Guide to AVMs

Not just a valuation tool

Guide to AVMs

The advantages of AVMs are well known. The substantial reductions in cost and time that they allow have huge implications for the mortgage industry, making protracted and significantly more costly physical valuations redundant in the majority of cases. As a result, Hometrack is expecting business volumes to treble in the next two years as lenders increasingly choose to use online valuations as a means of providing borrowers with a more efficient and streamlined service.

This surge in activity is partly due to the introduction of the instant mortgage, which has resulted in buyers receiving a mortgage offer at point of sale via automated valuations and credit checks. With specialist lenders GMAC-RFC, Edeus, Birmingham Midshires and ING Direct already committed to instant mortgages, Hometrack expects the remainder of the market to follow suit within the coming year.

Progress never stands still though. The mortgage industry has for many years applied credit scoring to all new borrowers before approving a mortgage. However, there has been far less emphasis on scoring the mortgage asset, the house. That is until now. The next stage in the evolution of AVMs will involve using the service to analyse more complex asset and risk factors for loan decisions.

Hometrack’s Realtime AVM

Hometrack’s Realtime AVM is based on an advanced computer model comprising a database of extensive property data which incorporates a wide range of unique housing-market data combined with socio-economic information. This data can be used to provide a more rounded picture of what’s driving and potentially affecting property values, or indeed putting them at risk. Much of this data is now being accessed directly by lenders.

A growing number of our customers are starting to explore our model’s potential when considering loans for individual properties and portfolios. As well as establishing the true value of a property, they are able to assess wider influencing factors to which they can assign a corresponding ‘asset and risk score’ when evaluating a loan. By way of example, the current state of the local property market and its projected rate of growth, the performance of different types of housing stock, and localised supply and demand characteristics, from large family homes to one-bed flats, are just some of the market factors that can be considered.

Furthermore, other data services can be used to assess the demographic profile and economic backdrop of an area, with models providing information relating to the ratio of different age groups, employment levels and private-sector rents within the local vicinity.

For example, lenders offering a loan to a buy-to-let investor would ‘asset-score’ a property by identifying its true value as well as evaluating the level of demand, local competition and investment returns. This would be achieved by calculating factors such as the ratio of the most common rental age group, (18 to 30-year-olds), the volume of different types of stock and the private-sector rents.

AVMs versus indexation

As well as being used for considering loans on individual properties for mortgage origination, remortgage and point-of-sale approval, AVMs also enable new applications for rapid mass valuation at unprecedented levels of accuracy, e.g. audit, balance sheet, risk assessment (i.e. Basel II), capital efficiency, securitisation and marketing. Standard & Poor’s and Fitch, two of the leading rating agencies, have rigorously tested AVMs and now look more favourably on this method of valuation as opposed to the traditional indexation approach. As a direct result of this ruling an increasing number of lenders are adopting the technology for portfolio valuation.

When rating agencies rate a mortgage-backed securitisation they assess the risk of each mortgage loan in terms of both default and loss in the event of default. A key factor in assessing loss is the loan to value (LTV) of the loan. As property prices change, so do the current LTVs on each loan and hence the risk. Therefore, for some time, there has been a need to assess accurately the value of large portfolios of properties and in doing so the risk attached to them.

Up until recently, the only way of reassessing the underlying value of properties was basic house price indexation. However, the indexation method is widely regarded as an approximate method. Accordingly, the rating agencies tend to treat such revaluations in a conservative manner, applying draconian ‘haircuts’ that allow for potential margins of error. As AVMs are more accurate than basic indexation, the deductions applied by rating agencies on a loan-by-loan basis are considerably less. Standard & Poor’s for example, applies a minimum 50 per cent haircut on indexation versus a 1–5 per cent haircut on AVMs depending on the proven accuracy of the particular AVM.

The reduction in haircuts will lead to significantly lower LTVs, which is consequently reflected in the overall risk of loss. If, for example, the overall LTV is lower, there is less chance of loss in the event of loan default, which means that in secured transactions less capital support is required to attain a specific rating. The impact for financial institutions switching from indexation to AVM revaluation can be a very large reduction in the capital required to support transactions. This in turn has the benefit of increasing return on capital, or in the event of securitisation, freeing up capital for further lending. Clearly, however, the quality of the AVM used will determine just how much benefit can be achieved by taking this approach.

AVMs and Basel II

We’ve also seen more lenders starting to look at our AVM as a means of delivering risk-modelling and stress-testing of mortgage portfolios for Basel II purposes. With the introduction of Basel II fast approaching, lenders are preparing for the new capital adequacy regulatory regime, adopting new approaches to risk and capital management. Sophisticated AVMs – such as Hometrack’s Realtime – will enable lenders to refocus on the quality of mortgage lending rather than just the volume. Basel II represents a great opportunity for lenders to improve their risk-management practices and risk data while reducing their overall capital requirements for loans. The benefits to lenders in terms of capital savings will be substantial.

Despite this revolution in lending, however, Hometrack is the first to acknowledge that the AVM is unlikely ever to replace physical valuations entirely, as there will always be properties where the valuation is difficult to derive due to a lack of comparable properties, or the diverse nature of stock in the area. In addition, where the lending risk is unacceptably high, more traditional valuation methods will be needed.

In recent years, the takeup of our AVM has been dramatic to the extent that it is now providing a streamlined and diverse business solution to property valuation for a large proportion of the lending community. The approach they are taking is enabling lenders to use the model not only as a valuation tool but as a comprehensive asset and risk indicator.