Clear shortcomings in valuation practices for real estate collateral and credit risk management for housing company loans

In spring 2024, a thematic review of banks under direct supervision by FIN-FSA was launched, focusing on risks in the real estate sector. It focused on the risks in the real estate sector, which is one of the main drivers of instability and financial risk for credit institutions due to rising interest rates and decreasing real estate market prices.

This supervision release describes the results of the thematic review concerning the valuation practices for the real estate sector and the housing company loans of banks under direct FIN-FSA supervision. The purpose of the thematic review was to assess the extent to which banks subject to the review comply with the regulation on valuation practices applicable to real estate collateral and to identify how supervised entities manage credit risks associated with housing company loans. The results are based on information provided by the banks.

Compliance with the regulation on valuation practices for real estate collateral

Differences were found in the valuation practices for real estate collateral between banks under the FIN-FSA's direct supervision. All banks were found to have some shortcomings, some of them even material. The most significant shortcomings are related to

• the time at which individual collateral valuation is carried out and updated on non-performing loans
• the consideration of the location of commercial and residential immovable property in the assessment of climate and environmental risks
• the independence of the valuation of commercial real estate collateral from the credit decision-making process; and
• the frequency with which residential and commercial property collateral values are monitored.

There were inconsistencies in the responses to the quantitative questions with the banks' other responses.

The following weaknesses in the valuation practices for real estate collateral were identified in the thematic review:

• The location of residential and commercial real estate is not taken into consideration in the assessment of climate and environmental risks.
• Individual revaluation of residential and commercial real estate collateral for a non-performing exposure is not carried out when the exposure is classified as non-performing.
• The valuation of residential and commercial real estate is not independent of the credit decision process.
• The necessary qualificationsof the valuer and their independence of the credit decision making process are inadequate in the context of reviewing the values of residential and commercial properties.
• The valuer’s professional competence and independence relative to the credit decision making process are inadequate in the context of individual valuation of residential and commercial real estate properties.
• The threshold value recommended by the FIN-FSA (exposure of €300,000) is not applied in the individual valuation of non-performing exposures with residential and commercial real estate collateral.
• The methods in place do not identify residential properties whose values have been declined materially relative to general market prices.
• The market value of residential real estate collateral is determined using a statistical model only.
• The monitoring frequency of commercial real estate collateral values does not reflect a significant change in market conditions.
• The process of monitoring developments in the value of commercial real estate collateral is incomplete.
• The identification of commercial properties subject to material impairment is inadequate.
• The use of international valuation standards in determination of market values for real estate collateral is inadequate.
• Monitoring of the value of real estate collateral has not taken place at least every three years.
• Monitoring of the value of commercial real estate collateral has not taken place at least once a year.
• The valuer has not carried out a review of the real estate collateral at least every three years for the loans exceeding EUR 3 million.

Management of credit risks related to housing company loans

Differences were identified across the banks in managing credit risks to housing company loans. Each bank was found to have some shortcomings, and some of them shortcomings were even material. The most significant shortcomings are related to the determination of market value of residential properties and factors that should be reflected in the market value or trigger a review of the market value.

In the thematic review, the following shortcomings were identified with respect to the management of credit risks associated with housing company loans:

• Progress in the sales of apartments of a new housing company was not used as a trigger for a collateral review.
• Special conditions offered by developers are not taken into account in the market valuation of the property.
• Pricing covenants are not applied to prepare for a rise in investor-ownership.
• Ownership concentrations are not considered in the guidelines for credit decisions on housing company loans.
• Other covenants than covenants to prepare for a rise in investor-ownership are not used in lending to housing companies with respect to, for example, the ownership structure of tenement houses, LTV (loan-to-value) ratio, advance reservations for projects covered by the RS guarantee, and the maximum share allowed for a single owner.
• Special conditions offered by construction developers to buyers were not recognised in the context of the financed new-built properties and their marketing.
• Ownership concentrations are not reviewed during the life cycle of housing company loans.

FIN-FSA's actions

The findings will be used as a basis in focusing supervision. The FIN-FSA requires that the supervised entities remediate the shortcomings identified in these reviews.

For further information, please contact

• Torsten Groschup, Chief Specialist, telephone +358 9 183 5333 or torsten.groschup(at)fiva.fi
• Matti Suni, Senior Inspector, telephone +358 9 183 5259 or matti.suni(at)fiva.fi
  
  

The corresponding Finnish-language supervision release was published on 24 October 2024