A PERFECT storm of tighter lending, softening house prices, potential taxation changes and upcoming settlements of off-the-plan apartments in a falling market, means it is imperative that an independent robust valuation profession is not weakened, to ensure stability in the Australian financial system, according to the Australian Property Institute.
The API in its submission to the Royal Commission identified six barriers effectively diminishing or distorting the valuation function and deserve the attention of the Commission given the role valuers play in maintaining integrity in the $1.8 trillion residential and commercial property sectors.
The barriers are:
- The use of an automated valuation model (AVM) generated assessment by financial institutions from a single system;
- Intellectual property ownership in valuations has devolved to banks;
- Imbalances of power between banks and Valuers have intensified;
- Valuer professional indemnity insurance has been relied on by banks to offset poor lending practices;
- Kate Carnell in her Report at recommendation 8 and the Australian Banking Association have, without consultation with the API, unintentionally extended a duty of care to third parties raising greater opportunities for PI claims and extending a duty of care; and
- Mortgage brokers are stepping in between Valuers and bankers, attempting to reduce standards.
The API which represents around 8,000 members nationally, believes that there is a direct correlation between an imbalance in the key structural risks and barriers to professional valuation practice and some of the areas of banking activity already examined by the Royal Commission.
API CEO Amelia Hodge said the API considers the crucial role of a robust valuation profession is to provide a higher level of independent certainty for the capital framework of the Australian financial system and by extension, the Australian economy, its property investors and residential home owners.
“The valuation profession is essential to determining the capital adequacy of financial services entities in Australia. All professional valuers take this role very seriously. A valuers’ highest priority is compliance with strict guidelines, methodologies, codes of conduct and practices, standing instructions from their client banks and including the International Valuations Standards to ensure accurate, independent and robust valuations for good reason.
“Valuations are not only critical for the management of credit risk, they also underpin the many assets held by real estate investment trusts (REITs) and superannuation funds that manage the pension funds of Australians, as well as financial transactions and investments across the board,” she added.
“Valuations are used as a cornerstone balance sheet measure, not only in the assessment of personal wealth, but backing the successful issuance of residential mortgage backed securities for all major and secondary Australian financial institutions.”
However, the API submission outlined the shifts in valuation practices and policies by the financial institutions in the past 5-7 years, and it believes these shifts raise an increasing likelihood of a failure of risk management impacting the financial services industry over the medium-term, the valuation (and by extension property market) in the short-term and in the longer-term on individual consumers.
In the submission, API members believe through their PI insurance, they have inappropriately underwritten for some time, the poor lending practices of financial services entities and cyclical changes in the property market.
“Internal connections in financial services entities between credit risk, property risk and procurement functional operations units obscure accountability and combined with ineffective communication lead to mistakes and reported ‘stuff-ups’. Borrowers with a grievance because a loan did not proceed or a property was repossessed by a bank, or the property market simply corrected, are provided with limited information leaving valuers as the only source of redress and, who are then forced to rely on their PI insurance. In these instances, the valuers concerned are known to rely on the lender for ongoing work.”
The API said financial institution tendering processes that determine the relationships with valuers as suppliers of services are heavy handed.
“At best, they lack appropriate governance and are overlaid with a significant power imbalance between valuation businesses and the much larger financial institutions and banks,”
With valuers relying on lenders for ongoing work, the API claims’ the banks use of bullying tactics to leverage valuers’ PI insurance whilst threatening panel appointments/agreements and contracts etc. all before and without any proven cause creates significant problems.
“This has resulted in valuation firms being levered to settle losses through PI insurance without proper process or risk their work being removed. Continued misuse by banks of Valuers PI insurance could lead to an inability to obtain insurance in the Australian market which is already seen as too small to service on a global scale currently. This was significantly tested in 2011, with only one UK insurer left in the market threatening to walk away,”
Another risk to PI insurance is the unintended consequences and broader serious ramifications borne from the recommendations from the Carnell Report, where valuation information prepared for mortgage purposes will be made available to borrowers.
The API argues that it potentially extends a valuer’s duty of care to borrowers who may use and rely on the report for making decisions which are outside the purpose for which the report was prepared.
“The extension of the duty of care means borrowers (in addition to banks which are the direct client) could make claims of negligence and misrepresentation against valuers. Valuers will have to show on a case by case basis that no such duty rises. The exposure of valuers to another class of claimants will make PI insurers cautious. PI insurers may place further exclusions on valuers limiting their coverage, or worse, stop insuring valuers altogether.
“The flow on risk to PI insurance remaining competitive and available in this market is enormous which potentially has an extremely material impact on every API member, across the spectrum from small business owner to large corporation. The API underwriters have advised that they are currently looking at exclusions in policies in this regard and there is a very high risk that capacity for valuers in the Australian market will cease,”
In one example, the API made references to a struggling Queensland development that had been sold off the plan over two years ago and has settlements pending shortly, which demonstrates that the sharing of independent valuations to developers and potential property owners and the unintended consequences.
“The API considers that there may be a very dangerous precedent set where valuers are explicitly threatened with legal action if they do not value in accordance with a property developer’s requirements.
“The property market is shifting nationally, with valuations coming in on average 20-40% less in some areas, and, at the higher end of the spectrum for lower quality stock,” the API warned.
Hodge said it is clear that the property market is undergoing a cyclical correction, impacted further by matters raised during the course of the Royal Banking Commission and the tightening of credit, particularly in off the plan contracts executed some time ago across Australia.
The submission said the banks are also diluting the value of valuations.
One practise is the use of finance and mortgage brokers as intermediaries, which has led to a separation of the ultimate debt provider from the API members undertaking a mortgage valuation.
“The insertion of finance brokers into this process has created situations, of which the API has been made aware, where valuations are being disregarded, changed or pressure placed upon the valuer to elicit a required value, so that the broker can secure the debt provision.
“Mortgage brokers have a clear conflict of interest in relation to the valuation. It is in their interest to raise the valuation to increase the potential for a mortgage and a sale. API members report that it is not unusual for mortgage brokers to attempt to persuade the valuer that the property represents higher value than the initial valuation. Depending on the long term financial relationship between the broker and the valuer this can represent more or less pressure,”
The API said Australia should follow other markets such as New Zealand and the USA, which have created more distance between lender and borrower for this and many other prudent reasons.
Another practise diluting valuations is the banks’ emphasis on price and speed rather than quality, through desktop and automated valuation models (AVMs). Hodge said the consequences of an incorrect valuation are serious.
“The structural arrangements, under which valuers deliver services have a profound impact on the operation of the financial services industry and importantly on outcomes for consumers. The consequences are serious.
“For most Australians their home and/or their investment properties are largely the whole sum of their wealth. Incorrect valuation advice or the lessening of the quality of that information has the potential to seriously impact the Australian economy,” she added.
“With this ownership mortgage brokers or third party companies retained by mortgage brokers and banks create models of valuation and use these models for different purposes relating to risk, bundling and sale of mortgages.
“The US housing crisis is reported to have been precipitated by the manipulation of bundled mortgages in financial instruments,”
The API has called on the introduction of industry guidelines based on the regulations introduced in the wake of US financial crisis which removed the ability to use AVMs to secure real assets.
“The API further recommends external independent reviews of internal financial services valuations and in particular both the models and loan-to-value ratio parameters set by banks and financial institutions where internal valuations are conducted, if at all.”
Australian Property Journal