Collateral valuation

In general in finance and especially in banking, collateral valuation is the initial and permanent valuation of the value of loan collateral during the term of a loan .

General

If the creditworthiness of a borrower is not sufficient for a blank loan, but a loan is still justifiable against the provision of loan collateral, the collateral offered must meet certain criteria ( "bank collateral" ). This loan collateral should represent a monetary value that is sufficient at all times to completely cover the open claims of the bank in the event of non-repayment of the loan or loan interest. The loan collateral provided is assessed on the basis of the lending documents with regard to the expected long-term sales proceeds after a possible loan termination . The result of the collateral assessment is the lending value . Depending on the fluctuation in value or faster usability, a security discount is applied depending on the type of security. This deduction from the lending value results in the lending limit , which normally represents the maximum upper limit up to which a bank may grant loans.

The question of the evaluation of loan collateral does not arise in the case of unsecured loans, but regularly when lenders request collateral from the borrower or third party collateral providers to hedge the credit risk . As a result, the risk of fluctuations in the value of the collateral accepted becomes a further component of the credit risk. The risk of fluctuations in value consists in the risk that the current value of loan collateral falls below the respective remaining credit during the term of the loan and is therefore insufficient to cover the remaining credit in the event of realization . The ratio of the loan loss amount then appearing to simultaneously considered loan size is a parameter default loss ratio (English default loss given , acronym LGD) estimated. In order to reduce the loss of default rate, the risk of fluctuations in value must be reduced through a careful valuation of collateral.

The legal risk of the legal validity and enforceability of the collateral agreements is an operational risk for banks according to Art. 4 Para. 1 No. 52 Capital Adequacy Ordinance (CRR) .

purpose

The proper assessment of loan collateral is an essential prerequisite for reliable risk assessment at the level of the individual loan and the level of the entire loan portfolio of a credit institution. This collateral assessment has four objectives:

• Assessment of the credit risk when lending:

With regard to the collateral provided, in the event of a loan default , the bank expects the remaining credit from the realization of its loan collateral in the amount of the collateral valuation; In the ideal case, the recovery rate is 100%, which means that the value of the loan security corresponds exactly to the outstanding amount of the claim - then the complementary variable default loss rate is 0%.

• Careful and sustainable assessment of the collateral:

If the collateral value is cautiously determined, a bank has the extensive guarantee that market fluctuations affecting the collateral value have already been taken into account in the process of collateral valuation and will therefore not lead to unsecured loan parts subsequently.

• Pricing based on imputed risk:

Most of the time, loan collateral reduces the credit risk. This leads to a lower credit margin because the risk components within this margin become smaller due to the collateral or even go back to "zero". This means that loans must be backed by a credit institution with little or no equity . This in turn results in a lower lending rate .

• Determination of the basis for credit relief under the KWG and the CRR when ordering as well as subsequent monitoring and updating of the collateral values:

Furthermore, the collateral assessment is used to determine the necessary equity backing for the loan by the bank ( risk position ) and to meet the requirements of regulatory reporting .

Legal issues

On the basis of Section 25a (1) KWG , BaFin issued the minimum risk management requirements for credit institutions in December 2012 . These represent a general requirement if they require in BTO 1.2 No. 2 that credit institutions have to define the bank-internal “procedures for reviewing, managing and realizing collateral provided”. According to BTO 1.2.1 No. 2 and 3, the intrinsic value of collateral must be checked before the loan is granted. When checking the intrinsic value, existing collateral values ​​can be used, provided there are no indications of changes in value. If the value of the collateral depends largely on the circumstances of a third party (e.g. guarantee), an appropriate review of the counterparty default risk of the third party must be carried out.

According to Section 1a KWG, the Capital Adequacy Ordinance applies to all CRR credit institutions , so that the more specific valuation principles set out in the ordinance must be applied in all EU member states . These valuation principles only exist in detail for real estate collateral, while regulations for other loan collateral are only available in fragments.

Real security

Among the physical collateral include real estate , movable property and rights .

Property valuation

The most common - and at the same time the most difficult to assess - loan security in the banking sector is the mortgage on residential and commercial property .

According to Section 10 No. 8 KWG , the provisions of the Capital Adequacy Ordinance have been in effect since January 2014 for the requirements for measuring the mortgage lending value . These allow the use of a mortgage lending value of real estate when determining the risk weights and exposure values of real estate loans and mortgage loans only in those Member States which have stipulated strict requirements for its assessment in their legal or administrative provisions. The new SolvV therefore clarifies the requirements that a mortgage lending value that can be taken into account for the purposes of the Capital Adequacy Ordinance must meet. These requirements are finally listed in Section 22 SolvV. Thereafter, the mortgage lending value must meet one of the following conditions:

• Determined in accordance with Section 16 Paragraph 2 Clause 1 to 3 PfandBG in conjunction with the Mortgage Lending Value Determination Ordinance (BelWertV)
• Determined in accordance with Section 7 ( 7 ) of the Building Societies Act, taking into account a provision approved by BaFin in accordance with Section 5 (2) No. 3 of the Building Societies Act
• In relation to a property in another country of the European Economic Area and determined on the basis of the strict legal or administrative provisions applicable in this country, which BaFin has recognized as being equivalent to the Mortgage Lending Value Determination Ordinance
• The mortgage lending value is a sustainably achievable value determined differently, which meets the requirements of Section 16 (2) sentences 1 to 3 PfandBG.

According to Art. 4 Para. 1 No. 74 Capital Adequacy Ordinance (CRR), the mortgage lending value represents the value of a property based on a careful assessment of its future marketability, taking into account the long-term, durable properties, "normal and local market conditions, current use and appropriate alternative uses is determined ". Value-determining factors are therefore the careful assessment of marketability, taking into account permanent properties and future usability.

The loan object must meet the following requirements:

• it is to be monitored annually (commercial real estate) or every three years (residential real estate) by the lending bank (Art. 208 CRR) and
• it must be estimated by an independent expert (Art. 229 Para. 1 CRR) and
• it must be usable promptly (Art. 208 Para. 2c CRR).

Residential properties that meet these requirements and are used or rented by the owner themselves receive a risk weighting of 35% of the risk-weighted credit (Art. 125 No. 1a CRR) for the risk position in the standardized approach , whereby the value of the residential property does not have a significantly positive credit rating of the borrower may correlate (Art. 125 No. 2a CRR). This is the case, for example, with commercial real estate on industrial property used by the borrower himself , the values ​​of which depend significantly on the income that he achieves through the special use of the commercial real estate (e.g. for factory buildings). According to Art. 126 No. 1a CRR, commercial real estate is assigned a risk weight of 50%. In the case of commercial real estate, the third-party usability of the loan object is also important. Since the loans therefore do not have to be fully backed by the financing bank's own funds , the borrower can benefit from lower credit margins , especially with real estate loans .

Operationally, the Valuation Ordinance (ImmoWertV) applies, which regulates the determination of the market values ​​(market values) of land and land rights , their components and accessories ( Section 1 ImmoWertV). The general value relationships on the property market on the valuation date ( § 2 ImmoWertV) are to be taken as a basis. The Mortgage Lending Value Ordinance (BelWertV), issued as an implementation provision for Section 16 (2) of the PfandBG, defines the mortgage lending value in Section 3 BelWertV as the value of the property, which experience has shown is independent of temporary fluctuations in value ( real estate bubble ) on the relevant property market and excluding speculative elements can be expected to be achieved in the event of a sale for the entire duration of the loan . Are to be applied when determining the value either the earnings method with the yield value (§ § 9 ff. BelWertV) or the asset value method (§ § 14 ff. BelWertV) with the real value as a value conventions for the loan to value ratio.

Assessment of other property security

Other physical collateral includes bank balances at the lending institution (Art. 197 Para. 1a), claims , certain securities ( bonds from states and central banks with a credit rating of at least 4 and shares and convertible bonds in the main index) and gold (Art. 197 Para. 1a, Art. 207 CRR). Their market value must be calculated and reassessed every 6 months (Art. 207 Para. 4d CRR), the remaining term of the collateral must be at least as long as the remaining term of the loans (Art. 207 Para. 5 CRR). Art. 210 d CRR requires that the loan agreement contain comprehensive information on the type and frequency of the revaluation in the case of other physical collateral . Art. 224 (1) CRR requires a volatility-oriented reassessment of the collateral, in extreme cases daily.

Personal security

In the case of personal security, according to Art. 233 (1) CRR, the amount that the security provider has undertaken to pay in the event of a credit event is to be used as credit security . This applies to sureties , guarantees , letters of comfort or other joint and several liabilities and to protection providers in the case of credit derivatives , in particular in the case of credit default swaps . Guarantees must be absolute and must not be designed as a default liability (Art. 215 Para. 1a CRR). The economic circumstances of the liable protection seller must be examined in the same way as those of the borrower (Art. 183 in conjunction with Art. 171-173 CRR) in order to quantify the counterparty risk. The counterparty risk is in accordance with Art. 272 para. 1 CRR the risk of default of a counterparty to a transaction defaults before the final settlement of the transaction's cash flows. A credit institution may not enter into a business relationship with a counterparty without having assessed its creditworthiness (Art. 286 para. 2a CRR). Collateral provided by a counterparty is treated as a claim that exists in the context of a derivative transaction (buy position) against the counterparty and is due on the day the risk position is determined (Art. 279a CRR).

If a bank refrains from checking the security seller in whole or in part in the case of personal security, i.e. if it does not ask the co-liable security seller in particular about his current and future financial possibilities, then in case of doubt under civil law it is to be assumed that she has the objective facts justifying the gross financial overload and knew the situation when the contract was signed or was consciously closed to them. Guarantees are then void , this also applies to the assumption of debt and the assumption of joint liability. These civil law aspects mean that guarantees with these deficiencies do not constitute credit security that can be recognized by supervisory law.

Basis of valuation

All loan collateral has its own characteristic value convention . These include the denomination in receivables , bank deposits and savings certificates , the market value in shares and bonds , the cash surrender value in life insurance or the market value of real estate. These value conventions are initially determined for the purpose of evaluating the loan security when accepting the loan and permanently during the collateral review and form the starting value for further valuation. Value conventions either dynamically map the current value (general market value , market value) or remain statically unchanged (nominal value). For the latter, the current or expected value-determining factors influencing the nominal value of the security must be taken into account.

In low-risk collateral such as visual , scheduling and savings , home loan credit, refund claims from life insurance policies, certain government bonds or precious metals and even residential properties (while maintaining a 80% lending limit and trouble-free debt service ) within the applicable credit check the duty of disclosure according to § 18 set KWG .

Appraisal

Banks calculated according to Art 223 Abs 2 CRR to be taken into account.. Volatility adjusted value of the security as follows: ${\displaystyle C_{VA}}$

${\displaystyle C_{VA}=C\cdot (1-H_{C}-H_{fx})}$

This corresponds to

${\displaystyle C}$ the lending value of the security,

${\displaystyle H_{C}}$ the collateral-appropriate volatility adjustment calculated in accordance with Articles 224, 227 CRR (lending limit or "haircut"),

${\displaystyle H_{fx}}$the volatility adjustment calculated in accordance with Articles 224, 227 CRR and commensurate with the currency mismatch (if credit and collateral are denominated in different currencies).

If, for example, the default loan amount (EaD) is 800,000 euros, the lending value (market value) of the collateral is 900,000 euros, the standard haircut is 25% (lending limit for shares in the secondary index) and there is no currency mismatch ( ), the loan amount is to be backed with own funds after credit risk reduction EUR 125,000 ( risk position value ): ${\displaystyle C}$ ${\displaystyle H_{C}}$ ${\displaystyle H_{fx}=0}$ ${\displaystyle C_{VA}}$

   Ausfallkredithöhe (EaD):                               800.000 Euro
   Beleihungswert verpfändete Aktien:     900.000 Euro 
   - Beleihungsgrenze (Haircut) 25 %:     675.000 Euro
   Kredithöhe nach Kreditrisikominderung:                 125.000 Euro

See also

• Repurchase agreement

Individual evidence

1. ↑ BaFin: Circular 10/2012 (BA), Minimum Requirements for Risk Management - MaRisk of December 14, 2012
2. ↑ BGH WM 2000, 410, 412
3. ↑ BGH, judgment of October 14, 2003 - XI ZR 121/02
4. ^ BGH, judgment of November 14, 2000 - XI ZR 248/99
5. ↑ BGH, judgment of January 25, 2005 - XI ZR 325/03
6. ↑ Value conventions are figures that can be objectively determined according to certain rules. They must be designed in such a way that they always generate the same value numbers for the same object. They relate primarily to tangible real goods such as book value , market value , market value , fair value , acquisition and production costs , material value or income value