Do valuers contribute to growth of ‘bad loans’ in financial institutions?

The Valuers’ Registration Board (VRB), created under the Valuation and Valuers Registration Act, 2016 (No. 7 of 2016), recently held a successful 3rd Annual General Meeting in Arusha at Lush Garden Hotel, from 20 to 21 October 2022. The theme was “Valuation as an Investment Stimulant”.

Valuers work hand in hand with financial institutions, assisting the latter by providing the value of 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 can easily be appreciated, lending is an important aspect of investment.

The valuer will normally give opinion of three values. One is the property’s open market value which will reflect what can be expected to be realized if the property is bought or sold in an open competitive market. Comparative sales of similar properties in recent times can act as a guide.

Two, is the property’s insurable value. This is useful to determine how much to insure the property for, as a precaution against unpredicted harmful happenings. This is usually based on the replacement cost of the property, plus a few other considerations such as debris removal in case of the property’s destruction, and the cost of confirming to new planning requirements, which may not have been there when the property was constructed in the first instance.

The third value is known as the “forced sale value”. This is the value, where the sale of the property is conducted under non-competitive circumstances. The valuer takes cognizance that the property needs to be sold within a short duration possibly at an immediate auction. This could be seen as a kind of “distress sale”, which occurs when a property, stock, or other asset must be sold quickly. The forced sale value will almost certainly be lower that the open market value.

Why is property, important in the lending process? This takes us into the due diligence usually done by lenders on the potential borrower. The key consideration is that the borrower is robust enough to be able to repay the loan. Loans are assets for lending institutions, from which they derive income. There used to be three “C”s of lending but these have now grown into 5. These are:

One, “Character” of the borrower and their history with handling debt in the past. Here, consideration is taken of the borrower’s personal character, integrity, employment status, credit history and rating as a credit risk.

Two, is “Capacity”, that is the ability of the borrower to repay the loan. For personal loans, this may depend on their employment status and salaries. For corporate loans, capacity may be judged from how the business is faring, and credible business projections.

Three is “Capital”, that is the cash that the lender is able to put up as a deposit. While seeking capital from the lender, the latter will often require a deposit or down payment to be put up in cash.

Four is “Condition”, the condition and health of the economy in which both the borrower and lender are operating; the market for business and clear purpose of loan.

Five is “Collateral”, this is the asset, many times in the form of real property, which is offered by the borrower as a backup for the loan. Contrary to popular belief, lenders are not interested in taking over the property of the borrower. However, they must have some fallback position, in case the borrower fails to pay the loan, and the lender has to foreclose.

It is in this last “C”, “Collateral”, that the valuer comes in, to determine the value of the collateral. If loaning conditions are good, the Loan-to-Value (LTV) ratio will be high, and vice versa.

While the lender expects the borrower to pay back the loan on schedule, sometimes, the borrower fails to do so. A non-performing loan (NPL) or bad loan is where the loan has not been serviced for 90 days or more.

NPLs are to be expected in the lending industry but the proportion of NPLs to total loans should not exceed the threshold of five percent. In Tanzania, in March 2020, this was 10.5 percent.

In March 2021, non-performing loans in Tanzania stood at 9.36 percent of total loans, nearly twice the recommended threshold of five percent.

In the case of NPLs, and foreclosure, it has been realized in a number of cases that the expected forced sale value is not realized, and subsequently, valuers are blamed for this. This blame is wrongly placed. Failure to repay the loan is a result of poor business performance, sometimes accompanied by poor follow up and supervision.

Moreover, conditions, when a forced sale is triggered, are usually different from those when the valuation is made. Thus, valuers are hardly to blame for the high levels of NPLs in Tanzania.