Europe launches reform to facilitate credit for real estate developers and builders

The housing crisis facing Spain requires action in many different areas to be able to resolve it. And even then it will take time. The European Union has launched a reform that seeks to help with this situation that is occurring throughout the continent. It is finalising a relaxation of the requirements that are required by law for banks to grant credit for the purpose of building and promoting housing. These were tightened considerably after the financial crisis of 2008, and will now be lowered provided that one of two conditions is met. On the one hand, there must be a minimum of significant pre-sales of the development - and that it is the same throughout Europe - or a number of rental contracts already committed (which can also be, for example, places in residences for the elderly or students). The other will be that the developer contributes some capital (the so-called skin in the game : that he puts part of his money at stake and therefore has something to lose).

This reform provides that, when one of these two requirements is met, the capital requirement imposed by law on banks can be reduced by a third: instead of the risk weighting being 150% as is currently the case, it will be 100%. In practice, for each euro lent, the entity will have to set aside around 12%, which are the current solvency levels, instead of 18%. Thus, loans for housing development will no longer be treated as speculative or high-risk investments, as was given to this type of credit in a European regulation in 2013, approved in response to the financial crisis.

This new regulation has been in force since January of this year. However, the European Banking Authority (EBA) has yet to draw up guidelines for its application. The European regulatory agency, headed by the Spaniard José Manuel Campa, has to define what is considered a capital contribution: money, land, guarantees, subsidies, expenses or other concepts. In a public consultation it held a year ago, the EBA proposed that the required capital contribution should be higher than 35%.

The banking authority must also establish the levels of pre-sales or rentals already subscribed to be able to benefit from this regulatory relaxation. In the aforementioned consultation, the EBA established a 50% pre-sales requirement. And this requirement of houses already sold or rentals already subscribed would be reduced if it is a promotion with public support or not for profit. It would be considered a pre-sale if there is a deposit of 10% of the price of the property, and pre-rental with three months' rent. In principle, the EBA report will be ready in the second quarter of this year. From there, it is expected that the ECB and the Bank of Spain will adopt it quickly so that it is fully operational as soon as possible.

In general, developers complain that they have to operate with little external financing, practically on their own. And the banking sector in Spain has been reducing its exposure to this stigmatised sector since 2008 after the bubble burst . Sources consulted from the real estate sector consider that the initiative could mean a substantial change, since it could provide a certain boost to credit for building housing. This had been continuously reduced until the middle of last year. Since then, a certain stabilisation has been observed, although it is still at very low levels.

Before the financial crisis, credit for real estate development and construction activities was considered very safe. These were loans that lasted for about two years, the time it took to build. Once the work was finished, the financing was extinguished to make way for mortgages. Real estate credit was transferred from the company to individuals and the bank thus attracted customers. The reason for this security was that the individual was responsible for all his present and future income. In fact, Spanish banks have financed themselves quite a bit with mortgage bonds and securities in which a lot of credit to individuals had been included as collateral, and these were never defaulted.

Under this model, payment in kind only existed in practice and in a generalised way for legal entities, which could close the business and leave the construction to the bank. To the point that it was common to set up a company only for a single real estate development. This also avoided, albeit fictitiously, the problem of concentrating too much credit in one company. In essence, a highly leveraged activity was being allowed without the developer having to risk his own resources.

This was also reflected in the countercyclical provisions required by the Bank of Spain: this type of real estate loan was provided with relatively low buffers. Along the same lines, the idea was that it would end up being transferred to the buyer of the house and would not entail any risk. Until the financial crisis of 2008 came. The works were even left half-done. Real estate credit was no longer subrogated in mortgages. There were financial institutions with up to 80% default on credit to real estate agencies.

The Guindos decree, approved in 2012, forced banks to make adequate provisions for all these exposures to developers and builders. And the subsequent banking regulation, created in the international framework as a response to the financial crisis, tightened the conditions for granting these loans. They were classified as speculative-grade investments. And, consequently, they had to be provided for at 150% instead of 100%. Added to this was the fact that the international Basel III regulation increased the capital requirements and the quality of these buffers. All of this significantly increased the cost of granting these loans to developer companies.

Banks in Spain, which had 40% of GDP in loans to real estate and construction companies, reduced their portfolio to 6.5% of GDP. With the help of the bad bank, a part of it was taken off their balance sheets. But the entities are still cleaning up their accounts of real estate. So the less exposure there is, the better they look when it comes to obtaining external financing. And this is still the case despite the fact that more than a decade has passed. According to the analyses of the Bank of Spain, the real estate sector is still very polarized, with a significant part of companies doing well and another substantial portion still presenting delicate financial situations. The mobilization of this sector, supported by credit, would seek to alleviate the dysfunctions detected by the supervisor in the real estate market: the deficit of houses built in Spain, which grows year after year and complicates access to housing .