Tuesday, December 21, 2010

11 Predictions for AMC Liability Risks in 2011

We are looking forward to another challenging year in the business of insuring and defending claims in the appraisal industry.  Based on recently filed cases, threatened litigation and emerging issues, these are LIA Administrators & Insurance Services' predictions for the biggest liability risks that we expect for appraisal management companies in 2011:

  1. Several AMCs will be sued by the FDIC.  Hundreds of appraisers are currently involved in lawsuits or threatened with litigation by the FDIC relating to appraisals performed for failed lenders, principally for loans made from 2005 to early 2008.  Attorneys for the FDIC are presently evaluating claims against AMCs which delivered appraisals during that time period.  This threat will last well beyond 2011 because, under federal law per the FDIC's interpretation, the statutes of limitation for its claims as receiver of a failed financial institution are extended by 3 years for tort claims and 6 years for contract claims, running from the date of its appointment as receiver.
  2. AMCs sued by the FDIC will discover that their professional liability policies are not sufficient or exclude claims by the FDIC.  A large number of AMCs shop for the cheapest “E&O ticket” without any evaluation of coverage or exclusions, and many AMCs carry limits that are inadequate given the volume of transactions they handle.  There is also a strong likelihood that an AMC sued by the FDIC will discover that its professional liability policy contains a “regulatory exclusion” that may exclude coverage for an FDIC claim.
  3. A few AMCs will endure liability aftershocks relating to actual or threatened litigation by the purchasers of mortgage backed securities.  MBS litigation against mortgage originators recently has become more organized and better handled by more knowledgeable law firms.  The liability threat to AMCs is twofold: direct claims against AMCs by MBS investors and indemnification claims by lenders defending MBS investor claims.  This risk mostly affects AMCs which delivered appraisals between 2004 and early 2008 and will more likely affect the largest AMCs, but would quickly exhaust the insurance limits of or kill any smaller AMCs dragged into the litigation.  Because this liability exposure has started very late in the day (years after the mortgage originations), however, we think the risk of new MBS-related cases will subside late in 2011.
  4. More AMCs will be named as defendants in lawsuits filed by borrowers and lenders alleging claims about poor quality appraisals.  We have noticed a distinct trend that more AMCs are being named by borrowers in lawsuits which allege straightforward negligence or negligent misrepresentation in appraisals -- in other words, the garden variety consumer cases we see against individual appraisers.  This trend will continue to swell in 2011 and AMCs will find themselves involved in lawsuits that normally only would have named individual appraisers.  There are a handful of reasons for this: (a) AMCs are more visible to borrowers and plaintiffs' attorneys and manage a far greater proportion of residential appraisal work than pre-May 2009; (b) appraisers doing very low fee work are more likely to produce appraisals with quality issues and also more likely to leave the business (and drop their insurance coverage) leading to increased exposure of the AMC; (c) the line between appraising and appraisal management -- and their related liability -- has blurred; (d) some state AMC laws provide a basis for arguing that new duties and standards of care apply to AMCs; and (e) the AMC bonds required in some states will be an incentive for some borrowers to make claims. 
  5. We will see a few lenders sue AMCs to enforce appraisal “warranties” which obligate the AMCs to pay losses and costs for mortgage repurchases and other losses blamed on faulty appraisals.  If the AMC did not properly evaluate the wording of any representations and warranties given in recently drafted lender contracts, the AMC may find itself liable for liabilities relating to appraisals delivered long ago.  In some cases, the liabilities assumed by AMCs are well beyond their financial resources.
  6. Some AMCs will face liability because they do not understand current appraiser E&O issues.  As lender claims against appraisers continue at record levels in 2011, AMCs will more often discover in 2011 that their panel appraisers no longer have E&O covering the appraisals in question because the appraisers have left the business or obtained new insurance purchased at cheaper rates without coverage for their prior work (i.e., no “prior acts” coverage).  These cheap policies are being marketed to appraisers based on the theme that "AMCs and lenders don't look at appraisers' prior acts coverage" or "lenders do not require prior acts."  Some lenders making claims will hold the AMCs responsible for the losses because of contractual representations made by the AMCs.  
  7. More AMCs will realize why it’s a bad idea to require their panel appraisers to attach E&O declarations pages to appraisal reports.  It seems like common sense that having an E&O declarations page attached to an appraisal report incrementally increases the likelihood of an appraisal-related claim from a third party such as a borrower.  Yet, many AMCs require it.  We’ve seen firsthand, however, instances of AMCs themselves being dragged into legal claims as a result of having the appraiser’s insurance information attached to reports.  The risk here is two-fold for the AMC: first, having the E&O declarations page attached serves as bait for some consumer plaintiffs to file actions which may drag in not only the appraiser but also the AMC and lender; and second, there are instances where the attached E&O declarations page has been forged, resulting in lenders redirecting their claims at the AMC.  (READI members can read more about this subject here and here at readimember.org.)
  8. More AMCs will seek to enforce appraisers’ contractual agreements to indemnify the AMCs for claims by borrowers and lenders pursuant to the indemnification clauses in contractor agreements.  It’s been rare in the recent past that AMCs have actually sought to compel appraisers to indemnify them for appraisal-related claims under the terms of the indemnity provisions found in many AMC-appraiser contractor agreements.  We will likely see more attempts to transfer AMC liability in the coming year because more AMCs now have the provisions, more claims will be made against AMCs, and AMCs have agreed in their own contracts with their lender clients to assume more liability.   This trend will be complicated in a few states where new AMC laws prohibit AMCs from shifting liability for their own conduct. 
  9. We will see a few national AMCs penalized by state regulators.  With new authority under some state AMC laws, state boards will first go after the “low-hanging fruit.”  The easiest violations for them to prosecute are right out in the open because they appear on the face of AMC-appraiser contractor agreements.  As states have enacted AMC laws and adopted regulations over the last year, many AMCs have failed to update their agreements to meet the differing requirements in each state.  This will be an expensive trap for some, not only because of the penalties and costs of discipline but also because of the loss of lender business when discipline is publicized (most lenders will not want to take the risk of utilizing an AMC which has been the subject of state discipline).  It will be very important for AMCs to have access to legal counsel familiar with defending appraisal-related matters before state regulators.  (READI members can read about some typical AMC agreement problems here.)
  10. Dodd-Frank’s mandatory reporting of USPAP violations will create a dilemma for some AMCs.  Under Dodd-Frank, AMCs have a TILA-based duty to report appraisers to state regulators when there is a reasonable basis to believe a USPAP violation has occurred, while many AMCs have contractually promised their lender clients to indemnify them for damages and costs relating to appraisal reports which fail to comply with USPAP.
  11. Specific Litigation Predictions for 2011 (No New News Here): the FDIC will continue to be the single biggest source of appraisal-related claims; borrowers will continue to file more claims than lenders; First American CoreLogic will continue to be a very aggressive, but mostly unsuccessful, litigant against competing companies; and Florida, Arizona and North Carolina will continue to be the riskiest states for appraisal-related claims.
It is easy to see a few patterns that emerge in our assessment of risk for AMCs in the next year.  First, AMCs -- and other service providers -- who provided services relating to mortgages originated 2004 to mid-2008 are exposed to many threats of litigation stemming from that time period.  It's for this reason that at least one major insurer recently decided to cease renewing all appraisal-related insurance policies covering prior acts.  A continued cat-and-mouse game of mortgage repurchase demands and mortgage insurance rescissions fuels a lot of these liability exposures.  We even see the same lenders and companies trying to force mortgage liabilities back for alleged origination fraud in certain mortgage pools, while being blamed by other parties for the very same types of origination fraud in different pools.  (AMCs and appraisers are also attacking themselves in the same way.  We've heard from appraisers working for AMCs doing "forensic" reviews of origination appraisals to support FannieMae repurchases, who've then been on the receiving end of another appraiser's "forensic" review of their own origination appraisals.)

Second, with legal and regulatory changes, AMCs are exposed to new liability exposures, mostly stemming from their more visible presence and from the blurring of the liability line between AMC and appraiser.  Recent representations by AMCs to lenders with regard to quality control, appraisal review, indemnification and compliance will also fuel these liability exposures in the future.

Third, with the evolving liability exposures, the interests of AMCs and individual residential appraisers who work for them are becoming more aligned in some respects.  It's in both their interests to pay attention to loss prevention and avoid practices that expose them to potential joint liability.

Finally, I don't think that anyone in the appraisal industry should relish in the liability of other parties in the appraisal industry.  The bottom line is that no one -- whether it's a full-fee independent appraiser, an AMC or an AMC panel appraiser -- is paid an appraisal fee high enough to justify the treatment of any opinion of value as a guarantee of value or as alternative mortgage insurance.