BILL ANALYSIS Ó ----------------------------------------------------------------------- |Hearing Date:May 2, 2011 |Bill No:SB | | |6 | ----------------------------------------------------------------------- SENATE COMMITTEE ON BUSINESS, PROFESSIONS AND ECONOMIC DEVELOPMENT Senator Curren D. Price, Jr., Chair Bill No: SB 6 Author:Calderon As Amended:April 11, 2011 Fiscal:Yes SUBJECT: Real Estate: appraisal and valuation. SUMMARY: Updates California's Real Estate Law, Appraisal Law, and Civil Code to reflect recent changes enacted at the federal level, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act. NOTE: This measure was heard in Banking and Financial Institutions Committee on April 6, 2011, and passed out of Committee by a vote of 7-0. Existing law, the Business and Professions Code: 1) Provides for the licensure and regulation of real estate brokers and real estate salespersons by the Real Estate Commissioner (Commissioner) and makes a willful violation of the Real Estate Act a crime. (Business and Professions Code (BPC) § 10176) 2) Prohibits the generation of an inaccurate opinion of the value of residential real property in connection with a certain real estate transaction in order to, among other things, acquire a financial or business advantage that directly results from the inaccurate opinion of value. The Commissioner may punish a violator of this provision by suspending or revoking the real estate license. (Id.) 3) Provides for the licensure and regulation of real estate appraisers and appraisal management companies and makes a willful violation of SB 6 Page 2 the Real Estate Appraisers' Licensing and Certification Law a crime. (BPC § 11345.4) 4) Prohibits an appraisal management company from improperly influencing any appraisal by engaging in certain activities. (Id.) Existing law, the Civil Code: Prohibits a person with an interest in a real estate transaction involving an appraisal from improperly influencing or attempting to improperly influence, through coercion, extortion, or bribery, the development, reporting, result, or review of a real estate appraisal sought in connection with a mortgage loan, and specifies that a violation of this provision by a person licensed under a state licensing law also constitutes a violation of that law. (Civil Code § 1090.5) This bill: 1) Prohibits a licensee that provides an opinion of value of real property, which is used as the basis for a mortgage loan origination, refinancing, or modification from having an interest in the property. 2) Prohibits a licensee from knowingly or intentionally misrepresenting the value of real property. 3) Prohibits an appraisal management company from improperly influencing any appraisal through coercion, extortion, inducement, collusion, bribery, intimidation, compensation, or instruction. 4) Prohibits certain acts, including, but not limited to, seeking to influence an appraiser to report a minimum or maximum value for specified property, implying to an appraiser that their retention depends on their estimate of the real property value excluding an appraiser from future engagement because they reported a value that does not meet or exceed a certain threshold, and conditioning compensation paid to an appraiser on consummation of the real estate transaction. 5) Prohibits a person who prepares an appraisal or performs appraisal management functions in connection with the origination, modification or refinancing of a mortgage loan from having a direct or indirect interest, including financial interest, in the property or the transactions that the person is performing the services for. SB 6 Page 3 6) Clarifies that an appraisal management company is not hindered from asking an appraiser to: (1) consider additional, appropriate property information; (2) provide further detail, substantiation, or explanation for the appraiser's value conclusion; (3) correct errors in an appraisal report; (4) obtain multiple valuations, for purposes of selecting the most reliable valuation; (5) withhold compensation due to breach of contract or substandard performance of services; and (6) provide a copy of the sales contract in connection with a purchase transaction. 7) Revises the law to make the prohibition against improper interest in a real estate transaction applicable to a valuation. 8) Defines valuation as an estimate of the value of real property in written or electronic form, other than one produced solely by an automated model or system. 9) Prohibits specific acts in conjunction with valuation including, but not limited to, seeking to influence a valuation preparer to report a minimum or maximum value for specified property, implying to a valuation preparer that their retention depends on their estimate of the real property value, excluding a valuation preparer from future engagement because they reported a value that does not meet or exceed a certain threshold, and conditioning compensation paid to a valuation preparer on consummation of the real estate transaction. FISCAL EFFECT: Unknown. This bill has been keyed "fiscal" by Legislative Counsel. COMMENTS: 1. Purpose. This bill is sponsored by the California Subcommittee of the Appraisal Institute. The Author states that California has had more comprehensive and more protective consumer protection laws than the federal government in the past. In July 2010, the federal government passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). This bill intends to update California's Real Estate Law, Appraisal Law and the Civil Code in order to reflect these changes by the federal government. 2. Residential and Commercial Real Estate Transactions. In a SB 6 Page 4 residential home transaction, the buyer may be represented by a real estate agent or broker; and the seller may be represented by a real estate agent or broker; or the same agent or broker may represent both buyer and seller where there is consent from both parties. A buyer may also use a mortgage broker, who may or may not represent the buyer or seller in the transaction. A buyer will almost always seek a mortgage loan from a lender and an appraiser is used to value the home in connection with the mortgage loan. Commercial real estate transactions involve many of the same persons as residential real estate transactions; however, these transactions are usually much more complex in their structure and valuation processes. 3. Real Estate Brokers and Salespersons. Real estate brokers and real estate salespersons, often called real estate agents, are licensed by the Department of Real Estate under the Real Estate Law. A real estate broker or salesperson may also act as a mortgage broker in bringing borrowers and mortgage lenders together. Real Estate Law prohibits deceptive practices and any conduct which constitutes fraud or dishonest dealing. Currently, the law specifically prohibits the generation of an inaccurate opinion of the value of residential real property in connection with a certain real estate transaction in order to, among other things, acquire a financial or business advantage that directly results from the inaccurate opinion of value. 4. Appraisal Management Companies. An increasingly common practice has been the use of appraisal management companies (AMC). An AMC assembles panels of appraisers who are called upon when they receive an order for an appraisal. The AMCs, in turn, assign the appraisals requested by lenders and brokers to appraisers on their panels. When the appraisals are completed, the AMCs deliver them to the lenders and brokers who ordered them. The growth of AMCs has been driven, at least in part, by an agreement reached between Fannie Mae, Freddie Mac, and the New York State Attorney General Anthony Cuomo. This agreement is titled the Home Valuation Code of Conduct (HVCC). Although never promulgated as a regulation by any federal banking agency, the HVCC became a de facto regulation when Fannie Mae and Freddie Mac announced that, on and after May 1, 2009, they would not purchase or guarantee a mortgage loan entered into by a lender that did not comply with the HVCC. One of the key requirements of the HVCC is appraiser independence. Under the HVCC, lenders and mortgage brokers may not be directly SB 6 Page 5 involved in the selection of an appraiser on a loan in which they are involved; they must use a third party to order their appraisals, or use some other method intended to isolate the process of selecting an appraiser from the persons who are compensated based on whether a loan is approved. The use of the AMC as a third party to order appraisals can be beneficial by removing pressure on an appraiser by insulating the appraiser from the person or entity who orders the appraisal. Typically, the party who orders the appraisal has the most at stake from the appraised value. However, in practice, the AMC itself is able to impose pressure on the appraisers. SB 237, enacted in 2009, was meant to ensure regulation of AMCs and clarified prohibited acts by AMCs. This bill is meant to clarify and update those provisions. 5. The Problem of Inflated Appraisals. In the past, this Committee has heard other bills that were meant to combat the problem of inflated appraisals. Although it appeared that there was no organization that systematically documented the frequency or severity of appraisal inflation, much anecdotal evidence was given describing specific situations where an inflated appraisal can be requested by one or more parties to a transaction. Inflated appraisals also occur through the practice of predatory appraisals. A June 2005 report titled Predatory Appraisals: $tealing the American Dream by the National Community Reinvestment Coalition, concluded that problematic appraisal practices are a serious impediment to responsible lending, impede fair housing and equal access to credit, and place homeownership and the safety and soundness of the mortgage marketplace at risk. According to the report, a "predatory appraisal" occurs when the value of a property is falsely overstated during a new purchase or during the home equity or refinancing process. While appraisers are directly responsible for inflating the figures, lenders, brokers and other members of the industry are the ones pressuring appraisers to provide their desired valuation and to close the deal. Lenders and brokers have an incentive to inflate property values because they are paid commissions based on the value of the loans they secure. Additionally, real estate developers and agents are paid profits and commissions based on the sales price of properties. However, appraisers are only paid on a per appraisal basis. The report also detailed the tactics that lenders and brokers use SB 6 Page 6 to obtain an inflated valuation. Some apply pressure by withholding payment, threatening not to do business with the appraiser, or even blacklisting him or her altogether unless the appraiser meets the lender's requested value. They may also demand that appraisers guarantee a predetermined value, ignore deficiencies in the property or simply increase the appraisal if the lender is unsatisfied with it. Lenders also "shop around" known as value shopping by contracting several appraisers to evaluate one property and then use the highest valuation they find. Although SB 223 was enacted in 2007 (Machado, Chapter 291) to combat this problem, this bill updates those provisions in order to align California law to the new federal laws. Also, it provides further clarification on what acts are prohibited by the law. 6. Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act is a federal statute that was signed into law by President Obama in July 2010. The Dodd-Frank Act was a response to the mortgage crisis in the middle of the last decade. This act created significant changes to the American financial regulatory environment and affects all Federal financial regulatory agencies and almost every aspect of the nation's financial services industry. Specifically related to this bill are the following provisions of the Dodd-Frank Act which reform the mortgage business. a. Real property valuations are defined, and those who perform them are protected from inappropriate influence. In its recently promulgated regulations, the Federal Reserve Board (FRB) recognized that many types of real property valuations, including, but not limited to appraisals, are being utilized in the current housing environment. To address this observation, the FRB defined the term "real property valuation" and enacted a series of rules designed to ensure that no entity which prepares a real property valuation is inappropriately influenced in connection with their value conclusion This measure adopts the FRB's definition of a real property valuation. In doing so, it broadens California's existing prohibition against inappropriate influence of appraisers, to cover all types of real property valuations and those who prepare them. This change will have the effect of protecting real estate brokers that perform broker price opinions from inappropriate influence, by covering them under the same rules that currently intended to protect appraisers from inappropriate influence. SB 6 Page 7 b. The Home Valuation Code of Conduct (HVCC) is revised and replaced. The HVCC, as stated above, was an agreement reached between Fannie Mae, Freddie Mac, and then- New York State Attorney General Anthony Cuomo in 2008. One of the core elements of the HVCC was the concept of appraiser independence. In its recent regulations, the FRB enacted rules intended to replace the HVCC. These rules have a similar intent as the HVCC, but are written differently and accompanied by extensive commentary never published in connection with the HVCC. California's existing laws pattern the HVCC. This measure updates California's statutes to reflect the changes made by the FRB to the HVCC, and remove the inconsistency between state law and the recently promulgated federal regulations. c. Conflicts of interest are prohibited in connection with mortgage loan origination. In its recent regulations, the FRB also enacted a provision intended to ensure that no entity which prepares a real property valuation in connection with the origination of a residential mortgage loan has a direct or indirect interest, as defined, in the property or the transaction for which the valuation is sought. The FRB included extensive commentary to describe acceptable and prohibited interests. In a parallel move, this measure amends California's Appraisal Law to prohibit appraisers and appraisal management companies from providing opinions of value of real property in connection with the origination, refinancing, or modification of a mortgage loan, if they have a direct or indirect interest, financial or otherwise, in the property or transaction for which the opinion of value was sought. The Authors of this measure are currently in negotiations with the California Association of Realtors to add language to the Real Estate Law, which would parallel this provision. d. Knowingly or intentionally misrepresenting the value of real property is expressly prohibited. This measure closes a loophole in California's Real Estate Law, by expressly prohibiting a real estate licensee from knowingly or intentionally misrepresenting the value of real property. California's Real Estate Law currently contains a narrow prohibition against knowingly or intentionally misrepresenting SB 6 Page 8 the value of real property in connection with a short sale; this bill broadens that prohibition to apply to all real property valuations performed by real estate licensees. A similar change is not necessary to California's Appraisal Law, appraisers and appraisal management companies are already prohibited from knowingly or intentionally misrepresenting the value of real property. 7. Previous legislation. In 2007, this Committee heard SB 223 (Machado, Chapter 291, Statutes of 2007), which prohibited any person with an interest in a real estate transaction from inappropriately influencing, or attempting to inappropriately influence, a real property appraiser, with the aim of convincing the appraiser to alter his or her value conclusion. In 2009, this Committee heard SB 237 (Chapter 173, Statues of 2009), also by the same Author, which closed a loop hole in California's appraisal regulatory scheme, by defining the term "appraisal management company," and requiring management companies doing business in California to register with California's Office of Real Estate Appraisers, and enacting a set of allowable and prohibited actions for appraisal management companies and the appraisers who work for them. 8. Arguments in Support. The California Government Relations Subcommittee of the Appraisal Institute supports this measure, as one intended to ensure that federal and state rules align on important questions of inappropriate pressure on appraisers and conflicts of interest in rending real property value conclusions. SUPPORT AND OPPOSITION: Support: California Government Relations Subcommittee of the Appraisal Institute (Sponsor) California Association of Realtors Opposition: None received as of April 26, 2011 Consultant: Candace Choe SB 6 Page 9