Cover Story: Developer-lending brings more risks than benefits

-A +A
This article first appeared in Corporate, The Edge Malaysia Weekly, on September 12 - 18, 2016.


URBAN Wellbeing, Housing and Local Government Minister Tan Sri Noh Omar seems to have created a shock wave by announcing the idea of having property developers apply for moneylending licences so that they can lend to homebuyers who fail to get mortgages from banks.

In fact, some ponder if it was a miscommunication.

“We were all surprised by the announcement. It is not good for the economy. In the first place, if individuals fail to get loans from banks, it is because they are not in a position to service the loans. How can we continue to burden them with debt that they are not able to service? Where is the moral standing?” asks a top executive of a local bank.

It runs completely counter to Bank Negara Malaysia’s tightening measures that aim to keep the high household debt-to-gross domestic product ratio, which is currently at nearly 90%, in check. The main concern will be an increase in subprime lending, which could result in contingent credit risks.

But can the move be considered a game changer when the minister hasn’t really changed anything?

“There are no restrictions under the Moneylenders Act 1951 that specifically prevent property developers from applying for a licence. In fact, several developers already have such a licence,” says a senior lawyer.

He points out that the requirements for a moneylending licence are the same for any company. Additionally, it simply requires the approval of the minister and the Registrar of Moneylenders.

In other words, Noh did not open any door for the developers. The door was always open; he merely drew attention to the fact.

That said, the minister plays many key roles in the act — approve, revoke and expedite licences. In that sense, Noh’s announcement last week should not be taken lightly either; more developers may possibly obtain licences in the coming months to help boost sales.

“The main problem with the Moneylenders Act is the lack of a regulatory framework to monitor and enforce best practice and governance. It is a far cry from the compliance that banks face,” says the lawyer.

“Banks have capital adequacy ratio and liquidity requirements. They also have to comply with international regulations like Basel III. On top of that, their deposits are insured. In contrast, moneylending is a relatively opaque industry.”

Note that moneylenders are only governed by the registrar and the Act does not come under the purview of Bank Negara.

Hence, it is not surprising that senior executives of banks The Edge spoke to were unanimously opposed to moneylending by property developers — and with legitimate concerns as well.

One of them says, “This does not make sense. It looks like subprime lending, and with those rates, people will have trouble servicing the loans.”

Subprime refers to loans extended to borrowers with a poor credit history. In large numbers, subprime lending can create a huge contingent risk for the banking sector as well as property developers themselves — the main concern of bankers.

“It is important that responsible lending is observed so that only those who can afford to borrow are given such financing to purchase a house,” says a veteran banker.

By the same token, property developers who are struggling to sell their products argue that moneylending is crucial to help some homebuyers who are on the margin get financing.

“This is good news. Of late, many buyers have been facing problems securing end-financing from banks. But if a developer can come in and lend about 10% to 20%, it could help close the gap,” Sunsuria Bhd chief executive Koong Wai Seng tells The Edge.

While acknowledging that the concerns over the risk to credit are valid, Koong points out that developers will have internal and external checks and balances.

“Even if we were to give a loan to a buyer, say, 20%, we still need the bank to approve the loan. The bank is going to look at where the buyer is getting his money. They will want to see the creditworthiness of the developer that is putting in the 20% as well,” he explains.

Hence, only developers with strong balance sheets will be able to give out loans.

“We are at almost zero gearing, so we will be able to lend to buyers because we have the excess cash. Those with high gearing will find it tough to lend,” says Koong.

On top of that, he argues that developers will be under just as much pressure as banks to ensure that borrowers do not go bust. In turn, developers will have to charge reasonable interest rates, he says, dispelling concerns of exorbitant rates.

A simplistic way to look at the whole issue is whether developers will be prudent in their lending practices. After all, there are no clear rules preventing them from obtaining a moneylending licence.

It should be noted that developers are not typical lenders as their top priority is to maximise property sales.

“Unlike other lenders, property developers face a moral hazard that could encourage them to give out subprime loans in order to secure more sales. A high household debt means there are not many quality borrowers left, and slow property sales mean developers may be desperate and their balance sheets weaker,” Dr Yeah Kim Leng, a professor of economics at Sunway University Business School, tells The Edge.

Just like the bankers, he too is worried about the contingent risk of lending by developers.

Even if they lend out 20%, they are still receiving 80% of the property’s value from the homebuyer and bank combined. Given that most developers boast 20% to 25% margins for residential properties and 40% margins for non-residential properties, there is certainly room for this level of financing.

In fact, there will be a strong incentive for developers to boost sales in this manner to lift take-up rates above the 70% to 75% mark typically needed for a project to be commercially viable.

To make matters worse, banks may have indirect exposure to developers’ lending habits, further exacerbating the contingent risks.

“Banks get funding for their loans from deposits. But where will developers get their funds? From the banks,” explains a senior banking executive.

Ironically, if developers are prudent and disciplined, lending may turn out to be a relatively ineffective tool to stimulate sales. Only a handful of buyers would be inadequate for bank financing but still be creditworthy for a developer’s loan.

If anything, many existing schemes and rebate programmes out there are already addressing this niche demographic. For example, Sunway Bhd is leveraging internally generated funds to offer loans of up to 88% at vacant possession.

Others like S P Setia Bhd and IOI Properties Group Bhd are implementing varying degrees of deferred payment, where buyers only have to secure loans upon completion of the properties.

However, most of these schemes still require buyers to secure a bank loan at some stage to finance the property. In a nutshell, these schemes are still a long way off from a plain vanilla property loan of 20 years or more.

After much noise that banks’ prudent lending practices were affecting sales, it will be interesting to see if prudent developers will be as keen to take on the risk themselves.

“Every system is prone to abuse. It is all about enforcement and regulation. Just because some abuse it, doesn’t mean everyone else should not be allowed to use it. Look at DIBS (developer interest bearing schemes). I think it was a good scheme. But some have abused it to goreng the property market. Now nobody can use it and the buyers suffer,” says Datuk Seri Lim Keng Cheng, managing director of Ekovest Bhd.

Lim himself says he is eager to secure a moneylending licence for Ekovest.

“If we lend, we will do so at low interest rates, a little more expensive than the banks, but still reasonable. On top of that, we will have to lend for up to 20 years, otherwise, how will the buyers repay? Only developers with strong balance sheets can do this,” he says.