CFPB Releases Outline of Proposals Governing Automated Valuation Models
A few weeks ago, the Consumer Financial Protection Bureau (CFPB or bureau) issued an outline of proposals and alternatives aimed at combatting bias and inaccuracy in automated valuation models (AVMs). As a refresher, the Dodd-Frank Act added section 1125 to the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), which requires that AVMs meet certain quality control standards, to be defined by the regulators of financial institutions (including the CFPB and NCUA). This outline of proposals is the first step in fulfilling the duty to propose regulations that govern AVMs (Yes, the regulators are still writing rules required under Dodd-Frank; there were a lot of requirements in that Act). AVMs are computer programs used to analyze data from a variety of sources to estimate the value of homes, and can be used in addition to or as a replacement for a traditional appraisal. Automated valuation models may expedite the lending processes if lenders, servicers, and appraisers are able to use these programs to accurately and quickly receive estimates of home values without waiting on an in-person appraisal. Over the past few months, the bureau has expressed concern about bias and discrimination in the appraisal process, which negatively affects homeownership rates for protected groups, such as people of color. The CFPB explained in its press release that these proposed options and any future rulemaking would be used to ensure the accuracy and fairness of AVMs, in an effort to decrease the bias and disparate outcomes that currently exist in the mortgage market. Specifically, the bureau is looking to determine how these options might interact with existing fair lending laws and how they could affect the housing market and small businesses.
The bureau’s main objectives in exploring these options are to:
- “Ensure a high level of confidence in the estimates produced by automated valuation models;
- Protect against the manipulation of data;
- Seek to avoid conflicts of interest;
- Require random sample testing and reviews; and
- Account for any other such factor that the agencies determine to be appropriate.”
The outline of proposals explains the CFPB will be careful in determining the scope of a future rule in order to leave flexibility for continued development and broad industry use of AVMs. For example, the bureau has explained it may issue a rule governing AVMs only when they are “used for making underwriting decisions regarding the value of collateral rather than broadly covering AVMs used to produce any valuation estimate.” In this case, a proposed rule would not govern AVMs used for purposes other than decision-making at origination, such as: reviewing decisions, conducting quality control, or compliance testing. The CFPB is collecting data on how AVMs are used in these processes to determine whether it would be appropriate to govern them in a future proposed rule. The bureau is also conducting research to determine whether it would be appropriate to cover AVMs used in decision-making for loans that already exist, such as refinances and mortgage modifications. In this case, AVMs would not be used at origination, because the loans have already been made, but AVMs would be used to make underwriting decisions for changing the terms of a member’s loan.
In addition to determining the scope of AVM use under the proposals, the CFPB will need to decide on which entities will be governed. This will include defining terms such as “mortgage originator”, “servicer”, and “secondary market issuer.” For example, the bureau is likely to use a definition of mortgage originator that aligns with TILA and Regulation Z, so that lenders will already be familiar with this term and will not need to make a new determination of whether they are covered.
Most importantly, the bureau will propose substantive quality control and nondiscrimination standards for the use of AVMs. This may include requiring credit unions and other lenders to follow a principles-based approach to create policies and procedures aimed at achieving the objectives mentioned above. This type of requirement would leave flexibility for each institution to create processes that best work for its operations. In the alternative, the bureau is considering issuing a more detailed rule that would create guidelines on how to use AVMs and how to implement quality control and testing to achieve the previously mentioned objectives. This approach would make compliance standards clearer. The CFPB will continue to conduct market research and collaborate with other regulators to determine which approach would be appropriate. A proposed rule may also describe steps to ensure that bias is tested and controlled for in order to prevent discrimination that would violate the Fair Housing Act, Equal Credit Opportunity Act and Regulation B. Because algorithms may reflect traditional patterns of discrimination, the CFPB has expressed the importance of mitigating the risk with controls and procedures to reverse that risk, even when lenders are not completely in control of how their AVMs are programmed.
The bureau’s next steps may include working with other federal regulators, including the NCUA, to issue a proposed rule on AVMs. NAFCU’s compliance and regulatory teams will update members on any proposed rule that is issued.