APRA warns banks on residential development

Australian Financial Review Mar 7 2017 5:30 PM

Nick Lenaghan

Residential developers face a further squeeze on credit as the bank regulator urges lenders to exercise more caution in their commercial property books.

The Australian Prudential Regulation Authority has flagged potential flashpoints within the development sector that could compromise the quality of a residential project and its funding.

"APRA has observed a general tightening of underwriting standards, especially for residential development lending, over the past year or so," the regulator said in a review of commercial property lending.

"This has not been uniform, however, and there is a need for authorised-deposit taking institutions to exercise particular care to ensure that they are not unduly accepting greater risk as other lenders step back."

Among the concerns for APRA, is the use of mezzanine debt and "quasi equity from third parties" to reduce the amount of capital needed from developers for a project.

Such funds along with a reliance on uplifts in land valuation to reduce the size of "hard equity" needed for a residential development.

"APRA expects ADIs ensure a sufficient level of 'hard equity' is at risk from sponsors," the regulator said.

The watchdog noted that banks now generally require the amount of presales in a project to be equivalent to at least 100 per cent of debt.

The proportion of qualifying presales permitted to foreign purchasers has also been tightened.

"However, there was still scope for improvement in a number of ADIs' policies on what constituted a qualifying presale, and the thoroughness of analysis of presales achieved for particular transactions was sometimes lacking," APRA said.

'Potential marketability issues'

The regulator has also called on lenders to pay closer attention to the kind of apartments being developed.

Lenders should consider "potential marketability issues" for properties that are poorly located and have small apartments lacking in amenities or with design issues, it said.

APRA said its review was in response to "recent market dynamics" and "indications that underwriting standards are under competitive pressure".

The major banks and other lenders are already tightening the supply of credit to retail property investors, in response to regulators' tough line on lending growth.

The Commonwealth Bank of Australia and its subsidiary BankWest announced changes to eligibility criteria that will slow the growth of loan books last month.

Last week APRA chairman Wayne Byres stepped up the pressure, saying the regulator would pull banks aside well before their investor loan books hit the annual growth speed limit of 10 per cent.

The Reserve Bank of Australia has issued repeated warnings – as recently as last month – on the vulnerability of the residential development sector to a potential apartment glut.