1. The role of Valuation Companies in the Mortgage Lending Industry
2018 SPRING GENERAL MEETING OF TEGoVA - CASCAIS
The role of Valuation Companies in the Mortgage Lending Industry
João Carvalho das Neves (Ph.D. in Business Administration, REV, FRICS, Registered Auditor)
Professor of Corporate Finance & Real Estate Investments
Director of the Post-Graduate Program in Real Estate Valuation and Management
© J.C. Neves, ISEG, 2018

2. Agenda
Introduction
How real estate became into the agenda of EU policy makers
Prudential requirements for credit institutions and investment firms
The Mortgage Credit Directive
2014 Asset Quality Review
Opportunities and threatens for the profession
The role of valuation companies in the mortgage lending industry
© J.C. Neves, ISEG, 2018

3. 1. Introduction
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4. Major purposes of Real estate valuations
Statutory financial reporting / IFRS
Performance measurement
Regulatory authorities
Taxation
Corporate M&A
Securing finance
Arrears management
Property portfolio transactions
Investment property fund and asset management
Regulatory capital requirement for banks
Review of balance sheet asstes (Asset Quality Review)
Non-performing loans
Support feasibility studies
Mortgage Lending
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5. Two criteria are used in determining financing of real estate acquisition
Ability of the investor and/or the investment to service the loan
𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 𝐷𝑒𝑏𝑡 𝑠𝑒𝑟𝑣𝑖𝑐𝑒
The relation of the purchase price of the property to its value
𝐿𝑜𝑎𝑛 𝑉𝑎𝑙𝑢𝑒
© J.C. Neves, ISEG, 2018

6. Politics and the valuation profession
Before the financial crisis the EU policy and laws for the real estate industry was secondary.
The collapse of Lehman Brothers in 2008 and all that followed, created the required awareness of the EU policy makers to set the importance of real estate valuation to the banking & investment firms industry.
Since then, real estate industry got caught up in regulation of credit institutions and investment firms.
© J.C. Neves, ISEG, 2018

7. 2. How real estate became into the agenda of EU policy makers
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8. The Rescue of the Financial Industry has been very expensive for tax payers in EU
€240 billion of taxpayers’ money has been permanently lost as a result of the various bailout packages in the EU .
Statistics from the EC Directorate General for Competition indicate that more than €1.5 trillion was used in different forms of rescue packages
Source: Eurostat Statistics
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9. The Financial crisis made real estate valuation a high priority for EU policy makers
Three main documents:
Regulation 575/2013 of 23 June 2013 on prudential requirements for credit institutions and investment firms has requirements for financial institutions to monitor property values and property valuations.
A key drive for the valuation profession was the property valuation article of the Mortgage Credit Directive 2014/17/EU 4 February 2014 and the Recital 29 that introduce European Valuation Standards (EVS) in the European Law
The 2014 Asset Quality Review (AQR) by European Central Bank
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10. prudential requirements for credit institutions and investment firms (Regulation 575/2013 of 23 June 2013 )
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11. Financial Institutions must monitor property value
“Institutions monitor the value of the property on a frequent basis and at a minimum once every year for commercial immovable property and once every three years for residential real estate.”
“Institutions carry out more frequent monitoring where the market is subject to significant changes in conditions”
the property valuation is reviewed when information available to institutions indicates that the value of the property may have decline materially … that review is carried out by a valuer who possesses the necessary qualifications, ability and experience to execute a valuation … “
“Institutions may use statistical methods to monitor the value of the property and to identify property that needs revaluation”
Regulation EU 575/2013 of the European Parliament and of the Council of 26 June 2013
© J.C. Neves, ISEG, 2018

12. EU law concepts that are basic to the valuer profession
“Market value”
“Mortgage lending value” - is a concept defined in the Capital Requirement Regulation (CRR) (Article 4 (74)), as follows: “the value of immovable property as determined by a prudent assessment of the future marketability of the property taking into account long-term sustainable aspects of the property, the normal and local market conditions, the current use and alternative appropriate uses of the property’
“Asset valuer”
“Independent valuer”
“Speculative immovable property financing”
An appraisal is simply an estimate or an opinion of a property’s current market worth, considering what the market is responding to and other factors. This is usually offered as a free service by real estate agencies.
Valuation is a written report prepared on the property and a fee is charged for this service.
Regulation EU 575/2013 of the European Parliament and of the Council of 26 June 2013
© J.C. Neves, ISEG, 2018

13. The approach for Mortgage Lending Value
“Institutions shall require the independent valuer not to take into account speculative elements in the assessment of the mortgage lending value and to document that value in a transparent and clear manner”
This is a long-term valuation approach which is distinct from market value. Valuer must eliminate the short-term market volatility. This underpines all aspects of the method:
Capitalization rates should be based on long-term sustainable rates, not the current market capitalization rates
Rents and rental values should be sustainable
MLV is normally based on the current use of the property, unless there is a proven intention to change the use.
Site values based on market assessed if land values are in a particular phase of the cycle
similarly to other valuations
There are 3 situations where MLV is included in the Capital Requirements Regulations:
Within the standardized approach (Article 124, 125 and 126)
Credit risk mitigation (Article 229)
In the large exposure framework (Article 402)
The term standardized approach refers to a set of credit risk measurement techniques proposed under Basel II capital adequacy rules for banking institutions. Under this approach the banks are required to use ratings from External Credit Rating Agencies to quantify required capital for credit risk.
Claims secured by residential property Risk weight: 35%
Claims secured by commercial real estate Risk weight: 100%
Overdue loans
more than 90 days other than residential mortgage loans.Risk weight:150% for provisions that are less than 20% of the outstanding amount100% for provisions that are between 20% - 49% of the outstanding amount100% for provisions that are no less than 50% of the outstanding amount, but with supervisory discretion are reduced to 50% of the outstanding amount
The Large Exposures framework is a key component of the prudential rules
It is an important tool to limit concentration risk and an important complement to the capital
framework. To work effectively, it is important that exposures and credit concentrations are
appropriately identified and measured. Internal models have been able to achieve this
accurately.
Regulation EU 575/2013, Article 229, paragraph 1
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14. the Mortgage Credit Directive (2014/17/EU 4 February 2014)
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15. EVS are recognized by eu as valuation standards
“It is important to ensure that the residential immovable property is appropriately valued before the conclusion of the credit agreement and, in particular where the valuation affects the residual obligation of the consumer in the event of default”.
“Member State should therefore ensure that reliable valuation standards are in place”.
“In order to be considered reliable valuation standards should take into account internationally recognized valuation standards, in particular those developed by the International Valuation Standards Committee, the European Group of Valuers’ Associations or the Royal Institution of Chartered Surveyors.”
“Those internationally recognized valuation standards contain high level principles …”
“… that all appraisal reports are prepared with appropriate professional skill and diligence and that appraisers meet certain qualifications requirements …”
Source: Directive 2014/17/EU – Mortgage Credit Directive - Recital 26
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16. EU recognizes the importance of reliable valuation standards and qualified professionals
“Member States shall ensure that reliable standards for the valuation of residential immovable property for mortgage lending purposes are developed within their territory
“Member States shall require creditors to ensure that those standards are used whre they carry out a property valuation …. National authorities are responsible for regulating independent appraisers who carry out property valuations they shall ensure that they comply with the national rules that are in place”
“Member States shall ensure that internal and external appraisers conducting property valuations are professionally competent and sufficiently independent from the credit underwriting process so they can provide an impartiaç and objective valuation …”
Source: Directive 2014/17/EU – Mortgage Credit Directive - Article 19 Property Valuation
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17. Qualified professionals are the cornerstone of reliable valuations - Professional titles are more important than ever
Recognised European Valuer (REV) – the mark of excellence in real estate valuation (any kind of property), demonstrating the valuer is qualified to a consistent high European standard of practice.
TEGoVA Residential Valuer - the mark of excellence in residential valuation, demonstrating that the residential valuer is qualified to a consistent high European standard of practice.
Very important that these qualifications are really recognized by the market as QUALIFIED PROFESSIONALS
© J.C. Neves, ISEG, 2018

18. 2014 Asset Quality Review
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19. Banks must value their real estate exposures
Banks must value their real estate exposures. EU Authorities want reliable valuation standards
After ECB took over from national banking authorities in supervising the systemic banks of the Eurozone, the valuation of banks real estate collateral became a important issue.
According to the 2014 Asset Quality Review (AQR) “Real estate should be valued in line with European Standards EVS-2012 (Blue Book) and other international standards such as the Royal Institute of Chartered Surveyors (RICS) guidelines – where a conflict is seen EVS2012 will apply...”
Desk based valuations are expected to be carried out. Internal inspections are not expected. Drive by inspections may occur in circumstances where a desk based valuation is not viewed as sufficient by the NCA bank team.
The European Central Bank (ECB) Asset Quality Review
© J.C. Neves, ISEG, 2018

20. EU regulation has given a new relevance to the valuation profession
Under the Mortgage Credit Directive the approach to valuation was principles-based
ECB’s AQR understand the viral consequences of inadequate valuations
the importance of the independence of the valuer (from the insourcing to the outsourcing)
The need to limit much reliance on desktop valuation or other short-cuts
© J.C. Neves, ISEG, 2018

21. Opportunities and threatens for the profession
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22. Opportunities for the valuation profession in the eu
Financial crisis signaled the importance of rigor, professionalism and independence on real estate valuations
EU policy makers are sensitive to the importance of real estate prices and valuations for credit institutions and investment firms
Technology allows the use of advanced statistical methods on real estate valuation
The advance of technology is a threat to the traditional valuer and an opportunity for the more advanced valuer. Examples:
Data Processing: Big data, Blockchain, Artificial Intelligence, Automated valuation models
Contracting: Smart contracts, etc.
Collecting data: Drones, Internet of things
Valuation Report: Image streaming, videos, 3D Visualization, heat mapping and virtual reality.
© J.C. Neves, ISEG, 2018

23. Threats for the valuation profession in the eu
Misunderstanding of what real estate valuation is, by policy makers, that might create too much bureaucracy to the process
Inadequate legislation for recognizing the qualified valuer
Inadequate processes that might be unable to identify the proper qualified valuer
Valuers not adopting the new technologies, or using them inappropriately.
Valuers
© J.C. Neves, ISEG, 2018

24. The role of valuation companies in the mortgage lending industry
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25. The role of valuation companies is not limited to the mortgage lending industry
Must recruit professionals with adequate academic education and for senior positions add the importance of experience on valuation
Must ensure relevant in-job training for younger professionals
Must ensure continuing education for valuation staff
Create incentives for valuers study advanced courses on valuation and submit their credentials to TEGOVA for their qualification as REV or TRV
Must guarantee that each valuation report is revised by their quality control department before sending it to the client
Create a process of control of quality that comply with EVS is crucial for the credibility of the profession
© J.C. Neves, ISEG, 2018

26. The role of Valuation Companies in the Mortgage Lending Industry
2018 SPRING GENERAL MEETING OF TEGoVA - CASCAIS
The role of Valuation Companies in the Mortgage Lending Industry
João Carvalho das Neves (Ph.D. in Business Administration, REV, FRICS, Registered Auditor)
Professor of Corporate Finance & Real Estate Investments
Director of the Post-Graduate Program in Real Estate Valuation and Management
© J.C. Neves, ISEG, 2018