APRA Issues Warning Over Commercial Lending

Australia's banking watchdog has flagged concerns about commercial property lending, issuing a warning about lending standards falling at Australian and overseas banks.

In its review of commercial property lending over 2016, Australian Prudential Regulation Authority’s (APRA) review revealed that "the ability of the Board and senior management to fully understand and challenge the risk profile of lending has often been hampered by inadequate data, poor monitoring and incomplete portfolio controls".

APRA said it expects ADIs to "improve their capabilities in this area, and has written to individual ADIs with specific requirements in these areas," the report said.

Banks were falling "well short of expectations" in their portfolio controls for commercial property, it said.

In current market conditions, the report said it was important that the Boards of ADIs were conscious of the settings for underwriting standards and portfolio controls, and in a position to "challenge as appropriate".

A key finding from the review was that many participating ADIs fell well short of expectations regarding portfolio controls for commercial property. This has been in part driven by an underinvestment in information systems, leading to challenges in extracting portfolio data. Ready availability of detailed and reliable transaction level data, appropriately aggregated, is a key component in obtaining a sound and complete understanding of the risk profile of the commercial property portfolio.

Deficiencies in data hamper an ADI’s ability to implement and monitor underwriting standards and portfolio controls.

The regulator also highlighted that banks should to be more careful about their loan-to-value ratios in light of recent strong growth in asset prices.

It warned banks about mezzanine debt and quasi equity that developers they were lending to had taken on, as well as refinancing risk and settlement risk, particularly from foreign purchasers.
Residential Development Lending
Sponsors to contribute sufficient equity: A number of ADIs noted an increasing awareness of the use of mezzanine debt / quasi equity from third parties and reliance on material uplifts in land valuations to reduce the size of a sponsor’s contribution of ‘hard equity’. APRA expects ADIs ensure a sufficient level of ‘hard equity’ is at risk from sponsors.

Presale quality and coverage: In the past year, some ADIs have tightened underwriting criteria for presales coverage following market concerns with regard to settlement risk. ADIs are now generally requiring qualifying presales equivalent to at least 100 per cent Australian Prudential Regulation Authority 3 of committed debt and have tightened the proportion of qualifying presales permitted to foreign purchasers.

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.

Need to consider end product, location and quality: The consideration of potential marketability issues for properties, such as being poorly located, small apartments lacking in amenities and/or suffering from design issues, was not always evidenced in transaction analysis.