Warning: What you are about to read could be career-ending. For me that is. But only if those who intend to drive a stake in to the heart of the AMC (Appraisal Management Company) industry win the day.
It’s worth it though, if it brings some people around to the genuine threat facing the mortgage lending ecosystem that state AMC registration laws pose. I remain convinced that federal AMC oversight is the safest, most effective, and least costly alternative, and is far better than the state-by-state approach underway. In fact, I wouldn't even be too worked up if there was a single, federal overseer, with states taking on the enforcement role. It's the 50 states crafting their own legislation that's worrisome. What some state legislatures propose to rein in AMCs will put them out of business.
But before it goes that far a few points are worth noting. I’ll use New Mexico’s proposed AMC act as just one example of what can happen when states attempts to regulate entities that they don’t understand on the advice and counsel of populist outrage.
Lenders have two (2) choices when it comes to managing appraisal panels.
They can do it themselves or have someone else do it. Each choice has advantages and disadvantages; and each involves tradeoffs. By outsourcing to an AMC, the lender avoids appraisal coordination costs that it would otherwise incur.
Appraisal coordination includes the cost of hiring, equipping, training, and supervising people to find and qualify appraisers, place and track orders, perform underwriting reviews of finished products, among other duties. By outsourcing, lenders avoid certain technology investments, labor burden, order volume fluctuations, and keep the appraiser and originator at arms-length.
Significantly, AMCs enable lenders to convert the numerous fixed costs associated with fee panel management into variable costs. Lenders managing fee panels themselves must invest in all the requisite resources to perform these functions on a mostly fixed-cost basis. And it adds yet another cost center managing non-core functions.
Hence we arrive at critical point number 1: Appraisal reports don’t just show up; someone must invest in IT, facilities and carbon-based resources to acquire them; the lender… or AMC.
Production cost + coordination cost = the total cost of any good or service.
Few would dispute that it costs something to coordinate appraisal transactions. We can debate the amount of the cost. But surely we’d agree that there is some coordination cost. Someone has to find the appraiser, perform a background check, negotiate fees, turnaround times, and delivery methods; handle customer complaints, status updates, and underwriting reviews; pay the appraiser and bill the customer.
Charlie Elliott, who operates one of the nation’s largest appraisal firms, put this cost at $100 per appraisal. My own pro formas support his estimate. And it’s important to consider that that’s the cost to an AMC; the cost to a lender self-managing a panel will be even greater. Why? Because, while an AMC approaches supplier management as a core-competency, a lender necessarily does not. AMCs spend tons of time and resources organizing their value chains to maximize productivity and innovation, and reducing overall operating costs. Cost saving is another advantage for lenders that use AMCs.
Thus we come to critical point number 2: There’s upwards of $100 in transaction coordination cost to an AMC above and beyond the cost of the appraisal; even more to a lender self-managing suppliers.
New Mexico proposes to cap AMC fees at 10 percent of the appraisal cost.
That’s the poison pill at the center of Senate Bill 138, which was introduced this month by Senator Mark Boitano. If it carries, an AMC that pays an appraiser say $250 would earn $25, just one-forth of its internal coordination cost; at $400 it would earn $40, a not much better two-fifths of its cost.
[Author's Note: My understanding is that the NM legislature has dropped the 10% fee cap subsequent to the post being published. ]
Therefore, a 10% fee cap would mean one of two things. The AMC would either need to pay the appraiser $1,000 per appraisal, to cover the $100 cost to coordinate the transaction, or leave. This would mean NM consumers would pay more than twice what they pay today, which won’t sit well. Or AMCs will bail on the state.
So here are critical point(s) 3 and 3.1: Arbitrary fee caps will put AMCs out of business, harming the mortgage lending ecosystem, and raising administrative costs. 3.1: Such clauses demonstrate a stunning lack of understanding of the economics of the business model being regulated.
All this is stacked atop a $1,000 AMC registration fee.
Last year, New Mexico passed an AMC registration act requiring AMCs to pay a $1,000 registration fee the first year (and $550 annually thereafter). Of course, this won’t much matter because few AMCs will make it past the one-year mark. But regardless, coupling the $1,000 registration fee with the 10% fee cap means an AMC that earns $25 (in fee-cap imposed earnings) needs to do 40 appraisals that year; at $40 they’d need 25 orders in year-one, or 2.1 per month. Not huge order numbers relatively speaking. But given that the fee cap guarantees a loss on each order it’s understandable why the better option is to bail.
This suggests critical point number 4: High registration fees only add to the twisted cost-benefit equation for doing business in a state; adding a fee cap is lethal poison.
The problem is clear. Someone must pay to coordinate the transaction. The coordination cost -- to AMC is upwards of $100 per order; to the lender potentially much more. Unable to pay premium appraisal fees to cover coordination costs under the cap, and having also to pay a $1,000 registration fee, and the specter of a large loss on each transaction, means that enacting NM SB 138 as-is will cause AMCs not to serve lenders that do business in New Mexico.
Four likely outcomes if I turn out to be right.
If I’m right there will be four (4) outcomes… beyond ridding the state of AMCs.
The first is that other states will unwittingly adopt similar poison pills. Not understanding the unintended consequences of such a clause on not only AMCs but also mortgage lenders and mortgage availability to living, breathing, and voting taxpayers state legislators will view the fee cap poison pill as aspirin. It won’t be.
The second outcome will be that lenders who formerly used AMCs will suddenly have to manage appraisals themselves. This is significant given that 17 of the top 20 lenders use or own AMCs. Trouble is they won’t have the resources to tackle this new responsibility, at least for a while. And assuming they finally get their act together it is unlikely that lenders will replicate the productivity, innovation, cost controls and strategic advantage that the AMC industry – whose core competency after all is managing appraiser contracts and workflow – achieve currently.
The third outcome will be that lenders, faced with the prospect of building an AMC-light operation, will pass on the additional costs to consumers. These costs will prove significant. Beyond the coordination costs mentioned already, lenders would now need to reserve for risks they’re taking on. Some of these risks include HVCC compliance risk and reporting risk. Way more significant will be risk (and cost) associated with order volume volatility. Today, many lenders mitigate order volume volatility simply by placing more or fewer orders with AMCs. Absent that outsource safeguard, they’ll need to forever staff up and lay off workers in response to often wild swings in volume. Capacity will be constant anchor on profitability.
The forth outcome -- and there surely are more than just these -- is that we’ll quickly discover a disparity between the laws of various states with regard to bank-owned AMCs. Many states exempt banks from their AMC registration laws. I suspect this is to avoid going head to head with the existing federal bank exemption. Other states, including New Mexico, do not carve out banks from their AMC laws.
I’m not sure about how this bank-exemption thing will play out. However, in states that exempt banks, I suspect, bank-owned AMCs will claim the exemption. Should that strategy ultimately fail in a handful of states they’d simply bring the subsidiary AMC in-house as a department of the bank: the appraisal management department.
An opportunity for meaningful registration lost.