Response to consultation on draft Guidelines on ADC exposures to residential property under CRR 3
Q1: What is the materiality of the pre-sale and pre-lease contracts that would not have the expected characteristics of legally binding contract?
no further comments
Q2: Do you agree with the approach proposed to specify the term “substantial cash deposit”?
yes
Q3: Do you consider the 10% ratio to be appropriate for the determination of the ADC exposures benefitting from the lower risk weight?
yes
Q4: Do you have any concerns with applying a single ratio to all ADC projects? Are there any practical options the EBA should consider setting the ratio in a more granular way (e.g., threshold subject to case by case adjustments for either insufficient incentives or for non-enforceability of sufficient incentives but floored at potential market price deterioration over the relevant period) keeping in mind the simplicity of the Standardised Approach and the level playing field across institutions? If yes, please elaborate these options in detail.
unfortunately, developments of income-producing property particularly, hotels or other tourist accommodations which previously were not considered as ADC, will most likely not have any possibility of lowering the RWA percentages. Presales will naturally not be possible.
The possibility would be the substantial equity but this will prove very difficult as the end value of the property would normally be based on future cash flows / DCF models and will potentially be higher than the expected costs.
A lower percentage threshold should be considered for accommodation developments.
Q5: Do you see any drawbacks in adopting the selected option? In case you prefer the alternative option, could you provide the rationale and an example of the calculation and estimation of the net present value of total payments?
The main drawback faced will be for the development of accommodation properties such as hotels.
Q6: Are there any other practices that should be considered by the EBA?
a different denominator for the calculation of significant obligor-contributed equity. Mainly utilise the expected total development costs. Such cost would have already been estimated and verified through Architect reports.
Q7: Do you have any concerns with applying a single threshold to all ADC projects? Are there any practical options the EBA should consider setting the threshold in a more granular way, keeping in mind the simplicity of the Standardised Approach and the level playing field across institutions? If yes, please elaborate these options in detail.
Yes. Income-producing property will prove more difficult to have high pre-lease agreements. Also, properties aimed for short-term rental such as hotels or holiday accommodations will not benefit from any possible RWA adjustments.
Q8: Is the relation between the “substantial” cash deposit required for a pre-sale contract and the “substantial” cash deposit required for a pre-lease contract appropriate from your perspective? If, not, please explain why and how this relationship should be adjusted.
for pre-sale Yes.
For pre-lease, it will prove difficult to secure high releases before the project is finalised.
Q9: Do you agree with the approach of strict equivalence with respect to cash deposit proposed? Do you deem other forms equivalent to the cash deposit from a risk perspective? If yes, please explain.
no further comments
Q10: Do you agree in using two different options for pre-sale/sale and pre-lease/lease contracts?
yes
Q12: What is the materiality of ADC projects with mixed use foreseen? How are these projects structured and whether the proposed options raise any particular issues to be applied in practice?
The application of capital requirements may prove difficult to compute. Mix projects are not uncommon in Malta, whereby the developer may retain some units for leasing or fit a shop in the lower levels of the property.
Whilst presales are rather common, pre-leases are much less frequent as potential tenants would rarely commit before the project is fully completed. If the Method B1 under Section 17 Test case is used, a very conservative approach would be taken unnecessarily.
A splitting method would be preferred in such instances. The loan is considered as 2 separate projects and risk weights are calculated accordingly, i.e. part for resale and part for lease.
Q14: Do you agree with the use of method B1 for the aggregation of pre-sale/sale contracts with pre-lease/lease contracts? Can method B1 be applied in practice using option 1 for pre-sale/sale contracts and option 3 for pre-lease/lease contracts? Is it possible to separately identify the amount of the ADC exposure used for financing housing units for sale or for lease ?
no
A splitting method would be preferred in such instances. The loan is considered as 2 separate projects and risk weights are calculated accordingly, i.e. part for resale and part for lease.
Q16: Which alternative should be considered for assessing whether, for a project where a mixed use is foreseen, the eligible pre-sale/sale and pre-lease/lease contracts are a significant portion of total contracts?
A splitting method would be preferred in such instances. The loan is considered as 2 separate projects and risk weights are calculated accordingly, i.e. part for resale and part for lease.
Q17: Do you foresee any practical impediments to include the verification that the developer only has a residual claim on the property in the underwriting standards? How could this “residual claim” feature be ensured in practice in your jurisdiction (e.g., SPV, pledge, mortgages, …)? Please provide reasoning, taking into account market practices and underwriting standards if you think that an adjustment of the EBA’s definition of obligor contributed equity is necessary.
Malta - The banks will require a first-ranking special hypothec on the full development. This is part of the contractual contract and therefore the claim that property can only be removed from the discretion of the lending bank. once a sale is agreed, the banks will generally agree to 'waive' the particular unit subject to a predetermined reduction into the loan.
Q19: Do you agree to use Approach 4 for identifying the appropriate amount of obligor-contributed equity? If not, what alternative options should the EBA consider?
for the numerator, we agree.
we disagree on the denominator part. In many instances, we note a significant increase in the property value upon completion and therefore this 35% threshold will prove unrealistic to reach. A better alternative would be the total cost of the project.
The Bank generally lends on a 70:30 basis of the expected cost of the project, typically 70% of the purchase price of the land and 70% of the development costs.
Naturally, the expectation is that the Property Value upon Completion should be significantly higher than the total cost of the project otherwise it would not make economic sense. To this extent, it may prove very difficult to meet this threshold for most of the projects.
Q20: Do you see any rationale for setting different threshold levels?
Yes, a combination threshold could also be considered. For example setting lower threshold when a combination of high equity and presales are achieved.
For example: if there are 30% presales AND 25% obliger equity it could also meet the threshold to lower the RWA from 150% to 100%
Q21: Do you agree with the adjusted criteria for public housing or not-for-profit entities?
yes