Tightening the money tap

Banks are being forced to increase the level of capital they have at their disposal. The supposed intention behind this is to make the banking system safer and more stable, and has been stipulated by new international principles commonly referred to as Basel III. "There is a belief that the introduction of these new regulations will result in higher capital acquisition costs for banks," remarks Grzegorz Trawiński, director of Eurohypo bank in Poland. Consequently it might contribute to limiting the number of loans granted, including those related to the property market. Grzegorz Trawiński emphasises that according to the new Basel III regulations, banks will have to maintain their tier-one capital at a minimum level of 4.5 pct of their assets (having included the risk connected with the value of these assets). The level will be 2.5 pct higher than the current one. Furthermore, banks in the European Union will also have to maintain the ?capital conservation buffer' of 2.5 pct of their assets, as well as capital ranging from 0 to 2.5 pct of the assets adjusted for the economic climate. These requirements are higher than those at present and are to be implemented gradually by 2019.

In the long term
Agnieszka Domaradzka, the vice-president of the management board of Bank Nordea, points out that the long-term character of property- related credit obliges banks also to provide long-term financing, the source of which are mainly the long-term savings of the banks customers. However, in the Polish banking system loans exceed deposits and the difference is covered by funds from foreign markets. "There is a shortage of long-term money in the country. Unlike in previous years we cannot count on the parents of foreign banks operating in Poland keeping credit lines open for their subsidiaries," claims Agnieszka Domaradzka. In other words, credit, especially mortgages, was financed from abroad. But the availability of such funds is much diminished.
Agnieszka Domaradzka expects that European and Polish banks will compete with each other for long-term funds on the international market, where lenders correlate the cost of money with the financial position and credibility of an institution. Profitable and adequately capitalised banks with healthy loan portfolios will obtain cheaper financing. It seems that the introduction of stricter liquidity norms will increase the cost of credit financing activities.
The Basel regulations impose an adjustment to the scale of a financial institution's operations according to the level of their capital to shore up the security of the banking system in the future. If a bank with low capital fails to attract investors prepared to buy new shares or fails to increase its capital by, e.g. retaining profits (provided it generates them), it will undoubtedly have to limit its credit action.
Having taken this into consideration, we can expect limited accessibility for long-term loans related to the property market in Poland. Banks will be interested in financing less risky commercial properties, i.e. those in good locations and providing healthy profits from leasing contracts with strong business entities. The developer's own required contribution, the LtV index (credit to property value), will continue to be important, as well as the LtC index (credit to project cost). The margins charged by banks when granting property-related loans will also be higher. Credit for this purpose eats up quite a lot of capital and the cost of refinancing this is growing (long-term liquidity).

Finance for the best
Grzegorz Trawiński draws our attention to the fact that the European Union decision on improving the so-called credit adequacy of banks (that is, strengthening their capitalisation levels) will soon have a significant impact on their willingness to finance projects on the property market. Banks will have to adjust to these requirements by June 30th 2012. "Because many large European banks have not yet complied with this requirement, we can expect that banks' involvement in financing construction projects will become selective and limited. Of course, this does not mean that projects with the best potential will fail to find sources of financing," explains Grzegorz Trawiński. He adds at the same time that Polish banks remain in good health. In spite of this, the Basel III requirements might force them to provide loan financing mainly to the lowest-risk property projects. This concerns, for example, facilities that have an opportunity to acquire tenants. Developers with reputations for residential projects that find buyers will also probably be granted finance. But smaller companies operating on the property market and developing projects considered riskier by the banks will have more difficulties obtaining loans," concludes Grzegorz Trawiński.
Also Agnieszka Domaradzka, the vice-president of Bank Nordea, points out that Polish banks have a solid capital base compared to European financial institutions at this point, which guarantees solvency. However, implementing all the requirements connected with Basel III by 2019 will also bring about an increase in the demand for capital from banks operating in Poland. Agnieszka Domaradzka emphasises that property loans require more bank capital than other transactions. So there is a dilemma that needs to be settled by each bank in accordance with its policy - which transactions to engage in for the most effective use of their capital and to achieve the profitability expected by the owner - i.e. the entity that is investing the capital with a view to making a profit. For example, the goal of the Nordea group is to provide a 15 pct return on equity. At the moment this index is at the level of 11 pct.
Soren Rodian Olsen, a senior investment consultant in the capital markets group of Cushman & Wakefield, is convinced that the Basel III regulations will have a wide-reaching impact on financial institutions and their credit approval processes, although this might be felt to a lesser extent in Poland compared to other markets. This results from the fact that most development projects are financed by banks and the biggest of them have very high ratings. "What we see right now is a preference by banks to finance existing clients, including developers with a proven track record in Poland and the capability to execute projects. We also see a preference to provide construction financing in local currency due to the nature of sub-contracting with local partners as well as the cost/availability of the euro," claims Soren Rodian Olsen. He emphasises that some financial institutions operating in Poland will certainly feel the influence of the recommendations and policies of their parent companies, which may have to face bigger challenges connected with the capital requirements. Meanwhile, Polish banks, with a few exceptions, enjoy a good position in regard to capitalisation and have been less exposed during the recent credit crunch.

Adjusting to the recommendations
Marcin Tryba, finance manager of ING Bank Śląski, stresses that his bank has no plans to introduce any additional changes in its policy concerning property-related loans in connection with Basel III. "We can now see that banks are adjusting to the S II recommendation with regard to tightening policies related to allowing loans in foreign currencies. The banks with considerable foreign currency portfolios have had to restructure their offers. ING Bank had already fulfilled these requirements prior to this," says Marcin Tryba.
Meanwhile, Tomasz Raczyński, director of the modelling and risk integration department of Bank BPH, believes that the changes introduced by Basel III should not have a direct influence on credit connected with the property market offered by banks in Poland. This is due to the fact that most banks currently maintain indexes that are higher than the minimum dictated by Basel III. According to the Polish Financial Supervision Authority, the average capital adequacy ratio of the banking sector was app. 13 pct at the end of November 2011, whereas the minimum level required by Basel III will amount (after a gradual growth) to 10.5 pct in 2019 (including the capital conservation buffer).
This does not mean there will be no changes. "The activities of the Polish Financial Supervision Authority which do not result from Basel III directly will have a bigger influence on the availability of property-related credits," emphasises Tomasz Raczyński. He points out that the level of the required capital which banks maintain to cover potential losses connected with loans denominated in foreign currencies is to be increased. The resolution of the Financial Supervision Authority comes into force on June 30th 2012. ?

Yann Guen
vice-president of the management board of Mayland Real Estate
Increased scrutiny
Now most banks are using stricter criteria for granting loans to developers compared to only a few months ago. In the case of applying for finance for residential and commercial projects, banks are carefully scrutinising the financial condition of development companies. They now analyse how the developer has repaid its previous loans, whether it is meeting its current liabilities, and they also check their financial statements. Also, the developer's credibility as a financial partner is significant - has the company successfully developed any projects so far and how extensive is their experience in this respect. In practice banks now expect the developer's own contribution to amount to app. 35 pct of the value for a commercial project, such as a shopping centre. In negotiations over loans for shopping centres, banks expect the developer to present data proving that they have secured tenants for all the retail areas. In practice the developer must demonstrate that it has already found tenants for app. 60 pct of the area at the stage of negotiating the loan. In my opinion, most banks have made their criteria for granting loans to developers stricter because they have to adjust to the requirements of Basel III, which oblige them to increase their equity capital. I expect that after fulfilling the Basel III requirements, i.e. after strengthening their capital, the banks will return to their previous, more liberal criteria of providing loans for development projects.