Final part of an extended series
In the third part of this special report series on the Philippines’ residential real estate sector (“Demand bursting but market tempered by ‘bubble’ fears,” September 12), one of the serious concerns expressed by market watchers was about the rapid growth of “in-house financing.” As a common practice among local property developers, in-house financing provides high-interest credit with less rigid requirements for buyers, as an option to the more conventional mortgage loan through a bank or lending company.
There are several reasons why the high and growing level of in-house financing is considered a significant risk. The first is its potential adverse financial impact on families, who may be taking on much bigger debt burdens than they can manage. The second reason is the threat that it poses to the real estate sector, and in some ways, the wider economy. In addition, property market analysts are gravely concerned about the lack of oversight on the practice; in-house financing is virtually unregulated, to the extent that even determining its monetary value is virtually impossible.
And finally, and most worryingly, there are indications that in-house financing is leading to a surge in banks’ bundled-debt asset business—the same sort of product whose collapse in the United States led to a global-scale financial crisis in 2007-2008.
While monetary authorities have recently tightened regulation on the use of these assets as lending collateral within the banking system, the real worry is that their underlying value—which is based on homeowners’ continuing ability to pay their mortgages—is susceptible to economic shocks.
The same risk applies and, in fact, may even be greater for the large amount of home buyer debt generated through in-house financing that escapes any sort of regulation by simply being carried by property companies without being used for further lending.
A quick path to ownership
Many homebuyers, particularly first-timers and buyers from among the OFW and domestic middle-income segments that have become the target market for most developers, do not qualify for more stringently regulated conventional bank loans or otherwise choose not to undergo what is even under the best of circumstances a time-consuming approval process.
Buyers who meet the qualifications for Social Security System (SSS) or Pag-Ibig Fund financing do have those options, which lie somewhere between bank mortgages and developers’ in-house financing in terms of the level of requirements and interest rates charged, but the process is still time-consuming.
Bank mortgages typically average between 5.75 percent and 12 percent, with terms up to 30 years for loan amounts of up to 80 percent of the purchase price, usually a minimum of P400,000. SSS and Pag-Ibig loans are charged more interest—between 8 percent and 11 percent—and SSS loans are limited to P2 million and terms of 20 years. All three also have age requirements; typically, borrowers are rejected if they are over 60 years of age, or will be over age 70 by the time the loan matures.
In-house financing, by contrast, has no age limitations and generally requires nothing more than verifiable proof of income and financial capacity to make a down payment, which typically averages 10 to 20 percent of the purchase price. Sometimes, that is even reduced to a very low “teaser” rate—these are the deals that are frequently advertised as “move in for only P5,000” or some similarly low amount—accompanied by significant discounts on the total price, or in some cases, waived entirely for ‘qualified’ buyers. Loan terms are short, rarely exceeding five years, and interest rates are high; a survey of various offers by Philippine developers across the country indicates an average of 14 to 18 percent, although some are as high as 22 percent for longer-term loans.
As Bank of the Philippine Islands (BPI) lead economist on real estate Emilio Neri Jr. explained in an interview last week, there is virtually no data available that depicts exactly how big the in-house financing business actually is, because the practice is not monitored or regulated by either the Securities and Exchange Commission (SEC) or the Bangko Sentral ng Pilipinas (BSP).
“We really are in the dark as to how much property companies lend to their clients,” Neri commented.
The basic reason for this is that the term “loan” to describe an in-house financing transaction is actually a misnomer. Property companies are not lending funds to their customers, they are extending credit terms on a purchase; in a sense, in-house financing is no different than any other installment purchase.
Provided the property company has sufficient financial resources to cover construction and other costs while customer payments are recorded as receivables, it has great flexibility in setting the terms by which it sells its product, and the interest rate charged becomes pure profit for the company.
Chief financial officer Joseph Dolina of Amicus Inc., the holding company for developer ProFriends, implied as much when he described ProFriends’ typical in-house financing arrangement: 12.5 percent down payment payable over 15 months, followed by a five-year term at 18 percent interest or a 10-year term at 21 percent interest to pay the balance, the high interest rates being imposed “to encourage buyers’ financing with our other partner banks.”
Apparently, not many buyers are taking the bait. According to a manager in one of ProFriends’ branch offices, only about 1 in 10 customers opts for something other than in-house financing; other property companies we spoke to offered estimates of 60 to 90 percent of the proportion of in-house financing to bank or other lender financing in their customer portfolios.
Many property companies cannot, or choose not to carry buyer credit on their own, which has led to growth in bank lending to the real estate sector and an expansion of the debt-based asset market. In the latter, customer accounts are bundled into securities and either used as collateral for loans by property developers, or sold outright to banks or other lenders, who then become the creditors for the buyers; these packages are handled either by banks, or by specialized finance companies such as Bahay Financial Services (BFS).
BFS specializes in, among other things, credit underwriting for developers, servicing of delinquent mortgages, and sales of foreclosed properties. The company was tangentially involved in some controversy in 2006 when it took on management of a portfolio of more than 52,000 delinquent mortgages originating in the National Home Mortgage Finance Corporation (NHMFC) and carried by Balikatan Housing Finance, Inc., a special-purpose vehicle jointly owned by NHMFC and Deutsche Bank.
Complaints of aggressive collection tactics and wholesale foreclosures by BFS, particularly since the properties involved were socialized and other low-income housing, prompted Senator Loren Legarda to accuse BFS of being a ‘vulture fund’ and to call for a Senate investigation.
In October 2012, the BSP became concerned about the level of in-house financing in the property sector, and called on the Financial Stability Coordinating Council (FSCC) to investigate, because the BSP alone does not have jurisdiction over finance companies or corporations. The result of that review was a circular issued by the BSP in November 2012 that set forth reference practices to banks for sound “contract-to-sell” (CTS) financing; in other words, a set of guidelines for bank lending to property companies or asset managers like BFS for loans based on in-house financing contracts.
The new rules did impose some controls to protect the exposure of the banking system to risks from the in-house financing business, such as requiring registration of issuing developers and a number of due diligence steps to be undertaken by the banks to confirm the financial viability of both the property company seeking a loan, and the project on which the company’s CTS were based. Nevertheless, because of the BSP’s limited jurisdiction, the new rules could not directly address the practice of in-house financing; if a property company did not seek funding through a bank, the rules would not apply.
A nightmare scenario?
Although there does not appear to be an imminent threat from the in-house financing business, one banking executive, whose bank’s portfolio of purchased CTS instruments is being managed by BFS, succinctly summed up the financial sector’s biggest fear:
“The real elephant in the room is the risk of widespread defaults,” he said. “2012-084 [the BSP circular on CTS-backed lending guidelines]did improve reporting and ‘quality assurance,’ so to speak, but it’s not a guarantee. A lot of credit is being extended on the presumption that all but a very small percentage of buyers will pay their debts in full and on schedule. But we have to have some degree of faith that the property companies are exercising prudence in whom they finance, and that makes a lot of us nervous.”
The problem, he explained, is that an external economic shock could cause a rash of borrower defaults, which would cascade through the financial system.
“Even if everyone’s done their homework, and they have a portfolio of stable borrowers who are easily paying their loans now, there’s nothing at all in our current set-up that protects us against a change in economic conditions that tightens incomes and sets off an increase in defaults,” he said.
“We don’t know that’s going to happen, we don’t foresee it happening, but the reality is once we recognize it if it does happen, we’ll already be too late. If that’s the case, we’re looking at our own version of the MBS [mortgage-backed securities] disaster in the US a few years ago. A little different in that they’re not traded on the market, but just as bad, because a lot of credit has been extended based on CTS value, and if that value disappears, the losses could be huge.”
The likely solution, he added, is the imposition of stricter rules on the “front end”—rules governing how property companies determine creditworthiness of their buyers—which would, in turn, reduce the risk associated with CTS packages. Doing that, however, might have other negative consequences: Eliminating some buyers from the market could depress prices, and put some companies in a tenuous financial position.
“We may have reached the point where we have to accept a trade-off,” the banker observed. “Either a growing property sector that’s putting a lot of money into the economy, but at a higher risk level, or a considerable downturn in exchange for greater stability. What I hope doesn’t happen, though, is that we do nothing. Because we’ll all pay for that, eventually.”