Mixed benefits for banks from independent valuations

Flaws in the valuation of complex securities have driven a renewed focus on independent valuations, but vendors remain divided in their assessment of the use banks are making of their services.

Since the subprime crisis began in 2007 and sapped liquidity from the structured finance market, banks have been criticised for failing to accurately value the asset-backed securities held on their books. The use of flawed input assumptions and data spanning only a limited time horizon when markets were relatively benign often led to inaccurate valuations.

Regulatory bodies, including the Senior Supervisors Group and the Basel Committee on Banking Supervision, have called on banks to improve their models and seek independent verification of internal valuations if possible. But independent data vendors who provide valuations say there is a greater interest from asset managers and hedge funds seeking to assure investors their valuations are accurate and well-researched.

Those banks that have sought out their services have done so more as a simple compliance exercise than a true risk management practice. "The banks are definitely not the most active group in seeking out independent valuations. If they do, then it will be to confirm what they already believe to be the correct valuation," said Curtis Pyke, director of sales at OTCValuations, a Vancouver-based data vendor. "We have not had many price challenges from banks, so it is hard to say exactly how the numbers are being used."

One reason why banks may not have rushed to seek out independent valuations is that despite increasing regulatory focus on the issue, there is not yet any binding legal requirement on banks to use third-party valuations. The models and assumptions used by data vendors are also not significantly different to those banks have used in the past, so the sole benefit is the neutrality of the vendor and its ability to source data from across the market.

"Our valuations are fairly close to those of the banks because we're essentially replicating what they do but in an unbiased fashion," said Greg Cripps, chief executive of Prism Valuation, a London-based provider of valuations on a range of complex instruments.

But other vendors insist the need for independent valuations is being taken seriously and is more than a compliance exercise, with banks often challenging the values and the assumptions used to reach them. "It's a lot more than just a box-ticking exercise," said Peter Jones, head of valuations at Standard & Poor's. "Banks are looking at this in a much more educated way because they now realise they can't just take a price at face value."

See also: Bernanke: Public-private partnership required to value toxic assets