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Collateral Valuation: Credit Risk: General principles

Before moving on to the specific techniques for valuing collateral we will consider some of the general principles of undertaking a valuation.

The purpose of collateral valuation is not to find an accurate or single unique solution to the price but rather to find one that would be considered realistic, practical and acceptable to ordinary market participants.

Further collateral should be evaluated based on the market value rather than the book value of the asset. Usually it should also be one that is based on the most conservative assessment approach.

For property pledged as collateral, it is desirable that it should be located within a reasonable distance from the lenders office, so that the lender (or his subordinates/ employees) is able to make frequent visits for the purpose of inventory checks and physical inspection.

Also related to property pledged as collateral, lenders should keep an eye on the market as rapidly rising market prices could be an indicator of the development of a price bubble and a subsequent substantial decline in property values.

The appraisal and valuation process should be independent and segregated from the lender’s loan production and collection process. The appraiser should have no interest, financial or otherwise, in the property being valued or the loan transaction.

In this section we have reviewed some of the basic principles of carrying out a valuation of assets pledged as capital. In the following posts we will look at some of the specific valuation methodologies for real estate.

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