Are appraisers contributing to the growth of “bad loans” in financial institutions?
The Assessors Registration Board (VRB), established under the Assessors Assessment and Registration Act 2016 (No. 7 of 2016), recently successfully held its 3rd Annual General Meeting in Arusha, at the Lush Garden Hotel, October 20-21, 2022. The theme was “Valuation as an Investment Incentive”.
Appraisers work hand-in-hand with financial institutions, assisting them by providing the value of the property offered to the lender by the potential borrower, as one of the considerations in determining whether to lend and if so, how much to lend . As one can easily understand, lending is an important aspect of investing.
The expert will normally issue an opinion on three values. One is the free market value of the property which will reflect what one can expect to realize if the property is bought or sold in an open competitive market. Comparative sales of similar properties in recent times can serve as a guide.
Second, the insurable value of the property. This is useful in determining the amount of property insurance, as a precaution against unforeseen harmful events. This is usually based on the cost of replacing the property, plus a few other considerations such as debris removal should the property be destroyed, and the cost of confirming to new planning requirements, which were perhaps not not be there when the property was built in the first instance.
The third value is known as the “forced sale value”. This is the value, when the sale of the property is made under non-competitive circumstances. The expert becomes aware of the fact that the property must be sold in a short time, possibly at an immediate auction. This could be considered a kind of “distress selling,” which occurs when a property, stock, or other asset needs to be sold quickly. The forced sale value will almost certainly be less than the free market value.
Why is property important in the loan process? This brings us to the due diligence usually performed by lenders on the potential borrower. The main consideration is that the borrower is strong enough to be able to repay the loan. Loans are assets for credit institutions, from which they derive income. Previously, there were three “C”s of loan, but these have now changed to 5. They are:
One, “Character” of the borrower and their history with debt management in the past. Here, the personal character, integrity, employment status, credit history and credit risk rating of the borrower are considered.
Second, the “capacity”, ie the ability of the borrower to repay the loan. For personal loans, it may depend on their employment status and salaries. For business loans, capacity can be judged based on the business situation and credible business projections.
Three is the “Capital”, i.e. the money that the lender is able to deposit on deposit. When seeking capital from the lender, the lender will often require a down payment or down payment in cash.
Four is “Condition,” the condition and health of the economy in which the borrower and lender operate; the business market and the clear purpose of the loan.
Five is “Collateral”, it is the asset, often in the form of real estate, which is offered by the borrower as security for the loan. Contrary to popular belief, lenders are not interested in repossessing the borrower’s property. However, they must have a fallback position, in case the borrower does not repay the loan, and the lender must foreclose.
It is in this last “C”, “Collateral”, that the expert intervenes, to determine the value of the collateral. If the loan conditions are good, the Loan-to-Value (LTV) ratio will be high, and vice versa.
While the lender expects the borrower to repay the loan on time, sometimes the borrower does not. A non-performing loan (NPL) or bad loan is a loan that has not been repaid for 90 days or more.
NPLs are to be expected in the lending industry, but the proportion of NPLs to total lending should not exceed the 5% threshold. In Tanzania, in March 2020, this figure was 10.5%.
As of March 2021, non-performing loans in Tanzania accounted for 9.36% of total loans, almost double the recommended threshold of 5%.
In the case of PNPs and foreclosures, it has been realized in a number of cases that the expected forced sale value was not realized, and subsequently appraisers are blamed for this. This blame is misplaced. Loan non-repayment is the result of poor business performance, sometimes accompanied by poor monitoring and supervision.
Moreover, the conditions, when a forced sale is triggered, are generally different from those at the time of the valuation. Thus, evaluators are hardly responsible for the high levels of NPL in Tanzania.