valuation_mortgage_security_italian_banks.pdf

7/27/2019 Valuation_Mortgage_Security_Italian_Banks.pdf

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REAL ESTATE ISSUES

INTRODUCTION

THIS ARTICLE dESCRIbES A RESEARCH/CONSULTING pROJECT

conucte in 200809 on the resiential mortgage

lening rocess in Italian anks. The focus is on the

methos an the roceures imlemente y Italian

anks in aluing real estate use as collateral for loans

oth in the loan origination an in the creit monitoring

rocess. The roject was carrie out uner the ausices of

the Uniersity of Macerata, which has a strong rogram

in anking an real estate finance. Imetus for the stuy

resulte from the isastrous results of the holings of

mortgages an mortgage eriaties in Unite States

anks. The question naturally arose as to whether or notthese same risk factors, or others, coul e at work in

Italian anks, which hol an een greater ercentage of

their assets in resiential mortgage loansaout 24.4

ercent in 2008 comare with aout 19.1 ercent in U.S.

anks. Smaller an meium-size Italian anks hol an

een greater roortion of their assets (aout 30 ercent)

in these loans.

Sonsors of the stuy inclue four anks an four ank

founations (similar to ank holing comanies). The

four anks hae offices in the Marche region of east-

central Italy.1

In return for their cooeration the results ofthe stuy, incluing its recommenations, were mae

aailale to the four anks. The authors retaine the right

to ulish articles from the stuy incluing rocesses,

finings, an recommenations, without reealing the

anks rorietary information.

BACKGROUND

In orer to collect ata for the research, the authors

eeloe a etaile questionnaire that was comlete y

the releant officers of the anks. Aitionally, the

authors conucte two sets of interiews with the anksofficers. The questionnaire an interiews concerne the

ortfolios of mortgage loans of these anks, the roce-

ures use to grant mortgage loans, the methos an

techniques use to alue the real estate sering as collat-

eral, an the rocesses use to monitor these loans.

The Valuation of MortgageSecurity by Italian BanksBY MASSIMO BIASIN; AND HALBERT C. SMITH, CRE EMERITUS

CASE STUDY

About the Authors

Massimo Biasin is a professor of Financial

Intermediaries at the University of Macerata,

Italy. He is also a principal in the consulting

firm of Biasin & Partners, with offices inBolzano, Italy, and Munich, Germany, holding

the equivalent designation of CPA. He received a

doctorate in banking and finance in 1999 from

the University of Venice, and served on the

faculty of Catholic University of Milan prior to accepting the post at

Macerata. Biasin also serves on the investment boards of several Italian

REITs. He has held visiting positions at several universities in Europe

and the U.S., and is a Fellow of the Weimer School of the Homer Hoyt

Institute.

Halbert C. Smith, CRE Emeritus, is

Professor Emeritus of Real Estate and Finance

at the University of Florida. Prior to Florida,

he was a member of the faculty at Ohio State

University and was director of Economic

Research for the Federal Home Loan Bank

Board. He is a director of the Homer Hoyt

Institute and is a Founding Fellow of the

Weimer School of Advanced Studies in Land Economics. Smith was an

active member of The Counselors of Real Estate for many years,

serving on its board of directors from 19962000, and as editor in

chief ofReal Estate Issues from 19931998. In 1999, Smith

received the Lum Award. He has taught and conducted research in

several Italian and U.S. universities.

V o l u m e 3 5 , N u m b e r 2 , 2 0 1 028


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REAL ESTATE ISSUES Vo lu me 3 5 , Nu m b e r 2 , 2 0 10

CASE STUDY

The Valuation of Mortgage Security by Italian Banks

Unlike the U.S. market exerience, write-offs of

mortgages in Italy hae historically een limite an

rarely hae resulte in the istress of financial institu-

tions, een in the recent financial crisis. The stuy

inclue analysis of four rincial asects of the lening

an aluation rocess:

1. The ruential regulation of mortgage lening an

real estate aluation imose y the suerisory

authority (i.e., the bank of Italy) in conformance with

the recommenations of basel II.

2. The aluation ocuments (araisals) an roce-

ures use y the anks in aluing the real estate that

seres as security for mortgage loans.

3. The methos an roceures use y the anel of

Italian anks to screen alications for new mortgage

loans.

4. The roceures use in monitoring mortgage loans

for continuing creit worthiness.

We eliee that the insights we were ale to gain in this

stuy coul e useful not only to the four cooerating

anks ut also to other anks an financial institutions in

Italy an other countries. The recommenations shoul

e helful in ealuating an institutions own olicies an

roceures relate to mortgage lening an, ultimately, in

aoiing isastrous ank failures.

I. Regulatory Requirements

for Mortgage Lending

1. FRAMEWORK AND DEFINITIONS

THIS SECTION dESCRIbES the regulatory requirements for

mortgage lening romulgate y the bank of Italy an

emanating from basel II recommenations. The rules

for ruential igilance aly to the screening rocess

for new loans an the roceures for monitoring

existing mortgage exosures. In articular, the rules

focus on the oerational limits (i.e., the loan-to-alueratio) an the accetance of mortgages as creit risk

mitigation instruments.

As in the U.S., the term real estate mortgage loan (credito

fondiario) refers to a written loan agreement securitize

y a mortgage on a real roerty use as collateral for

orrowe funs. Such a loan enjoys riilege tax an

regulatory treatments ue to the social releance of

roerty inestments. The urose of the orrowe funs

is to uy, uil or renew a real roerty [bregoli (1999)].2

In orer to e classifie as a real estate mortgage, the

romissory note must contain the following roisions:

a. Maturity: The loan must hae a meium- or long-term

maturity (i.e., hae an aerage uration of more than 18months). With resiential mortgages, the amortization

term is usually etween eight an 30 years.

b.Mortgage: A so-calle first grae or senior mortgage

is a lege of roerty as collateral for the ayment of

the et. Suorinate liens may also e accete, ut

the loan-to-alue ratio state for regulatory uroses

(see elow)which efines the maximum creit

amountmust e calculate consiering oth the

amount of the new loan to e grante an the resiual

amount of any reious mortgage.

c. Loan-to-Value Ratio: As escrie in etail next, the

maximum loan amount is set y the Central bank as a

ercentage of the current market alue of the real

estate lege as collateral for the loan. Aitional

securities may leer the loan-to-alue ratio uner

secific circumstances. The reason for this ruential

rule is, of course, to limit a leners execte loss on

the creit in case of a orrowers efault an suse-

quent foreclosure on the roerty sering as security

for the loan.

If these roisions are fulfille, the mortgage loanenjoysas a meium- to long-term loana reuce

sustitute tax of 0.25 ercent calculate on the

orrowe amount; the sustitute tax is leie in lace of

the orinary, higher inirect taxes relate to the caastral

(lan) register an mortgage taxes. In aition to other

faorale legal stanars, mortgages leging roerty

are not suject to ankrutcy claw-ack actions if they

hae een recore at least 10 ays rior to the

ankrutcy eclaration of the mortgagor.

Also, a mortgage holer cannot terminate the loan

agreement an initiate foreclosure unless the orrower

fails seen times, at seeral oints in time, to make

interest an rincial ayments when ue uner the

romissory note.3 Another rotection for a mortgage

orrower is that wheneer he/she ays off at least one-

fifth of the original loan amount, he/she is entitle to

receie a roortional reuction of the mortgage or,

more recisely, of the interest in the roerty use as

security for the et.

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REAL ESTATE ISSUES 30 V o l u m e 3 5 , N u m b e r 2 , 2 0 1 0

CASE STUDY


2. OPERATIONAL LIMITS:

THE LOAN-TO-VALUE RATIO

As inicate reiously, a main characteristic of real

estate mortgageswith resect to other tyes of loansis

the fixe loan-to-value ratio, efine at the regulatory

leel y the anking suerisory authority, the bank of

Italy. At resent, the loan-to-alue ratio, calculate as the

ratio of the original loan amount to the current market

alue of the roerty sering as security for the loan,

cannot excee 80 ercent. Howeer, if the etor eliers

aitional collateral comliant with the legal stanars

efine y the same suerisory authority, the loan-to-

alue ratio may reach 100 ercent. Examles of sule-

mentary securities that may e amitte are ank

guarantees, insurance olicies or ayment guarantees of

other financial intermeiaries [bank of Italy (2008)].

3. RULES FOR PRUDENTIAL VIGILANCE

The rules goerning mortgage lening aly at the inter-

national leelmore secifically, at the Euroean Union

leel. The basel II framework secifies how mortgage

securities must e ealuate as creit risk mitigation

comonents affecting the caital aequacy of anks. In

rincile, the total minimum caital requirements for

creit (as well as for market an oerational) risk are

calculate as a ercentage of the risk-weighte assets of a

ank. The assessment of risk (i.e., the risk-weight) is

roie either y a anks internal risk rating system or

y consiering a stanar set of factors affecting creitrisk (counter-arty risk, country risk, uration, etc.). The

total caital ratio must e no lower than eight ercent. In

this resect, real estate mortgages are inclue in the

oerall category of collateralize loans, een though

ruential igilance is largely achiee y secifying a

manatory loan-to-alue ratio.

The ruential framework consiers mortgage security as

a creit risk mitigation instrument, as it reuces the risk

of loss at efault. Although mortgages o not reuce the

roaility of efault of the etor, they o roie a

source of alue that can e recoere through foreclosure

on the mortgage roerty. Howeer, as a general

rincile, mortgages are only accete as collateral if the

roerty securing the loan is not self-referring to the

exosure. This means that the rosects for reayment

an recoery on the exosure must not een rimarily

on the cash flows generate y the asset itself. The

rimary source of these cash flows is generally lease or

rental ayments, or the sale of the roerty [basel

Committee (2006, 2008)]. desite this requirement,

recognition an eligiility of mortgages as collateral ary

ase uon the tye of the unerlying roerty (asically,

commercial ersus resiential real estate).

The creit risk mitigation caaility of mortgages

eens further on the methoology for calculating thecaital requirements for creit risk aote y the ank,

one alternatie eing the so-calle Stanarize

Aroach, where creit risk is measure in a stanarize

manner, the other alternatie eing the Internal Ratings-

ase Aroach (IRb)slit into the founation or

aance methowhich allows anks to use their

internal rating systems for measuring creit risk.4

Most of the small- an meium-size Italian anks follow

a stanarize aroach while only large anks aot an

IRb methoology, either the founation or aance IRb.

In our secific case, three of the four anks of the samle

follow the stanarize aroach, while one ank (a

memer of a larger ank grou) has imlemente the

intermeiate metho (the founation IRb). In the

following section we therefore focus rimarily on the

recognition of mortgages as creit collateral in the

stanarize aroach.

a. Rules for screening and loan origination

pruential regulation in the stanarize aroach

classifies mortgage loans as claims secure y real

estate. This aroach inclues only the art of themortgage coere y the collateral that oes not excee

the regulatory loan-to-alue ratio limitation of 80

ercent5 an roies that the single loan arrangement

fulfills the following requirements [bank of Italy (2008)]:

1. The alue of the roerty must not e highly corre-

late to the creit rating of the orrower.

2. The roerty must e araise y an ineenent

rofessional (araiser). The araise alue cannot

excee the current market alue of the asset, efine

as the fair alue uner which the roerty coul esol uner riate contract etween a willing seller

an an arms-length uyer at the ate of aluation.

The araisal must e clearly an comrehensiely

ocumente.

3. The term ineenent refers to the requirement

that the araiser cannot articiate either irectly or

inirectly in the loan origination or monitoring

rocess.


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CASE STUDY


4. The collateral must e isosale within a reasonale

time frame. The ank must imlement a continuous

monitoring rocess of the alue of the collateral.

The ank must clearly ocument an aress the

tyes of real estate accete as collateral within the

oerall lening olicy.

5. The roerty must e aequately insure against

amage an eterioration.

Residential real estate. Loans secure y mortgages on

resiential roerties are generally risk-weighte at 35.0

ercent (i.e., the asset amount on which the caital

asortion rate is etermine is calculate y multilying

the loan amount y .35). This ercentage is use roie

the following requirements are met:

1. The roerties must e use or lease y the owner;

2. The rosects for reayment of the mortgage must

not een significantly on the cash flows generate

y the same real estate use as security;

3. Although the loan amount cannot excee 80 ercent

of the roerty alue, a loan-to-alue ratio of 100

ercent can e achiee uner the conition that

aitional securities such as ank or insurance

guarantees are eliere an roie that the oerall

exosure comlies with the following ratio: Loan /

[market value + additional securities] .80.

In the case of roerties alreay lege y reious

mortgages, the loan-to-alue ratio must e calculate y

aing to the new loan amount the resiual exosure of

the loans alreay in lace. This requirement accounts for

lien riority an for the reuce collateral alue of the

unerlying roerty.

Commercial real estate. Loans secure y mortgages

on commercial roerties such as factories, stores, offices,

etc., are generally risk-weighte at 50.0 ercent (0.5) for

the loan amount not exceeing 50 ercent of the marketalue of the roerty. The resiual loan exosure is fully

risk-weighte at 100.0 ercent. The reuce 50 ercent

risk rating also requires that reimursement of the loan

oes not heaily rely on the cash flows generate y the

real estate securing the exosure. The net effect of this

requirement is that financing for income-roucing real

estate is not consiere as a real estate mortgage for risk

rating purposes.

b. Rules for monitoring

The rules for ruential igilance require a continual

monitoring of the loan-to-alue ratio of the mortgage

ortfolio. This rule means that the market alue of the

roerties must e reiewe or reaffirme erioically.To accomlish this, anks must erify the alue of the

unerlying roerty at least:

I eery three years for resiential real estate;

I eery year for commercial real estate.

Araisals may e use to carry out this requirement.

Howeer, anks may also imlement statistical metho-

ologies (e.g., ataanks) to ientify real estate alues that

nee to e closely monitore. Shoul the statistical

analysis show a significant ecrease in the alues of

similar roerties, the ank must commission a new

araisal. A new araisal is, in any case, require eery

three years for loan exosures aoe three million euros

or for those exceeing fie ercent of the anks regula-

tory caital. Financial intermeiaries also must check the

alue of the roerties securing the mortgages more

frequently (than the one- an three-year requirements) if

real estate market conitions change significantly.

II. Valuation Procedures

and Techniques1. GENERAL SITUATION

OUR ANALYSIS SHOWEd that the four anks o not hae

significant rolems with loans in arrears or foreclosure.

Howeer, we eliee that aluation roceures an

techniques resent otential ifficulties for these, an

unoutely many other, anks in Italy. Although most

araisals are unertaken y cometent exerts traine

in fiels such as architecture, engineering, geometry,6 an

erhas accounting, these rofessionals often hae

limite eucation an training in aluation roceures

an techniques.

The authors note that in the araisals roie to them

there was little or no justification of crucial numers such

as selling rices, construction costs, incomes, or exenses

of other, similar roerties. Furthermore, the araisals of

resiential roerties contain few or no ajustments to

the selling rices of comarale roerties that hae

recently sol. The omission of ajustments for changes in

market conitions, financing arrangements, location, an


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CASE STUDY


hysical ifferences (such as size, numer of rooms,

quality of construction, an equiment) reners such

araisals susect to inaccurate or incomlete alue

conclusions. While the final alue conclusions may e

sufficiently oerale for lening uroses in a relatielystale market, a ownturn in the market of more than

510 ercent coul result in a ifficult or, ultimately, an

unaccetale leel of nonerforming loans.

The consulting reort recommene that the anks seek

to roie the necessary eucation an training for

emloyees to e ale to suerise roerly the efforts of

araisers, an to require araisers to emonstrate

knowlege of araisal methos an roceures, as well

as the technical knowlege of their rimary rofessions

(architecture, engineering, geometry, et al.).7 We recog-

nize, howeer, that eucational rograms in the aluationof real estate are in short suly in Italy. Therefore, it may

e in the anks interest, together with other anks an

financial intermeiaries, to romote the eeloment of

eucational rograms that woul e aailale to anyone

wanting to ecome a rofessional araiser.

2. ORGANIZATIONS PROMOTING APPRAISAL

STANDARDS AND EDUCATION

Some attemts alreay are eing mae to ientify an

romote the use of accete araisal methos an

techniques in Italy. NOMISMA8 an Tecnoorsa hae

eeloe a set of aluation stanars for some tyes ofcommercial an inustrial roerties, although these

stanars are incomlete.

TEGovA, the Euroean Grou of valuers Associations,

attemts to romote the imosition of stanars an the

eeloment of eucational rograms throughout

Euroe. It has ulishe a ook, European Valuation

Standards (402 ages) that contains nine valuation

Stanars, 14 Guielines an eight Aenices. We

eliee that the accetance of these stanars an their

wiesrea imlementation in Italy woul greatly enefit

the safe an soun lening ractices of anks an otherfinancial intermeiaries.

TEGovA has two memers in Italy, IsIvI (Istituto

Italiano valutazione Immoiliare) an GEOvAL

(Associazione Geometri valutatori Eserti). IsIvI has

some training rograms an materials, although they o

not seem to e wiely accete an use. GEOvAL has a

one-week rogram of araisal eucation an training

aime rimarily at geometers.

III. Screening

AS NOTEd pREvIOUSLY, screening is the rocess of ealu-

ating the alication y an owner, or a uyer, for a

mortgage loan. In the ealuation rocess, the ank nees

to weigh three funamental elements: (1) the likelihoo

of efault y the orrower, (2) the amount of creit at

risk; an (3) the otential loss in case of efault.

1. PROBABILITY OF DEFAULT

When assessing the roaility of efault in screening a

loan request, esecially for the urchase of resiential

roerties, a ank shoul consier the entire financial

situation of the orrower, incluing the income aailale

to the orrower to make the mortgage ayments uring

the life of the loan, other ets that the orrower may

hae, an the staility of the orrowers income.

2. AMOUNT OF CREDIT AT RISK

The amount of a loan requeste must not excee the

loan-to-alue ratio requirement, as note reiously. The

loan amount for single-family resiential roerties is

usually well within een a small anks caacity for

granting a mortgage loan, ut the exosure to all loans of

a articular tye shoul e ket in roortion to the

anks total assets an the ercentages of other exosures.

3. POTENTIAL LOSS IN CASE OF DEFAULT

The otential loss resulting from efault an foreclosure

is a function of the roaility of selling the roerty forat least its market alue (as estimate y an araiser) on

the oen market. The more general the tye of roerty,

the higher is this roaility, an ice ersa: The more

secialize the tye of roerty, the less roale is the

roaility. Single-family resiential roertiesthe

main scoe of this stuyusually carry a relatiely high

marketaility, i.e., the roaility of selling the roerty

for at least its market alue.

For resiential roerties, a ank shoul rely rimarily on

the income an assets of the orrower for reayment of

the loannot on the sale or rental of the roerty. The

otential sale of the roerty in case of efault an

foreclosure is an imortantut seconaryconsiera-

tion in the screening rocess. In general, if the income

an assets of the orrower are likely not to suort the

loan, the alication shoul e enie. A ank shoul

also consier whether there is a margin of error with

the alicants income an assets in terms of the general

economy an the real estate market. If an alicants

income an assets arely meet his or her aility to reay


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CASE STUDY


the loan, any ownturn in the local market (emanating

from either national or local trens) coul enanger the

loan. The recent market eacle in the U.S. illustrates the

risk unertaken y financial institutions when loans are

not ealuate carefully: efaults may occur in largenumers, utting financial institutions an een the

general economy in eril.

a. The valuation phase by a qualified professional

Regulations require that a qualifie an cometent

araiser shoul erform the araisal. While in the U.S.

asic qualification is inicate y state licensure, an

aitional qualifications may e roie y rofessional

organizations (such as the Araisal Institute), there is no

secific license law for araisers in Italy an, as note

aoe, there is little eucation an training y rofes-

sional organizations.

Neertheless, the cometence of araisers of large,

income-roucing roerties is quite highequal to that

of araisers in the U.S. This situation results from the

use of araisers who are knowlegeale aout financial

matters, incluing the use of aluation techniques such as

iscounte cash flow (dCF) analysis. Ironically, one of

the largest firms in Italy that araises these tyes of

roerties is American Araisal.

The more serious weakness in the Italian system ertains

to the araisal of one- to four-family resiential roer-

ties. To correct or ameliorate this situation, we recom-

men that anks seek to romote the imosition of an

araisal license law an to strengthen the role of rofes-

sional organizations in the eucation an training of real

estate araisers, esecially resiential araisers.9 While

highly cometent in their rimary fiels, many lack

knowlege an cometence in araisal theory, methos

an techniques.10

b.Evaluation of the job assignment

A ank is charge with assuring that the araiser is

inee ineenent. After this asic requirement is met,an the araiser sumits an araisal, a traine ank

emloyee shoul reiew the ocument carefully to insure

that correct roceures hae een followe an that all

aroriate roceures hae een erforme. He/she also

shoul check to make sure that the araiser has signe

the araisal an affirme his/her ineenence an

asence of conflicts of interest.

c. Validation of the estimated value

A ank is oligate to aliate the estimate alue in

terms of three consierations:

1. verification of the comleteness of the araisal an

the aroriateness of the methos an techniques

use. All numers an calculations shoul echecke for accuracy, incluing the hysical an legal

escritions of the roerty.

2. Informal aliation of the estimate alue from the

emloyee-reiewers own exerience an knowlege

of the releant market. In aition, the reiewer

coul resent in an aroriate form the following

elements:

(a) Location an tye of neighorhoo;

() Market trens (stale, uwar or ownwar) of

the neighorhoo;

(c) Tye of roerties realent in the neighor-

hoo;

() Consistency of the estimate alue with the

range of alues in the neighorhoo as exeri-

ence y other loans grante y the ank.

3. Formal aliation of the estimate alue through

comarison with other alue sources. In Italy there

are seeral ataanks that can e use for this

urose. For resiential roerties the real estate

ataank Osseratorio Mercato Immoiliare (OMI)of the Agenzia el Territorio (Goernment Lan

Agency) is ery useful. For core institutional

roerties an other large commercial real estate

such as offices, stores an inustrial roerties, other

ataanks such as those of NOMISMA-Ipd or

SCENARI IMMObILIARI comine arious sources

of market transactions an are ery useful.

IV. Monitoring

THE bASEL II AGREEMENTS recommen that central ankseelo require rocesses for monitoring anks creit

ortfolios, with the goal of estimating the roaility of

losses that coul occur in the eent of insolencies. Thus,

monitoring is require oth for loans on real estate an

the roerties that sere as security for the loans.

As note reiously, large anks can use internally gener-

ate estimates to etermine their rofiles of risk.

Meium- an smaller-size anks use the stanar


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REAL ESTATE ISSUES Vo lu me 3 5 , Nu m b e r 2 , 2 0 10

CASE STUDY


metho, which requires a erioic monitoring of the

alues of roerties that sere as security for loans. Two

methos may e use for this urose: (1) statistical

analysis; an, (2) iniiual reiew of loans that resent

relatiely high leels of risk.

As iscusse in the section on Screening, ataanks can e

use (where aailale) for the statistical analysis in orer to

assess the current ongoing alue, usually in terms of a

alue range, of the roerties. Shoul the comarison

etween initial an current market alue of the roerty

lea to a significant negatie ifference, the ank shoul

request a new araisal in orer to assess the current effec-

tie loan-to-alue ratio an to monitor negatie trens.

With resect to the secon metho of examining iniiual

roerties, anks may nee to hire araisers to reiew the

original araisals an etermine whether, or to whategree, they are still alicale. This etermination shoul

inclue ocumentation on at least the following issues:

1. Has the releant local market unergone significant

changes in the last three years? In the case of either a

ositie or negatie resonse, what are the elements

in suort of the analysts contention? Are alue

changes consistent with changes in the rate of infla-

tion? These conclusions shoul e ocumente.

2. Hae the construction an hysical characteristics of

the uilings een moifie uring the last three

years? In case of an affirmatie resonse, in what

ways hae the uilings change? Has the conition

of the uilings imroe or eteriorate? What

moifications were mae to the uilings?

3. Has the surrouning neighorhoo an the uran

area in general change in the last three years? If yes,

in what ways?

4. Is the alue of the roerty estimate as at least equal

to the alue estimate y the first araisal? The

resonse shoul e exlaine an ocumente.

ADDITIONAL ELEMENTS RELATIVE TO COMMERCIAL

PROPERTIES (CAPABLE OF PRODUCING INCOME)

1. Is the roerty caale of roucing net income at

least equal to the amount reiously estimate? The

resonse shoul e ocumente.

2. In the case of rental aartments, what are the

occuancy an acancy rates? Are they aoe or

elow the rates at the time the loan was mae?

3. Is the roerty in goo conition? Hae reairs een

mae when neee, an is maintenance u to

stanars?

4. Has there een a turnoer in tenants (commercial or

resiential), an how has turnoer affecte theroertys net income?

5. For manufacturing or storage facilities, hae the

tenants change? How an what effect o these

changes hae on the roertys net income?

6. Is the roerty still well-locate an well-esigne

for the urose it was intene? Why or why not?

base on the stuy of these Italian anks, the recommen-

ations of basel II, an the rules romulgate y the bank

of Italy, we recommene that each ank eelo a

scheule of roerties in an aroriate sreasheet or

ataase rogram, with the aroriate time frames for

monitoring. For anks not currently monitoring roerties

in this way, a major organizational effort will e require,

with staff to imlement an oersee the rocess. Secialists

in resiential, commercial, inustrial, an office roerties

will e require. We also conclue that that the

monitoring function of the anks shoul e comletely

searate from the lening eartment an staff.

SUMMARY AND CONCLUSIONS

This samle of anks oes not hae significant

rolems with mortgage efaults an foreclosures.

Losses from nonerforming an unererforming

mortgage loans are minimal, articularly in the resien-

tial sector. These anks, an in general Italian anks,

i not engage in either the irect lening of surime

loans or the financing of other nonank intermeiaries.

Furthermore, the ownturn in the Italian economy i

not result from a collase of the resiential real estate

market, as occurre in the U.S., ut rather from the

collase of financial institutions in the U.S. an the

susequent worlwie recession. Home alues in Italy,

in general, i not ecline nearly as much as they i inthe U.S.

The relatiely small losses on resiential mortgage loans

roaly can e attriute largely to the relatie strict

regulation of anks an other financial intermeiaries

an, more secifically, to the imosition of a secific

loan-to-alue ratio. In this resect, the roer assessment

of the alue of the securitizing roerty is a key element

that contriutes to the mitigation of the otential loss on

34


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CASE STUDY


the loan that coul occur in the case of efault. Moreoer,

lening institutions are require to assess the quantity

an quality of a orrowers income. Staility of income is

a major factor consiere in the lening rocess, as is the

loan-to-alue ratio. banks are careful to ealuate the

roerty, the neighorhoo an the general economy of

the surrouning area.

Careful analysis of oth the roaility of efault an the

alue of the unerlying securitizing roerty as a creit

risk mitigation instrument has sere Italian anks well.

Howeer, our analysis shows that, in general, the alue

estimates mae y Italian araisers are only weakly justi-

fie in terms of the:

I methos an techniques use in relation to the tye

of roerty araise (resiential, commercial,

inustrial or in construction);

I ata use in terms of comarale roerties an

ajustments mae to the rices ai for such

roerties.

Although we i not attemt to ealuate the actual

alues estimate, it stans to reason that the likelihoo

of alue estimates not accurately reflecting the market

an market exectations is unoutely greater if faulty

means are use to otain them. We eliee that imle-

mentation of stricter araisal stanars will hel

imroe the safety an the rofitaility of the samle

anks, an that these same oserations an recom-menations unoutely aly to other anksoth

omestic an foreign.

ENDNOTES

1. The financial institutions are: bank of the Marche, the peoles bank

of Ancona, the Cooeratie bank of Corinalo, an the Saings

bank of Fariano an Curamontana. bank of the Marche is art of

a large ank grou, the Saing bank of Fariano an Curamontana

an the peoles bank of Ancona are meium-size anks, an t heCooeratie bank of Corinalo is a small ank.

2. The question of whether or not the loan amount must e eicate

to real estate inestments is still controersial oth at the theoretical

an the jurisruential leels. Contrary to most of the octrine, in

2004 the Italian Sureme Court state that the orrowe funs are

not tie to a secific roerty [Constitutional Court, No. 175/2004].

3. payments are oerue if mae etween 30 an 180 ays after the

contractual term [bank Law No. 385/1993, Art. 38].

4. For a etaile oeriew an analysis of the basel II framework lease

refer to basel Committee on banking Suerision, Basel II:

International Convergence of Capital Measurement and Capital

Standards: A Revised Framework Comprehensive Version, bank for

International Settlements, June 2006, an relate amenments.

5. The loan amount exceeing the regulatory loan-to-alue ratio cannot

e classifie as claims secure y real estate.

6. In Italy geometry is a well-known an highly regare rofession. It

is comose of ersons who are highly traine in the measuring an

cost estimation of uilings.

7. The consulting reort sumitte to the anks containe a section on

araisal methos an techniques for oth one- to four-family

resiential araisal an income roerty araisal.

8. The letters NOMISMA o not stan for wors. Rather, the name ofthis research organization is taken from the ancient Greek wor

nomisma, which means the real alue of things.

9. Licensure is require for real estate agents.

10. An argument sometimes aance y those oose to licensure of

araisers is that the U.S., which has relatiely strict araisal licen-

sure requirements, has not aoie seere market ownturns.

Araisals without strict lening regulations hae een ineffectie in

reenting market collases, while in Italy the oosite has een true.

valuation_mortgage_security_italian_banks.pdf

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