2018 Appraisal FAQ 7 – When is it appropriate for financial institutions to use the “abundance of caution” exemption?

Compliance > Lending > Appraisal Regulations & Interagency Stmt.
Q:  When is it appropriate for financial institutions to use the “abundance of caution” exemption?
 
A:   The abundance of caution exemption25 may only be used in those transactions where a borrower qualifies for an extension of credit based on the strength of the associated cash flow or non-real estate collateral, and knowledge of the market value of the real estate collateral taken as security for the transaction is unnecessary in making the credit decision.  The financial institution’s credit analysis should clearly document and verify that the credit decision was well supported by repayment sources other than real estate collateral.  For transactions that meet the abundance of caution exemption, neither an appraisal nor an evaluation is required.26  Refer to the following examples.
 
Example 1:  Commercial and Industrial Cash Flow Loan.  A financial institution extends a commercial business line of credit to a heating and cooling repair business.  The financial institution holds the owner’s personal guaranty and has taken a security interest in an investment property owned by the guarantor.  The financial institution’s credit analysis determines that cash flow from business operations has generated sufficient debt service coverage.  The guarantor’s global cash flow also reflects sufficient debt service coverage, and the guarantor maintains a strong liquid asset position.  All of the borrower’s other credit attributes are satisfactory.  The financial institution’s credit analysis has verified and documented that the financial institution would have made the loan without knowledge of the market value of the real estate.  Based on the borrower’s overall creditworthiness and the sufficiency of cash flow generated by the business to cover the debt service on the loan, the security interest in the real estate can be considered an abundance of caution.  
 
Example 2:  Loan Secured by Other Collateral.  A financial institution extends a term loan to a construction company to purchase equipment used in the construction business and secures the loan with a lien on the equipment and the borrower’s headquarters building.27  The real estate lien can be considered an abundance of caution if, for example, the value of the equipment adequately secures the outstanding balance of the loan and the borrower’s global cash flow provides for repayment of the loan.  In such a case, the cash flow from the operation of the business is the primary source of repayment for the loan and the equipment is the secondary source of repayment.  All of the borrower’s other credit attributes are satisfactory.  The financial institution’s credit analysis verified and documented that the financial institution would have made the loan without knowledge of the market value of the real estate.   
 
Prior to making a final commitment to the borrower, the financial institution should document and retain in the credit file the analysis performed to verify that the abundance of caution exemption has been appropriately applied.  If the operating performance or financial condition of the borrower subsequently deteriorates and the financial institution determines that the real estate will be relied upon as a repayment source, an appraisal should then be obtained, unless another exemption applies.
 
25 The abundance of caution exemption generally has limited application.  See Valuation Guidelines, Appendix A, exemption 2.
26 OCC: 12 CFR 34.43(a)(2) and (b); Board: 12 CFR 225.63(a)(2) and (b); and FDIC: 12 CFR 323.3(a)(2) and (b).
27 The equipment pledged as collateral is not co-located with the headquarters building.
 
ADDITIONAL INFORMATION:
This can be found in the 2018 “Frequently Asked Questions on Appraisal Regulations and the Interagency Appraisal and Evaluation Guidelines,” which may be found here:
https://www2.occ.gov/news-issuances/bulletins/2018/bulletin-2018-39a.pdf

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