APRA has preserved this AFIC Practice Note as guidance for building societies and credit unions.
Practice Note 4/98
27 March 1998
APPLICABLE TO CREDIT UNIONS
AND BUILDING SOCIETIES
VALUATION PRACTICE
Background
The assessment of the value of the underlying security for a loan is an integral part of the lending process. The better the assessment of that value, the better the lending decision that may be made. Societies should ensure that they have in place appropriate systems for establishing, recording and reviewing the value of loan securities. This Practice Note is designed to provide guidance in the establishment and operation of those systems.
The requirement for a more rigorous approach to the valuation of securities has been brought into focus in recent times through several factors. These include the reduction or absence of inflation to create equity in properties; intense competition driving lenders to accept higher loan-to-valuation ratios; competitive pressures on paying appropriate fees for complete valuations; and low interest rates encouraging borrowers to over-borrow in terms of debt servicing capacity.
Valuation of securities can take many forms. Some are informal for example in making a small unsecured loan to a high net worth individual, a credit officer will informally review and ascribe values to the borrowers assets to confirm their worth. Other methods are more formal for example detailed reports from registered valuers. In all cases it must be recognised that valuation is not a precise science and that values may change over time.
Valuation is a professional skill and in Australia the appropriate qualification includes membership of the Australian Institute of Valuers and Land Economists (AIVLE). The Institute has its own professional standards and societies should become familiar with these. To practice as a valuer in most States and Territories, registration with a Valuers Registration Board or similar may also be required. This registration recognises appropriate tertiary studies and experience, and may be restricted to certain classes of valuation for example residential only.
For all residential valuations, the AIVLEs Proforma and Supporting Statement of Residential Valuation should be used as the reporting format. This document is used as the basis for valuation reports by AIVLE members throughout Australia and encompasses the Institutes professional standards and guidelines.
The Valuation Process
The valuation of securities is linked to the loan assessment, approval, management process, and to general risk management. The identifiable stages are:
- Loan Assessment
- Identification of the securities offered that require valuation.
The securities that are proposed to be taken need to be accurately and completely identified.
- Instruction of the Valuer
Each valuation request should be the subject of specific instructions to the valuer. For high volume and generic loans these can be in the form of a master instruction covering all such loans. These instructions should be reviewed periodically. For loans or properties not fitting these general descriptions, specific written instructions should be provided to the valuer.
For large or complex valuations, professional assistance may be required to properly draft the instructions.
A society should not accept a valuation instructed by a third party. The terms of the original instructions may not be known, and the liability of the valuer to the society may be impaired. If such a valuation is to be accepted, the valuer should be on the societys panel, and should specifically re-address the valuation to the society.
- Review of the Valuation report
The valuation report must be reviewed in detail by the society to ensure that the descriptions are accurate, the valuer has complied with instructions, and that the valuer has not noted any warnings that may influence the decision to lend. Valuations should be signed by the principal or a director of the valuing organisation.
Completion of this review should be evidenced by file note, checklist or other method. An inspection of the property by a society officer may be warranted, and should occur in all cases where the property is of high value or of a specialised nature.
- Loan Approval
Acceptance of the Valuation
As part of the sign off for approval of the loan, the valuation should be accepted.
- Loan Management
Revaluation of securities.
A policy should be implemented for securities to be periodically revalued. This may occur, for example, at various stages in a construction project, if the society becomes aware of adverse market changes in a particular area, or at defined time intervals for loans with higher LVRs.
A typical revaluation / inspection requirement may be:
Commercial properties > $250,000 - every 2 years
Commercial properties < $250,000 - every 3 years
Rural properties - every 3 years
Residential properties > $300,000 - every 3 years
Residential properties < $300,000 - every 5 years
- Risk Management
Establishment of a valuation requirement
While it is the responsibility of each society to determine the level of risk it is prepared to take in valuations, a typical requirement may be:
Unsecured loans - no valuation requirement
Motor vehicles (new) - invoiced purchase price
Motor vehicles (used) - Wholesale value - Dealers Guide
Houses / Units (under 50% LVR) - Real Estate agent / lending
manager written assessment
Houses / Units (over 50% LVR) - professional valuation
Industrial, Rural or specialised properties - professional valuation
Plant & Machinery - professional valuation
Societies may also make deduction from fair market valuations for contingencies such as selling and holding costs of securities in possession.
- Panel of Valuers
A panel of valuers acceptable to the society should be established and periodically reviewed. Factors that should be considered in selection on the panel include:
· professional qualifications
· relevant experience (including local knowledge)
· appropriate professional insurances
· choice in valuers to avoid concentration of valuation risk
If the society uses estimates of value by managers or other staff, the staff involved should be trained in basic property value research and valuation skills.
- Standard Instructions to Valuers
Standard instructions to valuers may be developed. Elements should include the following:
· Valuation purpose (e.g. for mortgage security purposes)
· Valuation basis required (fair market, fire sale, etc)
· Valuation for insurance purposes
· Valuation method (market, summation, capitalisation etc)
· Market summary / commentary
· Form of report required (AIVLE professional standards should be used)
· Valuation fee structures
- Review of Valuations
A program may be initiated of an independent review of a sample of valuations provided to the society. This may include internal reviews of valuations by management or audit staff and formal reviews by a valuer.
The reviewing valuer should not be involved in any other work for the society. This practice not only provides a form of quality control on the panel valuers but enables a better feel for market values generally to be obtained.
