as including the name and version of any AVM or other published source data used.

When applicable, we also propose that the appraisal or evaluation include a statement that different appraisal or evaluation standards were used but use of those standards was not a result of any prohibited discriminatory factors.

We propose these requirements to provide the reader of the report with sufficient information as to how the appraiser or evaluator chose the final market value and to provide some assurance on the validity of the process used to reach a final value so that it is recognized by other lenders as a fair market value.

3. Age of Appraisal or Evaluation Reports [Proposed § 614.4245(c)]

We propose a new provision addressing when to obtain a new appraisal or evaluation (outside the two events proposed under § 614.4245(a)). We are not proposing specific evaluation or appraisal age requirements at this time. Instead, proposed § 614.4245(c) would respect the existing practice of allowing appraisals and evaluations to be updated pursuant to the System lender's policies. This would include updating benchmarking methodologies used to track and identify market conditions for a specific type of asset. However, we propose adding a requirement that an appraisal or evaluation may only be used if the reported value reflects market conditions at the time the value is used by the lender.

We had considered regulating the age of appraisals and evaluations but decided a fixed age may not capture market changes in an appropriate timeframe. Instead, we believe each System lender is in a better position to identify upward and downward movement in market conditions within its territory. For that reason, we maintain high expectations that each System lender will incorporate within its appraisal and evaluation policies and procedures timely reviews of collateral value.

4. Using the Appraisal of Another Lender [Proposed § 614.4245(d)]

We propose moving the existing provision regarding sharing fee appraisals among System institutions from § 614.4255(d) to § 614.4245(d). We also propose expanding this authority to cover all types of real estate appraisals when the applicant or borrower consents. The ability to share collateral appraisals and/or evaluations for the sale and purchase of loans under subpart H of part 614 is unaffected by this proposal as System lenders are expected to address the sharing of collateral appraisals and/or evaluations in those transactions through their purchase of interests in loan agreements under § 614.4325(c)(3), as appropriate and necessary to satisfy underwriting criteria.

As proposed, a System lender may use the real estate appraisals of other lenders when the lender obtaining the appraisal will not be extending the requested credit and agrees to transfer the appraisal. FCA believes that it would be beneficial to System institutions and serve as a cost-savings measure for applicant to allow sharing appraisals among System lenders when one or more are involved in a credit transaction. To preserve the quality of the transferred appraisal, we propose retaining the existing requirement that such transfers may only occur with other System lenders or lenders subject to Title XI of FIRREA. Additionally, we propose that the System lender receiving the transferred appraisal assume responsibility for verifying the accuracy of the appraisal.

5. Releasing Appraisal or Evaluations [Proposed § 614.4245(e)]

We propose adding a provision on the release of appraisals and evaluations to applicants and borrowers. We are proposing this provision to further implement the requirements of section 4.13A of the Act, which provides that borrowers have the right to obtain reports valuing their assets anytime during the life of the loan. Specifically, borrowers must be given, when requested, “copies of each appraisal of the borrower's assets made or used by the qualified lender.” Additionally, we propose language specifying that a System lender is to release a copy of the collateral appraisal or evaluation to the applicant or borrower when issuing an adverse credit decision that relies in whole or part upon collateral values. This provision would align with provisions in Part 617 and our guidance regarding the contents of adverse credit decisions.

As proposed, appropriate duplication fees may be charged when more than one copy is given, excepting those copies included with notice of an adverse credit decision. We also propose that System lenders provide a copy of a collateral appraisal or evaluation within 7 days of the request. We are proposing a fixed time to ensure that applicants and borrowers receive the report within a reasonable time. We propose 7 calendar days in consideration of other regulatory timeframes where the asset's value may affect an applicant's or borrower's decision making or review rights.

In coordination with our proposed language on evaluation presentation format (§ 614.4245(b)), we propose that the appraisal or evaluation copies provided to applicants and borrowers contain all the information required by regulation or USPAP. These copies serve an essential role in an applicant's or borrower's decision on whether to challenge the value assigned an asset before the Credit Review Committee (CRC). Ensuring the applicant or borrower receives the relevant information forming the appraisal or evaluation will also fulfill Congressional intent behind section 4.13A. Additionally, we believe that the information provided in the documentation should be presented in a manner that is easily understood by the applicant or borrower.

6. Recordkeeping [Proposed § 614.4245(f)]

We propose adding a requirement on the amount of time System lenders are required to maintain appraisal and evaluation reports. As proposed, a lender's general recordkeeping policies would apply to appraisals and evaluations, except the lender would be required, at a minimum, to maintain them for the same duration as the related credit file. We also specifically propose that the lender preserve the data set used in establishing the value in effect as of the date of the appraisal or evaluation. Our proposal is intended to ensure that the appraisals and evaluations used in the credit process are preserved in case questions arise about the credit decision that may lead back to asset values and to inform whether any updated value is required. Additionally, the proposed requirement to retain the data source(s) used for an appraisal or evaluation reconciles this provision with proposed § 614.4245(e). Under new § 614.4245(e) we propose requirements addressing the statutory authority of a borrower to request, at any time during the borrowing relationship, copies of all appraisals and/or evaluations used by the System lender.

C. Policies, Standards, and Internal Controls [Proposed § 614.4250]

We propose consolidating into § 614.4250 the existing requirement that System lenders develop policies and standards for conducting appraisals and evaluations. The current requirements are located in §§ 614.4245(a) and 614.4250(a). As part of this consolidation, we propose additional requirements and conforming changes.

1. Policies [Proposed § 614.4250(a)]

As proposed, § 614.4250(a) would contain the existing requirement that System lenders adopt and maintain written policies on when and how to issue collateral appraisals or evaluations. The rule further proposes required minimum contents for the policies, including:

• Addressing when an evaluation instead of an appraisal will be used (where the regulations allow a choice);
• Establishing the frequency and timing of when to complete either an appraisal or evaluation;
• Monitoring market conditions;
• Authorizing or prohibiting the use of shared appraisals or using out-of-territory fee appraisers and evaluators;
• Setting parameters for using AVMs and other tools;
• Verifying the independence of those performing the valuation functions;
• Prohibiting any practice that would base an appraisal or evaluation on a requested minimum value or loan amount; and
• Outlining internal controls needed to ensure compliance with relevant laws and regulations.

We believe these minimum requirements provide the basic foundation for a good appraisal and evaluation policy.

Further, we propose requiring Farm Credit banks to address within their collateral appraisal and evaluation policies OFI compliance with those policies. Elsewhere in our regulations, OFI lending activities that are discounted with a Farm Credit bank are required to follow relevant policies and procedures contained in subpart P of 12 CFR 614. We believe specifically addressing OFIs in the collateral regulations and related institution policies will facilitate compliance with those regulations.

2. Standards [Proposed § 614.4250(b)]

We propose § 614.4250(b) contain the existing requirement of § 614.4250(a) that System lenders adopt and maintain written standards for appraisals and evaluations. In addition, we propose requiring those standards be designed to represent current market values to protect the lender's interest in maintaining adequate loan collateral. The rule would continue to identify minimum items the standards must address, including support for the identified market value, the selection process for appraisers and evaluators, continuous monitoring of market conditions, and addressing inspections of the subject property. The level of information each System lender requires within these standards is expected to be specific to the type and nature of the collateral securing the loan. A System lender might also include addressing what it considers appropriate evaluation techniques for complex and specialized assets or high-risk transactions. When valuing complex and specialized assets, additional information addressing the unique characteristics and conditions affecting the market value of such assets demands providing more than the minimums proposed to ensure a reader of the evaluation receives sufficient information on how the value was established. We believe the System lender is in the best position to determine the level of this additional information given territorial considerations.

When considering how and in what manner to conduct property inspections, we expect the lender to include controls addressing the accuracy and integrity of the inspections. We are aware industry practices continue to place increased reliance on various types of technology to enhance or replace the physical inspection process. When other methods such as these are used, additional controls may be necessary to validate the data's accuracy. While we have not proposed prohibiting the use of such technology, we continue to believe physical inspections are the most appropriate method to verify assets in most cases.

3. Internal Controls [Proposed § 614.4250(c)]

We are proposing § 614.4250(c) address internal controls in managing the collateral appraisal and evaluation process. We propose that each lender have written internal control policies and procedures specifically designed for the collateral appraisal and evaluation process. We believe the internal controls process for collateral valuations should be designed to protect the integrity of those values and the process by which they are determined. We propose requiring the controls include safeguarding the independence of those setting values from the credit process, verifying the condition of the asset being valued, and recognizing and reacting to changes in market conditions.

We recognize that existing § 618.8430 contains general requirements for internal controls in collateral valuations and other processes, but we believe there is a need for greater clarity on what the internal controls for collateral valuations should contain. We are not proposing any changes to § 618.8430 and do not intend for the proposed § 614.4250(c) to replace or supersede it. Instead, we intend proposed § 614.4250(c) as an elaboration on the requirements of § 618.8430. As such, we encourage commenters to advise us if they read any conflict between the two provisions.

D. Appraiser and Evaluator Qualifications and Independence [Proposed § 614.4255]

We propose consolidating into new § 614.4255 the existing appraiser and evaluator independence standards from §§ 614.4255 and 614.4267. We also propose that System lenders verify an appraiser's or evaluator's competency to value the type of collateral under review. In addition, we propose several clarifying changes to existing conflict of interest prohibitions for a lender's staff. As proposed, § 614.4255(b) would require lenders to establish written standards setting forth how independence from the credit decision will be determined. We had considered removing the ability of a single person to both establish the collateral value and make the related credit decision. However, we are mindful there are smaller associations or service offices where complete separation may not be possible. Also, we took into consideration the use of automated credit approval processes. As a result, we are not proposing to remove the current regulatory authority allowing one person to perform the valuation and credit function. However, we propose that those System lenders choosing to embrace such a practice implement a secondary review. We are proposing in § 614.4255 (b) that a secondary review occur either before credit approval or soon after loan closing. We believe System institutions already have the policies and procedures in place to address this requirement. Additionally, we propose in § 614.4255(b)(3) and (4) that a review of that person's work be conducted by someone separate from the credit transaction and the CRC. We also propose clarifying language that the CRC may not be treated as a secondary review source. Notwithstanding this proposed provision, all aspects of the proposed § 614.4255(b) would remain applicable to System lenders allowing a single person to both establish the collateral value and make the related credit decision.

Finally, we propose moving existing prohibitions on who may perform collateral appraisals and evaluations to new § 614.4255(c). We also propose clarifying that the existing prohibition against a fee appraiser or fee evaluator having a financial interest in the loan or subject property does not include fees earned for valuation services. In addition, we propose expanding the existing prohibition against directors, officers and employees of the System lender performing real estate appraisals and/or evaluations to include all assets where that person has a direct financial interest in the asset being valued. We do not propose extending this prohibition to those appraisals or evaluations prepared by the lender's staff where the staff is engaged in marketing, lending, collection, or credit decision process, but holds no financial interest in the asset and the appraisal or evaluation is subject to the aforementioned secondary review.

We propose new language in paragraph(c)(6) to prohibit directors, officers and employees of the System lender from serving on the CRC when that same director, officer or employee performed an appraisal or evaluation that is under review by the CRC. To ensure continued independence in the valuation process, we believe it is important to restrict those performing the appraisal or evaluation from serving on the CRC when a credit decision involving the appraisal or evaluation prepared by that person is under review by the CRC.

E. Valuing Business Chattel, Personal, and Intangible Property [Proposed § 614.4260]

We propose renumbering existing § 614.4266 as new § 614.4260 and keeping the existing requirements of § 614.4266 that chattels are valued using market-values and contain detailed descriptions of the chattel as well as identify the source(s) used to set the value. We also propose providing a nonexclusive list of acceptable sources. Additionally, we propose adding language to make clear that evaluations of business chattel, personal and intangible properties must use recognized techniques and sources when deriving the final value. We believe limiting the manner of identifying values to recognized techniques and sources helps ensure the accuracy of assigned values, which in turn strengthens the soundness of the related credit decision. It also furthers the likelihood of those evaluations being recognized as valid market values within the financial sector. As a conforming change, we propose adding language to reference the proposed regulatory sections on minimum content, borrower access, and record-keeping for chattel evaluations. However, for intangible property, we propose keeping, with slight modification, the existing requirements from §§ 614.4250(a)(6) and 614.4266(c) that evaluations of intangible property include discussion of the asset's marketability.

In developing this proposed rule, we considered proposing a “score card” exemption or, in the alternative, a reduced analysis for chattel taken out of an abundance of caution. Ultimately, we concluded that Congress expected all forms of chattel to be valued when making a loan. Within the Act, Congress established certain loan making actions to ensure safe and sound credit decisions and provided legal rights for borrowers regarding collateral. To satisfy these congressional requirements and expectations, all collateral needs a substantiated value. This is true particularly when an applicant seeks to challenge the value through the CRC process. Even though we have not proposed any exemptions or offered special provisions for chattel taken out of an abundance of caution, we believe our proposal to allow the expanded use of AVM and other source data procedures and our proposed changes in documentation required for chattel evaluations serve to address the majority of concerns expressed on the interaction of chattel evaluations and automated loan processes.

F. Valuing Real Property [Proposed § 614.4265]

We propose revising the current requirements of § 614.4265 by consolidating like provisions currently located in § 614.4260, reorganizing and clarifying content, and adding some additional requirements.

1. General [§ 614.4265(a) and (b)]

We propose clarifying in § 614.4265(a) that all real estate collateral must be appraised unless an evaluation is specifically permitted by new § 614.4265(c). We propose moving to new § 614.4265(b) the existing requirement of § 614.4260(b)(2) that if a real estate-related financial transaction is over $1 million dollars, then only a state certified appraiser may issue the appraisal report for the real estate security. We also propose removing the existing § 614.4260(b)(1) requirement that appraisals for transactions over $250,000 be completed by state-licensed or state-certified appraiser. Our other proposed changes, such as to the definition of “appraisal,” remove the need for this provision.

2. Permitted Use of Real Estate Evaluations [Existing § 614.4260(c); Proposed § 614.4265(c)]

We propose moving to new § 614.4265(c) the existing exceptions in § 614.4260(c) for when an evaluation of real estate may be used instead of an appraisal. We also propose adding clarifications to their use because over the years we have had to issue guidance and address questions on the meaning and applicability of the regulatory exceptions. We intend no change to the original scope of the exceptions unless otherwise provided for in the regulation and as explained in this preamble. Specifically, we are proposing to keep the existing authorization to issue an evaluation, not an appraisal, for real estate collateral in the following loan transactions when use of an exception is justified.

a. Transactions Valued at or Below $250,000

We propose moving the existing exception in § 614.4260(c)(1) for transactions that do not include a business loan and which are valued at or below $250,000 to new § 614.4265(c)(1) and naming it “non-business loan transactions”.

b. Business Loan Transactions

We propose moving the existing exception in § 614.4260(c)(2) for transactions that are business loans valued at or below $1 million to new § 614.4265(c)(2) and naming it “business loan transactions”. Those persons eligible for the business loan exception include individuals, corporations, sole proprietorships, et al. that meet the eligibility requirements of FCA regulations §§ 613.3000(b), 613.3010, and 613.3020.

Additionally, we clarify that we propose no change to this exemption being used for first-lien real estate taken under 12 U.S.C. 2018(a). The value of this first-lien security is used to establish the Loan-to-Value lending ratio (LTV) and so the Act requires it to be “appraised” because Congress intended values used in the LTV be strong and supportable. When developing the existing rule in 1992, we set in § 614.4265 the minimum requirement that all real estate evaluations determine market value after analyzing the property's value under three approaches: Income capitalization, sales comparison, and cost. This was to afford System lenders use of the FIRREA business loan transaction exemption for first-lien real estate taken under 12 U.S.C. 2018(a) while also satisfying the requirements of the Act. For that reason, in this rulemaking we propose no changes to allowing use of the business loan transaction exemption for first lien real estate taken under 12 U.S.C. 2018(a). In coordination with this, we propose no change in the requirement to use three approaches when either appraising or evaluating real estate, as discussed in the following preamble section III.F.3., “Determining value.”

We are proposing changes to one of the conditions for using the business loan exception. Currently, our regulations state that the repayment of the business loan cannot be dependent on income derived from the sale or cash rental of real estate as the primary source of repayment if using the exception. We are proposing to relax this limitation by restricting it to repayment coming from cash rental from nonagricultural operations. That is, we propose allowing business loan transactions at or below $1 million to use evaluations when repayment of the loan is from rental income derived from agricultural sources. We believe renting land for agricultural purposes should not prevent use of this exception. Farmers or ranchers who receive cash rents from production on agricultural land should not have to bear the cost of an appraisal solely because the repayment of their loan is from cash rents off that land. This includes those farmers or ranchers who have set aside land and receive conservation payments from a federal or state program.

c. Subsequent Loan Transactions

We propose moving the existing exception in § 614.4260(c)(5) for subsequent transactions that do not involve new collateral or new monies to new § 614.4265(c)(3) and naming it “subsequent loan transactions”. We propose clarifying changes to the existing language, but propose no material change to this exception.

d. Pooled Loan Transactions

We propose moving the existing exception in § 614.4260(c)(6) for loan transactions where a System lender purchases an interest in a loan or pool of loans to new § 614.4265(c)(4) and naming it “purchased loans”. We propose clarifying changes to existing language, but propose no material change to this exception.

e. Guaranteed Loan Transactions

We propose moving the existing exception in § 614.4260(c)(7) for loan transactions involving a U.S. Government guarantee to new § 614.4265(c)(5) and naming it “U.S. Government guarantee”. We propose clarifying changes to existing language, but propose no material change to this exception. Specifically, we propose clarifying the exception's applicability by converting the existing single sentence into two separate sentences: One for purchased loans already having a guarantee and one for when the lender is making the loan with a guarantee. We believe this clarification will facilitate use of the exception.

f. Additional Security in a Loan Transaction

We propose moving and consolidating the existing exceptions in § 614.4260(c)(3) and (c)(4) for loan transactions involving real property that is either not required by law or is taken for a purpose other than the land's value to new § 614.4265(c)(6), “Additional security”. As proposed, an evaluation process would be available for real estate taken under an abundance of caution. We believe this proposed change captures the intent of the existing exceptions but presents them in a simpler manner.

We considered adding a commercial real estate transaction exception in response to an exception of this nature being added by those regulators subject to FIRREA. The commercial real estate transaction exception recently authorized by other regulators, such as the Federal Deposit Insurance Corporation, provides that a commercial loan using real estate security, but not involving a single 1-to-4 family residence, may use an evaluation instead of an appraisal for the real estate when the loan transaction is at or below $500,000. The unique nature of the System would have made the exception of little value. Farm Credit direct lenders are non-depository institutions who primarily make commercial business loans to the agricultural sector. These System lenders have authority to make owner-occupied home loans in rural areas populated by 2,500 persons or less, but these home loans may not make up more than 15 percent of the institution's loan portfolio. Further, a loan made to finance one of these homes would not be a business loan or a commercial transaction, so would be ineligible for a commercial real estate transaction exception. Additionally, System institutions may make the occasional consumer loan as part of an agricultural operation's `other credit needs' and these loans would also not qualify for a commercial real estate transaction exception because they too would be consumer transactions. However, System institutions may finance certain commercial transactions under the same `other credit needs' authority and, if no residence were involved, these loans might qualify for a commercial real estate transaction exception. In evaluating the volume of loan transactions such an exception would cover and considering the fact that these loans would mainly be commercial transactions so most would already be eligible under the “business loan” exception (if the loan transaction is $1 million or less), we did not see the value in adding an additional exemption.

3. Determining Value [Proposed § 614.4265(d)]

We propose consolidating in new § 614.4265(d) the existing requirements of §§ 614.4250(a)(6) and 614.4265. We also propose moving from the existing definitions those explanations for the “cost approach”, “income capitalization approach”, and “sales comparison approach”, incorporating them into new § 614.4265(d).

As proposed, new § 614.4265(d) would continue to require real estate be valued on the basis of market value but would add clarification of how to arrive at a market value. We propose clarifying that market value is identified only after considering the three valuation methods: Income capitalization, sales comparison, and cost approach. We propose this clarification in part through relocating the existing definitions for “cost approach”, “income capitalization approach”, and “sales comparison approach” to new paragraph (d)(1) through (3). We further propose clarifying that arriving at a market value includes identification of nonagricultural influences, as is currently required in existing § 614.4265(f). Also, we propose requiring in all cases that real estate appraisals and evaluations contain detailed documentation of the best approach to value as part of the written report. We propose that details of the other approaches only be required when primarily used to identify the market value. We propose these modifications to provide better clarity as to why an appraiser or evaluator may not have chosen to use a specific valuation approach. It also increases transparency and allows the user to better understand the logic behind the final market value.

In proposed new paragraph (d)(1), the income capitalization approach would be explained using the current definition of such. Similarly, proposed new paragraph (d)(2) would contain expectations for the sales comparison approach, using the current definition and adding new requirements for using at least three comparable sales, unless the appraiser or evaluator provides documentation that such comparable sales are not available. FCA believes that requiring appraisals and evaluations to contain at least three comparable properties provides adequate information to form an opinion on the market value of the property in question. Additionally, three comparable sales would provide the end user with an adequate range of values for the subject property for comparison purposes.

Lastly, proposed new paragraph (d)(3) would contain expectations for the cost approach by using the current definition and adding a documentation requirement when the property has unique improvements. FCA believes adding the documentation requirement would allow end users to better understand the methodology chosen to derive the final recommended market value of the subject property. Additionally, we believe the documentation would provide greater transparency to the end user regarding the improvements on the property.

4. Valuation of Fixtures [Proposed § 614.4265(e)]

Proposed § 614.4265(e) would retain the existing requirement that real estate fixtures be included in the value of real estate. As proposed, greater specificity would be added to clarify that buildings capable of being used for income-producing purposes related to agriculture must have an assigned value. However, we propose language preserving the discretion of the appraiser or evaluator to assign certain obsolete buildings no value. In the past, questions have arisen on whether such buildings should be assigned even a salvage value. Since appraisers and evaluators are trained in assessing market demands, we believe they need to retain the final authority on what value is given obsolete fixtures. To ensure the fixtures are not prematurely determined obsolete, we also propose that the value assigned be premised upon the average buyer. We believe this will alleviate potential disputes among the owner, the lender, the examiner, and the appraiser/evaluator on whether the building is obsolete or retains some contributory value in each individual's opinion.

5. Additional Content Requirements [Proposed § 614.4265(f)]

We propose keeping, with slight modification, the existing requirements from §§ 614.4250(a)(6) that real property appraisals and evaluations include discussion of the land's marketability. We also propose requiring that appraisals and evaluations of real property include certain information in addition to the general contents proposed in new § 614.4245(b). Specifically, we propose that the appraisal or evaluation include a description of any permanent fixtures, known water or mineral rights, and recorded access rights associated with the land being valued. In recent years, we have had several situations arise where these items were not properly noted, resulting in disputes when the lender later went to act on its lien or there was a land transfer matter. We believe having an appraisal or evaluation notate known permanent fixtures, water or mineral rights, and recorded access rights will further aid lenders in verifying the information against title reports. We also propose keeping the existing requirement that an appraisal or evaluation name the purpose(s) for which the property will be used by the applicant or borrower when that purpose will be different from the land's highest and best use.

Next, we propose that an appraisal or evaluation of real property name readily observable conditions on the subject property that may pose an environmental hazard. As proposed, System lenders would have to inform the appraiser or evaluator of any reported or known potential hazards. FCA believes the identification of known hazards on the subject property provides valuable information in formalizing the valuation of the property.

Finally, we propose requiring System lenders provide appraisers and evaluators Federal Emergency Management Agency (FEMA) forms prepared on the subject property. Specifically, when the property includes items listed in a Special Flood Hazard Area, the lender would have to supply to the appraiser or evaluator the FEMA form showing the location of the buildings. We propose this provision to align our appraisal and evaluation rules with our existing flood insurance rule of § 614.4940.

G. Computer-Based Models and Other Tools [Proposed § 614.4270]

We propose adding a new § 614.4270 discussing the use of certain appraisal and evaluation tools. FCA previously issued Informational Memoranda addressing the use of automated analytical tools in assigning values to collateral and we propose incorporating most of that guidance into this new regulatory section. Specifically, we propose allowing System institutions to establish computer-based analytical methods and technological tools for collateral appraisal and evaluations, provided the lender can demonstrate that the method(s) used to establish a value is consistent with safe and sound lending practices and contains sufficient information and analysis to provide a market value conclusion. As proposed, analysis tools may not be used as a standalone appraisal or evaluation because these tools are intended for use in assisting appraisers and evaluators in the collateral evaluation process, not replacing them. For example, computer-based models may be used if there is sufficient data available for the type of property being evaluated and if the lender has the necessary expertise to interpret the data.

We propose that use of automated valuation models (AVM) be limited to situations where the AVM uses information specific to the subject property, including the actual physical condition of the subject property, rather than generalized `assumptions.' As proposed, assumptions used by the evaluator will require sufficient support and the evaluator will have to demonstrate that the `assumption' is appropriate for the subject property. Appropriate due diligence is also essential when using these models, including conducting independent reviews to ensure institutions' boards of directors and senior managers are receiving clear and informative descriptions of the model's assumptions and limitations. As such, we propose that System lenders perform due diligence through an independent validation process. We also propose that System lenders retain staff or contract with persons who have experience in using the AVM chosen by the System lender. FCA believes that lenders who maintain staff with AVM expertise would be better positioned to respond to questions or concerns from the output of the AVM or in the event the AVM does not perform as anticipated.

We further propose allowing the use of tax assessment values (TAV) when there is additional support to show a valid correlation between the TAV and market value but would limit TAV use to valuing real estate. As proposed, the lender would be required to document how the TAV is developed and updated by the tax authorities. We also propose using the TAV only in a manner consistent with safe and sound lending practices, which would involve using additional support for final recommended values rather than sole reliance upon the TAV. We are not proposing to allow use of TAVs for chattel and personal property. We are aware some states assess and tax chattel and personal property, but we do not believe those valuations processes are refined enough to use in credit decisions. As we understand them, chattel valuation processes vary widely by state, not all states provide such valuations, and the values do not consider any additional features or the actual condition of the chattel.

Additionally, we propose requiring System lenders using these tools have policies and procedures in place that, among other things, include appropriate internal controls. In new § 614.4270(c) we propose minimum control requirements that the policies and procedures must address. These requirements include ensuring staff training and expertise, validating model results and setting criteria when the models will be used and to what extent. We believe the proposed minimum internal control requirements are common industry practice and provide a sound basis for System institutions to develop additional institution-specific requirements.

H. Reservation of Authority [Proposed § 614.4275]

We propose moving to new § 614.4275 the existing contents of § 614.4260(d) regarding our authority to require appraisals and evaluations. We also propose clarifying that our collateral evaluation regulations do not prevent exercising this authority when safety and soundness issues or enforcement actions require it.

V. Regulatory Flexibility Act and Congressional Review Act Conclusions

Pursuant to section 605(b) of the Regulatory Flexibility Act (5 U.S.C. 601 et seq.), FCA hereby certifies that the proposed rule will not have a significant impact on a substantial number of small entities. Each of the banks in the Farm Credit System, considered together with its affiliated associations, has assets and annual income in excess of the amounts that would qualify them as small entities. Therefore, Farm Credit System institutions are not “small entities” as defined in the Regulatory Flexibility Act.

List of Subjects in 12 CFR Part 614

• Agriculture
• Banks, banking
• Foreign trade
• Reporting and recordkeeping requirements
• Rural areas

For the reasons stated in the preamble, the Farm Credit Administration proposes to amend part 614 of chapter VI, title 12 of the Code of Federal Regulations as follows:

PART 614—DISCLOSURE TO SHAREHOLDERS

1. The authority citation for part 614 continues to read as follows:

Authority: 42 U.S.C. 4012a, 4104a, 4104b, 4106, and 4128; 12 U.S.C. 2011, 2013, 2014, 2015, 2017, 2018, 2019, 2071, 2073, 2074, 2075, 2091, 2093, 2094, 2097, 2121, 2122, 2124, 2128, 2129, 2131, 2141, 2149, 2183, 2184, 2201, 2202, 2202a, 2202d, 2202e, 2206, 2206a, 2207, 2211, 2212, 2213, 2214, 2219a, 2219b, 2243, 2244, 2252, 2279a, 2279a-2, 2279b, 2279c-1, 2279f, 2279f-1, 2279aa, 2279aa-5; sec. 413 of Pub. L. 100-233, 101 Stat. 1568, 1639 (12 U.S.C. 2121 note).

2. Revise the heading of subpart F to read as follows:

Subpart F—Appraisal and Evaluation Requirements

3. Subpart F, consisting of §§ 614.4240 through 614.4275, is revised to read as follows: