On February 23, 2022, the US Consumer Financial Protection Bureau (“CFPB” or “Bureau”) took the first step in an eventual rulemaking by publishing an outline of proposals and alternatives under consideration to prevent algorithmic bias in automated valuation models (AVMs). AVMs are software-based tools used to determine the value of real estate as an alternative or supplement to traditional appraisals. The CFPB’s proposals are part of the mandate to promulgate interagency regulations under section 1125 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), which the Dodd-Frank Act added. Section 1125 sets quality control standards for AVMs and requires the CFPB, Federal Reserve Board (Board), Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), National Credit Union Administration (NCUA), and the Federal Housing Finance Agency (FHFA) to promulgate regulations to implement these quality control standards. Enforcement authority for the eventual section 1125 rule will rest with (a) the FDIC, Board, NCUA, and OCC with respect to insured banks, savings associations, and credit unions and their subsidiaries and (b) the CFPB, Federal Trade Commission, and state attorneys general with respect to other non-depository participants in the market for appraisals of 1- to 4-unit single-family residential real estate.
Recent Initiatives to Combat Discrimination in Appraisals
The broader issue of bias and discrimination in home valuations recently has been a topic of concern among several agencies and congressional committees. For example, in July 2021, the Department of Housing and Urban Development (HUD) announced the development of an Interagency Task Force on Property Appraisal and Valuation Equity (PAVE). In early February 2022, the Bureau’s Fair Lending Director and other senior officials from the federal agencies responsible for enforcing the Fair Housing Act and the Equal Opportunity Act sent a letter to The Appraisal Foundation suggesting that the Uniform Standards of Professional Appraisal Practice (USPAP) may need to be revised to ensure appraisers comply with the anti-discrimination provisions of these statutes and do not rely on conclusions related to prohibited characteristics. Most recently, on February 22, 2022, Congresswoman Maxine Waters, Chairwoman of the House Financial Services Committee (HFSC), sent a letter to the Secretary of HUD and others asking HUD to initiate a systemic investigation into housing valuation discrimination and indicating that she will be introducing legislation to combat appraisal bias.
Although most of the focus to date has been on discrimination by appraisers, rather than by models, this rulemaking will focus on models used in home valuations. CFPB Director Rohit Chopra has repeatedly focused on issues of algorithmic bias in recent public statements, and the agency has taken steps to increase its capabilities in this area, including by posting job openings for data scientists that specifically reference fair lending as a core responsibility. This effort to address algorithmic bias in AVMs is likely to be the first of many initiatives by Director Chopra to combat perceived algorithmic bias in the financial services industry.
Proposals under Consideration
The CFPB’s outline of proposals and alternatives specifically addresses the potential for bias in AVMs, which section 1125 defines as “any computerized model used by mortgage originators and secondary market issuers to determine the collateral worth of a mortgage secured by a consumer’s principal dwelling.” The CFPB emphasized that AVMs may either be discriminatory in their design or use biased data, which could lead to fair lending risk.
Whenever the CFPB is working on a rule that could have significant economic impacts on small entities, the Dodd-Frank Act requires the CFPB to organize a Small Business Review Panel. Part of that process involves seeking feedback from small entity representatives (“SERs”) on the regulatory options under consideration. To comply with this required process, the CFPB outlined a number of options that it (and the other agencies tasked with rulemaking under section 1125) may consider in a future rule:
Scope of Eventual Rule. Section 1125(a) of FIRREA requires AVMs to adhere to quality control standards designed to: (1) ensure a high level of confidence in the estimates produced; (2) protect against the manipulation of data; (3) seek to avoid conflicts of interest; (4) require random sample testing and reviews; and (5) account for any other such factor that the agencies determine to be appropriate.
- The CFPB is considering two alternative approaches for compliance with the first four statutory quality control factors. One is a flexible, principles-based approach; the other is a prescriptive, rules-based approach. The first four factors, according to the CFPB, are generally consistent with existing guidelines issued by the prudential regulators in 2010 (the Interagency Appraisal and Evaluation Guidelines), as well as various model risk management principles and supervisory expectations of the agencies. In light of this existing guidance, a principles-based approach that allows institutions to adopt and maintain their own systems for ensuring compliance may reduce regulatory burden while still fulfilling the objectives of section 1125. The alternative would be a more detailed, proposed prescriptive rule that could have the advantage of offering more certainty but could become quickly outdated as technology evolves. Accordingly, the Bureau is asking SERs whether a more prescriptive rule would be helpful to small entities or more burdensome.
- For the fifth factor, which allows the agencies to account for any other factor they deem appropriate, the CFPB is considering specifying that nondiscrimination quality control criteria are an appropriate area of analysis. Given the risk of bias in algorithmic systems, the CFPB says, it is critical for AVM model risk to be mitigated with fair lending controls. The Bureau notes that compliance with nondiscrimination laws is already encompassed within the first three statutory factors, thus perhaps rendering a separate nondiscrimination factor unnecessary. Its preliminary assessment, however, appears to be that a separate, explicit nondiscrimination QC factor is appropriate. As with the first four statutory factors, the Bureau is seeking feedback from SERs on potential approaches.
Defining “AVMs.” The CFPB announced that it is considering defining covered AVMs under section 1125 as those used for making underwriting decisions regarding the value of collateral (rather than AVMs used to produce any valuation estimate). The CFPB also indicated that it is considering whether to exclude the following categories from the definition of an AVM:
- AVMs used in subsequent reviews of a completed determination;
- AVMs used by a certified or licensed appraiser who is already subject to quality control standards under other federal and state regulation and supervision;
- AVMs used in transactions that do not result in the consumer receiving a new mortgage origination (e.g., a loan modification);
- AVMs used to make reduction or suspension decisions for home equity lines of credit (HELOCs);
- Secondary market issuers’ use of AVMs in the offer and sale of residential mortgage-backed securities (RMBS); and
- Mortgage originators’ use of secondary market issuers’ AVMs for appraisal waiver programs or, alternatively, mortgage originators’ use of AVMs used exclusively to determine whether a loan qualifies for an appraisal waiver program or generate a value estimate for such a program.
Defining “Mortgage Originators.” Since section 1125 does not define “mortgage originators” who use covered AVMs, the CFPB stated that it would draw heavily from the definitions in other consumer financial laws such as the Truth-in-Lending Act (TILA). The CFPB indicated that it is considering defining “mortgage originator” to cover persons who are “loan originators” under Regulation Z § 1026.36. Another option is to define “mortgage originator” to mean “creditors” under Regulation Z § 1026.2(a)(17). The CFPB is also considering proposing a definition of “mortgage originator” that would cover persons who are “servicers” under Regulation Z 1026.36(c) but only to the extent that they (1) perform loan origination activities that constitute a refinancing under Regulation Z § 1026.20(a) or (2) change an obligor on an existing debt.
Defining “Secondary Market Issuers.” Section 1125 also does not define “secondary market issuers” who use covered AVMs. To address this, the CFPB suggested that the interagency rulemaking could include two potential definitions. The first alternative would define “secondary market issuers” only as entities that issue RMBS. The second alternative would more broadly include issuers, guarantors, insurers, or underwriters of RMBS.
Defining “Mortgage.” Section 1125(d) further limits coverage to AVMs used to “determine the collateral worth of the mortgage” but does not define the word “mortgage.” The CFPB is considering defining “mortgage” as an extension of credit secured by a dwelling. The other option would be to define “mortgage” as a transaction in which a mortgage, deed of trust, purchase money security interest arising under an installment sales contract, or equivalent consensual security interest is created or retained in a dwelling.
Defining “Consumer’s Principal Dwelling.” Section 1125(d) states that it covers AVMs used to “determine the worth of a mortgage secured by a consumer’s principal dwelling.” The CFPB is considering basing its definition of a “consumer’s principal dwelling” on the valuation independence provisions codified in Regulation Z § 1026.42.
- “Consumer.” The CFPB is considering proposing that a “consumer” would be a natural person to whom credit is offered or extended. However, the CFPB stated it would consider clarifying that even if the CFPB uses a Regulation Z-based definition, the definition of “consumer’s principal dwelling” would include mortgages for which the proceeds are used for purposes other than personal, family, or household purposes as long as the mortgage is secured by a consumer’s principal dwelling.
- “Dwelling.” The CFPB stated that it would consider treating “dwelling” as a residential structure that contains one to four units, whether or not that structure is attached to real property, and includes an individual condominium unit, a cooperative unit, a manufactured home, and any other structure used as a residence, regardless of whether the structure is classified as “personalty” under state law. The alternative would be to limit the treatment of “dwelling” to transactions in which the dwelling is secured by real property.
- “Principal.” The CFPB is considering proposing that a vacation or second home would not be a “principal” dwelling and clarifying that a consumer can reside in only one principal dwelling at a time. Additionally, the CFPB is considering adopting the position that, if a consumer seeks financing for a dwelling under construction or to be constructed that will become the consumer’s principal dwelling upon or within a year following completion of construction, the mortgage secured by the new dwelling would be considered a transaction secured by a “principal” dwelling.
Implementation Period. The CFPB stated that it is considering a 12-month implementation period after the issuance of an interagency final rule. No institution would be required to comply with the new regulatory requirements before a final rule is issued and the implementation period concludes.
Written feedback from SERs and other stakeholders can be emailed to 2022-SBREFA-AVM@cfpb.gov. The CFPB requests feedback from SERs by April 8, 2022, in order to be considered and incorporated into the Small Business Review Panel Report. Other stakeholders wanting to provide written feedback may do so no later than May 13, 2022.