Articles & E-Books


The Need for Enhanced Appraisal Reviews – Credit Unions

Feb 27, 2018

The member business loan portfolios of many credit unions are largely comprised of commercial real estate loans, including both owner-occupied and non-owner-occupied properties. Over a year ago, the Fed’s Monetary Policy Report to Congress singled out “commercial property prices” as a growing concern. The report stated “commercial real estate (CRE) valuations, which have been an area of growing concern over the past year, rose further, with property prices continuing to climb and capitalization decreasing to historically low levels. The rising valuation pressures may leave some smaller financial institutions vulnerable to a sizable CRE price decline.” In 2017 the Fed also pointed out that prices of commercial real estate have grown faster than rents for an extended period and measures of the amount of operating income relative to the sale price of commercial properties have reached historic lows. Cap rates on commercial real estate are at the lowest point since 2007. As interest rates rise, heavily leveraged properties will produce even less net operating income. 


In 2007, the FDIC issued supervisory insights relating to commercial real estate concentrations.  The guidance covers market monitoring and analysis, credit underwriting and administration, portfolio management, credit risk rating and review, and stress testing.


A credit union’s ability to monitor developments in its CRE market area is a critical element of successful CRE lending. The necessary level of market monitoring can differ among institutions depending on the exposure level and perceived risk in a product type such as development lending, construction lending, and/or non-owner-occupied commercial real estate, retail, warehouse, and industrial loans. Market trends should be monitored closely in high concentration areas to determine when a credit union should curtail its lending in a specific area. As an example, with the changes we are seeing in consumer’s utilizing online shopping versus traditional brick and mortar stores, there are growing risks associated with financing large malls and strip malls. We have seen major anchor brick and mortar retailers such as Sears, K-Mart, J.C. Penney, Bon-Ton, and Macy’s close numerous stores in 2017 and into 2018. Careful analysis needs to be made regarding the type of retail tenants that can fill the space. Are they providing “experiences” to their customers to allow them to compete with online retailers? Is it sustainable?


A solid appraisal review process would incorporate up-to-date market analysis and knowledge.  Does the cap rate the appraiser is using make sense in today’s environment? The December 2010 Interagency Appraisal and Evaluation Guidelines state in part “through the review process, the institution should be able to assess the reasonableness of the appraisal or evaluation, including whether the valuation methods, assumptions, and data sources are appropriate and well-supported. An institution may use the review findings to monitor and evaluate the competency and ongoing performance of appraisers and persons who perform evaluations.”


Many credit unions lack the staff expertise to adequately monitor the various segments of their commercial real estate market. There is a heavy reliance on the appraiser, and the appraisal review process consists primarily of a checklist for compliance with USAP and does not really “dig into” the valuation methods used in the appraisal or the most current trends in the market on both a national and local scale. 


The FDIC Supervisory Insights harken back to the “History of the Eighties – Lessons for the Future,” which a few of us remember. It was a time when weak underwriting standards and portfolio management techniques contributed to a significant oversupply of CRE properties that weakened the entire CRE market, leaving borrowers unable to repay their loans and collateral that provided far less support than originally thought.


It is time for financial institutions to reassess their commercial real estate lending practices, procedures, and concentration levels. Institutions should seek to bolster their ability to objectively review appraisals and evaluations with the use of current and meaningful market data and trends. If you need extra resources to help keep up with your CRE exposure, consider utilizing Wipfli’s loan review team to avoid repeating the history of the more recent past—the great recession. Contact your Wipfli client relationship executive for further information.