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Society of fools

Fair Value Accounting question: how do banks value unsold homes ?

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Just wondering if somebody on this highly qualified forum can educate me: is it true that a UK bank is entirely free, within Britain's present accounting structure, to value a house more as a work of art- that is, to value it as they believe it to be valued- than at actual real provable market values ?

Here's my background to asking this question. A year or so ago, a buddy of mine was bidding on a foreclosed property- at auction. He particularly liked this property, and in fact, the auction concerned was the second in less than 12 months for the property in question. On both occasions the property was passed in and remained unsold and in the bank's hands, as it hadn't hit the reserve price.

Anyway, on the second occasion that this had happened, he managed to corner the auctioneer in the pub ( this was in a reasonably small town) and ask him, very forthrightly, what the hell kind of price did the bank actually expect for the property ? The answer was shocking. In fact, the auctioneer pointed out that the highest auction offer that had been received was, let's say, X. The bank, on the other hand, had valued the property at about 1.75 times X. So, to use real figures, people in the real live marketplace were offering say, 360,000 pounds, while the bank, on its balance sheet, had listed an asset as worth 630,000 pounds. And the bank apparently had a bunch of other, similar, foreclosed and unsold properties, that they had valued at more or less the same asset value.

My question is: in what other industry would this kind of creative accounting fly ? I work in petroleum products. I well remember how at one time our traders zigged when they should have zagged, and a tanker load of high quality petro-products dropped in price by 20% between loading in Texas and arriving at Thurrock. Did our accountants give us any latitude in how that cargo of petro-products should be valued ? HELL NO ! We had to disclose and account for the real market value of the product instantly in the next month's accounts.

But somehow Banks can somehow value an asset that the market clearly values at X - provable at a public auction- at 1.75 times X ? Does this make any sense ? And is this true ?

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This is a really good question and I don't know. But it should be auditable with a sane variation methodology and this might be higher than auction prices.

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In the UK, they dont.

They have performing loans and non performing loans.

 

Now in Spain, whihc makes our banking system look clean and above board ...

 

 

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6 minutes ago, spyguy said:

In the UK, they dont.

They have performing loans and non performing loans.

 

Now in Spain, whihc makes our banking system look clean and above board ...

 

 

Good point - the property either sells to cover the loan or it does not and the bank continues to chase the defaulted borrower. It never puts the property on its balance sheet as an asset. 

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I don't know much about this topic, and about banks in particular, but anyway, a couple of possible reasons.

 

Historic value. This is actually the usual way of recording property in the accounts (although revaluations based on professional advice would also be normal). The actual price paid. If there was evidence (such as failing to sell at auction) then the auditors should question it.

 

Income based valuation. If they are actually rented out, they may have a model for valuing it based on their own long term cost of capital

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39 minutes ago, Ah-so said:

Good point - the property either sells to cover the loan or it does not and the bank continues to chase the defaulted borrower. It never puts the property on its balance sheet as an asset. 

This. 

The bank's balance sheet has loans on the asset side and deposits and bit of shareholder capital on the other.

You could set up a bank by putting in £10 of your own money (shareholder capital or, if you prefer, equity funding) and borrow £90 from your wife. You then lend the whole lot to your neighbour to buy a duck house. On your bank's balance sheet there is an asset of £100 (the money the borrower owes you) and there are £100 of liabilities (£10 from the shareholders, £90 borrowed from the wife).

If your neighbour stops making payments on the loan then a robust procedure for assessing whether the loan (the asset) should still be on your books at £100 might eventually include the amount of money that you might expect to make by selling the duck house (if you had a right to get hold of it under the terms of the loan). However, if you write down the value at which the loan asset is held in order to reflect the arrears and any fall in the value of underlying asset (the purchase of which was financed by the loan) then your bank would be effectively recognising an additional cost, and if you recognise enough of these costs then your profits turn to losses.

By the way, the daft thing about the example above is the bank's leverage. £1 of equity for every £9 of debt would make it the safest bank in the country ;-)

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52 minutes ago, Bland Unsight said:

This. 

The bank's balance sheet has loans on the asset side and deposits and bit of shareholder capital on the other.

You could set up a bank by putting in £10 of your own money (shareholder capital or, if you prefer, equity funding) and borrow £90 from your wife. You then lend the whole lot to your neighbour to buy a duck house. On your bank's balance sheet there is an asset of £100 (the money the borrower owes you) and there are £100 of liabilities (£10 from the shareholders, £90 borrowed from the wife).

If your neighbour stops making payments on the loan then a robust procedure for assessing whether the loan (the asset) should still be on your books at £100 might eventually include the amount of money that you might expect to make by selling the duck house (if you had a right to get hold of it under the terms of the loan). However, if you write down the value at which the loan asset is held in order to reflect the arrears and any fall in the value of underlying asset (the purchase of which was financed by the loan) then your bank would be effectively recognising an additional cost, and if you recognise enough of these costs then your profits turn to losses.

By the way, the daft thing about the example above is the bank's leverage. £1 of equity for every £9 of debt would make it the safest bank in the country ;-)

You do know the Norfolk Turkey choker reads this thread?
Dont give him ideas FFS!

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'By the way, the daft thing about the example above is the bank's leverage. £1 of equity for every £9 of debt would make it the safest bank in the country ;-) '

 

And thats why, if we are to continue having private banks as the source of money, the level of leverage offered to indivudals and companies is important and most be kept waaaay down.

Even slightly too much and the bank is toast.

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2 hours ago, Society of fools said:

My question is: in what other industry would this kind of creative accounting fly ? I work in petroleum products. I well remember how at one time our traders zigged when they should have zagged, and a tanker load of high quality petro-products dropped in price by 20% between loading in Texas and arriving at Thurrock. Did our accountants give us any latitude in how that cargo of petro-products should be valued ? HELL NO ! We had to disclose and account for the real market value of the product instantly in the next month's accounts.

Playing devil's advocate, doesn't oil have a limited storage life? Land doesn't. 

 

 

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3 hours ago, Society of fools said:

Just wondering if somebody on this highly qualified forum can educate me: is it true that a UK bank is entirely free, within Britain's present accounting structure, to value a house more as a work of art- that is, to value it as they believe it to be valued- than at actual real provable market values ?

 

But somehow Banks can somehow value an asset that the market clearly values at X - provable at a public auction- at 1.75 times X ? Does this make any sense ? And is this true ?

Again, banks dont hold houses or anything. They have loans - performing, distressed, nonperforming.

A bank doesnot get into LLing, EAing or Hoteling. They repo, take possession and sell.

Any hit they take is recognised then.

Its why leverage is such a fcker for banks.

 

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1 hour ago, Bland Unsight said:

If your neighbour stops making payments on the loan then a robust procedure for assessing whether the loan (the asset) should still be on your books at £100 might eventually include the amount of money that you might expect to make by selling the duck house (if you had a right to get hold of it under the terms of the loan). However, if you write down the value at which the loan asset is held in order to reflect the arrears and any fall in the value of underlying asset (the purchase of which was financed by the loan) then your bank would be effectively recognising an additional cost, and if you recognise enough of these costs then your profits turn to losses.

But if non-performing loans mount up the bank's profits also turn to losses don't they? 

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11 minutes ago, Patient London FTB said:

But if non-performing loans mount up the bank's profits also turn to losses don't they? 

They can keep adding the outstanding interest to the loan outstanding.  Provided they can provide reasonable evidence that the value of the security underpinning the loan (ie. the property value plus any other assets of the borrower and guarantor - if there is one) exceeds the total amount of outstanding loan and accrued interest no need for a write down.

 

Non performing corporate loans tend to cause problems more quickly than property backed ones, as they are predicated on the profits of the underlying business, if the businesses isn't servicing the loan to terms it implies that profits have fallen and hence the underlying security is impaired.

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5 minutes ago, Exiled Canadian said:

They can keep adding the outstanding interest to the loan outstanding.  Provided they can provide reasonable evidence that the value of the security underpinning the loan (ie. the property value plus any other assets of the borrower and guarantor - if there is one) exceeds the total amount of outstanding loan and accrued interest no need for a write down.

 

Non performing corporate loans tend to cause problems more quickly than property backed ones, as they are predicated on the profits of the underlying business, if the businesses isn't servicing the loan to terms it implies that profits have fallen and hence the underlying security is impaired.

Got it, thanks for the explanation

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24 minutes ago, Patient London FTB said:

But if non-performing loans mount up the bank's profits also turn to losses don't they? 

They take a hit to their core capital.

 

At the leverage that banks have been lending out, a housing loan can go bad real quick and wipe out a lot of capital.

Banks go bust like petrol catches fire.

Its fun when you have the likes of Nationwide who, as a mutual, have fck all way of raising new capital.

Just as well they did not step in to NR shoes and start lending like afcking loon to BTL LL or IO mortgages i nthe London + SE.

What thats you say?

 

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48 minutes ago, spyguy said:

They take a hit to their core capital.

 

At the leverage that banks have been lending out, a housing loan can go bad real quick and wipe out a lot of capital.

Banks go bust like petrol catches fire.

Its fun when you have the likes of Nationwide who, as a mutual, have fck all way of raising new capital.

Just as well they did not step in to NR shoes and start lending like afcking loon to BTL LL or IO mortgages i nthe London + SE.

What thats you say?

 

Bailout?

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21 minutes ago, spyguy said:

Bailouts are politically a no no.

NW is fcked. Its a real popcorn and wait as Basel3 rolled out.

Agreed. But the masses don't know this, yet. Hence the standoff in house prices.

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2 hours ago, Exiled Canadian said:

They can keep adding the outstanding interest to the loan outstanding.  Provided they can provide reasonable evidence that the value of the security underpinning the loan (ie. the property value plus any other assets of the borrower and guarantor - if there is one) exceeds the total amount of outstanding loan and accrued interest no need for a write down.

 

Non performing corporate loans tend to cause problems more quickly than property backed ones, as they are predicated on the profits of the underlying business, if the businesses isn't servicing the loan to terms it implies that profits have fallen and hence the underlying security is impaired.

Once a mortgage had not been paid for 6 months it must be declared in default, the PD set to 100% and increased capital held against it. 

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2 hours ago, Ah-so said:

Once a mortgage had not been paid for 6 months it must be declared in default, the PD set to 100% and increased capital held against it. 

My experience (mostly with corporate loans) is that banks tend to "restructure" defaulting loans to keep them out of "default" AKA "extend and pretend" - I don't know about how this is reflected on the bank balance sheet,

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58 minutes ago, Patient London FTB said:

What does PD stand for?

Probability of default and is used in the calculation of how much capital needs to be held against a loans to absorb losses. 

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1 hour ago, Exiled Canadian said:

My experience (mostly with corporate loans) is that banks tend to "restructure" defaulting loans to keep them out of "default" AKA "extend and pretend" - I don't know about how this is reflected on the bank balance sheet,

I am a bit drunk so DYOR. As I recall matters one of the mechanisms by which the big lenders managed arrears post-2008 was simply to turn repayment mortgages into interest-only mortgages. Given the collapse in interest rates over the post-2008 years this was a very, very potent "extend and pretend" tool.

I absolutely cannot be @rsed to look this up, but I also recall reading how the big lenders couldn't give a decent appraisal of the extent of this forbearance because their systems (underwriting and IT) hadn't captured where clients had remortgaged to interest-only (because you could) or had done so as former repayment borrowers seeking forbearance.

Setting aside these matters, at 2008-2009 the level of forbearance was immense.

A banker is a somebody who lends you an umbrella but wants it back if is starts raining. In a financial crisis they use the umbrella to collect their own piss and then they make you drink it. Of course they don't sell it to you like that. They say that your money is making nothing as deposits so you might as well pile into buy-to-let, but it amounts to the same thing.

Buy now, buy everything.

Edited by Bland Unsight

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accounting 101 would say lower of cost or net realisable value. 

In your example the cost is 600k say, and the NRV is 300k. You have to record the asset at the end of the year at 300k.

But there is no obligation for the bank to sell at auction. So if it thinks the house is worth 500k and the best offer is 320k, it doesn't need to sell.

Edited by 999house

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9 hours ago, spyguy said:

In the UK, they dont.

They have performing loans and non performing loans.

 

Now in Spain, whihc makes our banking system look clean and above board ...

 

 

 

Surely the house would be marked as an asset? If a performing loan is an asset, then a non performing must be written off like any other bad debt, less the value of the house?

Performing loan is 100k (asset on balance sheet)

Loan goes bad, now non performing loan 100k (write off to P and L)

House     100k (asset moved to the balance sheet)

Tying it back to the question, the bank can sell for as much or as little as it wants, providing someone has offered that amount.

Edited by 999house

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Thank you for your answers. As a new guy, may I say how happy I am to have joined this site. This is one of the most knowledgeable forums I have ever encountered on the subject of real estate. The level  of expertise is truly impressive.

Here is what I was also wondering though. It seems to me that a great deal of latitude is given to banks to not-disclose the market values - as in the offers received- for their unsold property.

Could there be an argument- for the good of society- that perhaps this kind of price obfuscation is not healthy ?

Let's take my example above, using my pretend figures. If, for example, it was public knowledge that numerous properties that were valued by the bank at 600 K + pounds were in fact receiving offers of only 360 K +, would there then be serried ranks of idiots lining up to offer 600 K + pounds, because that is what the banks were signalling the property was worth ?

Its not exactly like the stock market is it ? You put a share up for sale, at any precise moment you can see 100 different offers for it, ranging from offers above the market price to well below it. And its all public. Nobody can complain they overpaid relative to their peers.

Real estate on the other hand, its a complete murky foggy swamp. And it is massively in the interests of the vendor and the banks that lent him or her the money to make sure that the market stays completely opaque.

9 hours ago, Patient London FTB said:

Playing devil's advocate, doesn't oil have a limited storage life? Land doesn't. 

A lot of Petroleum Products can last for many months, stored properly. And that's just the point. The shipload of product we took in arrived in the month of march. The accountants insisted on the following, as per the words of 999house. So we took the hit instantly. But I was not sure in Banks had to do the same. I had the impression that they didn't, that they were given latitude in their valuations.

2 hours ago, 999house said:

accounting 101 would say lower of cost or net realisable value. 

In your example the cost is 600k say, and the NRV is 300k. You have to record the asset at the end of the year at 300k.

 

 

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