Testing for Impairment: Are Appraisals Required?

written by Jacob Hall

Community bankers sometimes do not know whether or not an appraisal is required when loans secured by real estate are tested for impairment. Regulatory guidance does not clearly require an appraisal for a subsequent transaction, which is defined as one of the following:

• Renewal of an existing loan at maturity.
• Purchase of other real estate.
• Refinancing of an existing loan priority prior to maturity.
• Adjustment of a loan that involves more than a limited change in terms.

According to regulatory guidance, the subsequent transaction exemption applies if either:

• There has been no obvious and material change in market conditions or physical aspects of the property that threatens the adequacy of the real estate protection, even with the advancement of new monies.
• There is no advancement of new monies, other than funds to cover closing costs.

How can you determine the value of real estate collateral for the impairment computation without having a current appraisal completed? Lenders already know that a loan isn’t performing, so they aren’t inclined to spend thousands of dollars on an appraisal for an impaired loan. Although not explicitly required, it may be a good idea to get an appraisal in this scenario unless you can obtain a sufficiently strong evaluation. This is especially true if the loan is for more than $1 million and the sale of real estate will be the primary source of repayment. During course of an exam, a regulator may insist that you obtain an appraisal due to excessive exposure. If you do opt for an evaluation, you should thoroughly explain why this is preferable to an appraisal.

Please contact us if you have more questions about appraisal requirements 417-881-0145.