Automated Valuation Metrics
Our local community is a team, together we effect the most positive of changes! Many thanks to all those who attended the CI Alumni & Friends Happy Hour at the Hangar event (Thursday, 6/16). We raised over $12,000 for student scholarships and it was a blast doing it. AVMetrics is proud to be major sponsor and an active part of the CSUCI community.
It seems like only yesterday we were lamenting the hubris of Volkswagen, loading software into their TDI models to fake out emissions tests on tens of millions of vehicles. Here we are again, this time with Mitsubishi. The only real surprise is that these companies don’t learn.
Hyundai in 2012, Ford in 2014, Volkswagen in 2015, and now Mitsubishi, although this is not even their first scandal. In the early 2000s, Mitsubishi was embarrassed by defects that were covered up.
It’s surprising that these companies cannot identify the root cause is faulty business processes. Instead, they root out the responsible parties and do a mea culpa, or the CEOs resign in shame for their leadership failures (as in the case of Volkswagen last year). Why doesn’t anyone realize that if your system is to self-test for emissions and mileage, eventually you are going to have a problem, because that is not a foolproof system?
The faulty business process is their lack of independent testing. These emissions and mileage results are vital business inputs, and the integrity of those results is mission critical. Where are their controls?
Our industry is financial services, where federal regulations have long required independent testing in many areas. Our specific segment of the industry is the Automated Valuation Model (AVM) business, which has a regulatory mandate for independent validation. Financial institutions use many different kinds of computer models to improve decision making, and AVMs are one kind of model. They estimate property values, and for banks that makes loans on property, that comes in handy in dozens of ways.
But, if there are systematic problems with AVMs, for example, if they over-valued everything by 20%, it could cause a huge problem for banks and credit unions. This is where we come in. We independently test and validate every commercially available residential AVM on a continuous basis, thoroughly, rigorously and impartially. And, the beneficiaries are everyone. Banks and credit unions benefit, borrowers benefit, and even the AVM developers benefit because of the feedback we provide to them as well as the broader consumer confidence in their products.
Certainly it is incumbent upon leaders to create a culture of integrity. One way of doing that is to do more than admonish people to be honest. Instead, create a system where there is independent testing, and make sure that everyone knows that their results will be tested. Voila! When people know they are being checked, integrity soars, and everyone wins. Don’t just demand integrity; build it into the process!
Lee Kennedy, principal and founder of AVMetrics in 2005, has specialized in collateral valuation, AVM testing and related regulation for over three decades. Over the years, AVMetrics has guided companies through regulatory challenges, helped them meet their AVM validation requirements, and commented on pending regulations to help bring clarity and sanity to the situation. Lee is an author, speaker and expert witness on the testing and use of AVMs. Lee’s conviction is that independent, rigorous validation is the healthiest way to ensure that models serve their business purposes. Every commercially available AVM vendor trusts AVMetrics to provide feedback to them on their models, facilitating each model’s continuous improvement.
Thanks to the San Fernando Valley Business Journal for their coverage in the April 18 issue. Stephanie Henkel described how Lee has leveraged his expertise with AVMs and Real Estate Valuation into a second career as an expert witness.
Like many small business owners who develop expertise in their fields to survive and thrive in a competitive environment, Lee found that his expertise had more than one application. Not only could he use it in his business, but he could also apply it as an expert witness in litigation already taking place.
In the AVM world, there is a bit of confusion about what exactly is a “cascade.” It’s time to clear that up. Over the years, the terms “cascade” and “Model Preference Table”TM have been used interchangeably, but at AVMetrics, we draw an important distinction that the industry would do well to adopt as a standard.
In the beginning, as AVM users contemplated which of several available models to use, they hit on the idea of starting with the preferred model, and if it failed to return a result, trying a second model, and then a third, etc. This rather obvious sequential logic required a ranking, which was available from testing, and was designed to avoid “value shopping.”[1] More sophisticated users ranked AVMs across many different niches, starting with geographical regions, typically counties. Using a table, models were ranked across all regions, providing the necessary tool to allow a progression from primary AVM to secondary AVM and so on.
We use the term “Model Preference Table” for this straightforward ranking of AVMs, which can actually be fairly sophisticated if they are ranked within niches that include geography, property type and price range.
More sophisticated users realized that just because a model returned a value does not mean that they should use it. Models typically deliver some form of confidence in the estimate, either in the form of a confidence score, reliability grade, a “forecasted standard deviation” (FSD) or similar measure derived through testing processes. Based on these self-measuring outputs from the model, an AVM result can be accepted or rejected (based on testing results) in favor of the next AVM in the Model Preference Table. This application reflects the merger of MPT rankings with decision logic, which in our terminology makes it a “cascade.”
The final nuance is between a simple cascade and a “custom” cascade. The former simply sets across-the-board risk/confidence limits and rejects value estimates when they fail to meet the standard. For example, the builder of a simple cascade could choose to reject any value estimate with an FSD > 25%. A “custom cascade” integrates the risk tolerances of the organization into the decision logic. That might include lower FSD limits in certain regions or above certain property values, or it might reflect changing appetites for risk based on the application, e.g., HELOC lending decisions vs portfolio marketing applications.
We think that these terms represent significant differences that shouldn’t be ignored or conflated when discussing the application of AVMs.
Lee Kennedy, principal and founder of AVMetrics in 2005, has specialized in collateral valuation, AVM testing and related regulation for over three decades. Over the years, AVMetrics has guided companies through regulatory challenges, helped them meet their AVM validation requirements, and commented on pending regulations. Lee is an author, speaker and expert witness on the testing and use of AVMs. Lee’s conviction is that independent, rigorous validation is the healthiest way to ensure that models serve their business purposes.
[1] OCC 2005-22 (and the 2010 Interagency Appraisal and Evaluation Guidelines) warn against “value shopping” by advising, “If several different valuation tools or AVMs are used for the same property, the institution should adhere to a policy for selecting the most reliable method, rather than the highest value.”
On March 10, 2016, AVMetrics™ was pleased to welcome Rep. Steve Knight to the offices. The team talked to Rep. Knight about a wide range of issues, from the local economy to environmental issues.
Rep. Knight has been touring the District and meeting with constituents to develop an ever-greater understanding of the issues that his constituents face. Lee and the team explained AVMetrics’™ core business: the independent testing of AVMs. AVMetrics™ ‘ core philosophy is that independent testing creates an environment of integrity, and that businesses, systems, and markets with integrity do not suffer from fraud, corruption or bubbles. AVMetrics’™ mission is to ensure integrity in the AVM market to guarantee that AVMs remain a respected and reliable tool.
Rep. Knight also discussed the recent Porter Ranch gas leak disaster, having recently testified before Congress on the subject. The group discussed the advantages of AVMetrics’™ philosophy of independent oversight as an aspect of governmental response to prevent future disasters.
As a veteran of the U.S. Army, Rep. Knight was interested in AVMetrics’™ challenges and successes as a veteran-owned business. AVMetrics™ has been a veteran-owned business for almost 12 years but only last year was certified as a “Veteran Owned Small Business” by the U.S. Dept of Veterans Affairs.
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Right now, what Volkswagen needs most is probably not what you think. Yes, they need lawyers and public relations help, and probably more lawyers. And, they need some internal investigations and a new mission statement. But, what they need most is that magic thing that money simply cannot buy: Volkswagen needs to regain the consumer’s (and the world’s) trust, since the damage to their reputation will take years to repair; this was not simply a faulty product to recall and repair, as staggering as those reparations can also be, this was a direct assault on our belief systems, and that gets personal.
So what shocked you about this deception? Was it the tons of emissions pumped into the air by drivers who thought that they were driving “clean diesel?” Was it the brazen advertising of “clean diesel” by VW that (someone at) VW knew was not clean? Was it the deliberate creation of code loaded into every single TDI 2.0 liter engine that was designed to foil emissions tests? Not for me. The most shocking detail was that the car companies self-certify their emissions and mileage stats.
The reality is that we should never expect that people (or industries or corporations) will always be ethical. In almost all arenas of society we put systems of oversight in place to detect malicious acts in order to deter them. The police are trusted to enforce the laws and use lethal force if necessary; yes, they have an Internal Affairs division, but their oversight is ultimately civilian. The military has a civilian Commander in Chief. The federal government’s three branches are designed to provide mutual oversight.
Federal regulations in banking have long since recognized that banks and credit unions cannot self-regulate either. And as technology and social changes advance far more quickly than the regulators can keep up, they put controls in place to allow carefully vetted entities to serve as their proxy for oversight, most commonly in the form of independent divisions within an organization or third party service providers.
As a case in point, the financial industry depends heavily on sophisticated models to facilitate their business decisions. Specifically within the property valuation segment of the industry, Automated Valuation Models (AVMs) are the most common models used.
Banks use AVMs to estimate property values, quickly, cheaply and accurately. AVMs aren’t as accurate as an appraisal, but they cost a few dollars instead of a few hundred dollars. Banks use them for all sorts of things: portfolio valuation, sales, marketing, servicing, appraisal quality control, even equity lending decisions. And if lenders base their decisions on systematically erroneous data, or improperly built models, they can run into big problems not only to their bottom line, but also to their reputation. Understanding the risk that this creates, regulators have required all such models to be independently validated. There are two critical aspects to this precaution.
First, validation must be independent. The validation must be done by a person or team that is separate from the developers, users and buyers (most AVMs are built by independent companies that specialize in their development). Very specifically, in the regulatory guidance, the model’s builders cannot be relied upon as an objective source of validation.
Second, the validation must be conducted by staff qualified in modeling or analytics, with the adequate authority to blow the whistle if they find issues. The validation must be performed in real-world conditions, it should be ongoing, and it should be reported on at least annually. When there are changes to the models, the business environment or the marketplace, the models need to be re-validated.
Banks and credit unions can do their own AVM validation, but most find it generally difficult to meet all of the requirements, including the authority to blow the whistle if they find issues. These validation caveats are the best justifications for looking to a company like AVMetrics to provide this service for you.
AVMetrics is in no way beholden to banks and credit unions, the AVM developers, or the resellers in any way; we draw no income from selling, developing or using AVM products. AVMetrics conducts extensive ongoing AVM validation and has done so for over a decade. Independence is essential, because self-certification can be an invitation to abuse, and as Volkswagen just found out, it can be devastating. Our industry implemented independent testing years ago. It is rigorous, exhaustive and frequent, but that is appropriate because there is a lot at stake.
If Volkswagen ever hopes to get the public’s trust back, they need to open the curtains and put on all the lights. In addition, every result and claim will need to be independently validated, since no one is likely to believe them otherwise.
These are common-sense controls, and while the application to the auto industry is not perfectly analogous to the testing of AVMs, the basic lesson is clear: we should not trust companies to test and certify themselves.
Lee Kennedy, principal and founder of AVMetrics in 2005, has specialized in collateral valuation, AVM testing and related regulation for over three decades. Over the years, AVMetrics has guided companies through regulatory challenges, helped them meet their AVM validation requirements, and commented on pending regulations to help bring clarity and sanity to the situation. Lee is an author, speaker and expert witness on the testing and use of AVMs. Lee’s conviction is that independent, rigorous validation is the healthiest way to ensure that models serve their business purposes. Every commercially available AVM vendor trusts AVMetrics to provide feedback to them on their models, facilitating each model’s continuous improvement.
