Lenders use a variety of techniques, including full appraisals, so-called “drive-by” appraisals based on the exterior of the home, and databases of market prices, to evaluate homes. The values they arrive at help determine how much money they should lend to mortgage borrowers. They are also key for measures such as the loan-to-value ratio that are used to track the health of loan portfolios and borrowers’ debt loads.
Banks are emphasizing on-site visits to value properties, especially those above a certain price or in rural areas. They are also paying closer attention to who does the appraisal. The higher level of diligence aims to get more accurate values amid fears of an overheated housing market. If standards tighten or appraisals become more conservative, it could result in a decrease of the amount of mortgages that banks lend.
Appraisal values become most important to banks when a borrower defaults, and the bank has to sell the property to recoup money. Their accuracy is especially important in the current environment, in which home prices are believed to be inflated and borrowers are taking on record debt levels, increasing the risk of defaults.
There has been no suggestion of widespread or serious problems in Canada’s appraisal system, and bankers say they are comfortable with the values on their books. But lenders and regulators have recently been scrutinizing appraisal systems in an effort to ensure that these values are as accurate as possible.
“We have tightened our process, and make sure that we are getting an accurate read,” David McKay, the head of Canadian banking at Royal Bank of Canada, the country’s largest mortgage lender, told analysts on a recent conference call. “When you think you have an 80 per cent loan-to-value ratio, you want to make sure you have an 80 per cent loan-to-value ratio.”
Mark Chauvin, Toronto-Dominion Bank’s chief risk officer, told analysts that in some of the hotter markets such as Vancouver and Toronto, appraisal values are coming in slightly above purchase prices.
“We’re really not seeing a lot of it,” he said. “But we feel our existing policies will protect us against that.”
TD lends 80 per cent loan-to-value up to $900,000, but after that only lends 50 per cent, to protect itself against inflated values on expensive homes. “So if you take a $2-million house, you get a loan-to-value of 56 per cent under the sliding scale,” he said.
Some banks began to focus more on this last year, after an American insurance company reported a significant charge in connection with insurance it was selling to them. That insurance was covering risks associated with the possibility that appraisal values were off.
California-based First American Financial Corp. had been selling Canadian banks a “guaranteed valuation” product that guaranteed the valuation of a property was accurate on the day a mortgage was issued. If it turned out later that it wasn’t, the bank could make a claim.
But First American posted a first-quarter loss in 2011 as it took a $45-million reserve strengthening charge relating to this obscure Canadian product.
Policies that were experiencing claims had been written mostly in 2007 and 2008. Sources say the issue stemmed mainly from Alberta, where the housing market underwent a correction starting in 2007, and problems became apparent as default rates increased, leading banks to seize more homes as collateral.
“This is just a case where we mispriced the risk,” First American CEO Dennis Gilmore told analysts. (The firm declined to comment).
The company is no longer offering that insurance in the same form, bankers said. “It’s a big change in the industry; we’ve all kind of morphed our property valuation strategies as a result of this occurring,” said a senior banker.
Spokespeople at Bank of Montreal and Bank of Nova Scotia said Monday that their institutions were already focused on in-person appraisals.
The Office of the Superintendent of Financial Institutions is ushering in new mortgage underwriting rules that require banks to have clear policies outlining how they value properties. It is urging them to use a combination of tools, and to include a comprehensive on-site appraisal unless there’s an appropriate reason to use an alternative method.
Banks “should not use title insurance or valuation insurance as a substitute for a sound appraisal or valuation process,” OSFI stated.