Real estate lending risks

Vietnam’s property cycles

Cameron Joyce Manager, Research Department, Viet Capital Securities

Vietnam last had a property downturn in the 2008-2013 period which was primarily driven by a market that overheated on speculative buying amid a limited primary supply of condos. In the aftermath of the crisis, the government took several measures aimed at preventing a repeat of the situation in the future. Along with encouraging developers to provide residential units more suited to genuine demand from homebuyers, an important change was to hike the risk weighting of real estate loans in the banking system to 250 per cent.

In Vietnam’s pre-Basel II environment, banks are required to hold Tier I and Tier II capital equal to at least 9 per cent of their risk weighted assets. Increasing the risk weighting of real estate loans to 250 per cent means that for every new real estate loan extended, risk weighted assets increases by 2.5x the amount of the loan. This significantly disincentivised banks from providing new loans to the real estate market and helped to take some of the heat out of the sector.

With the mortgage market being practically non-existent in the previous real estate cycle, credit growth to the sector was focused on the developers who would in turn sell property to buyers for cash. One particularly unhealthy activity was the procurement of loans by developers to simply buy land as a form of speculation. Once the property market corrected, this led to the formation of a number of non-preforming loans (NPL) which continued to burden the banking system for a number of years. Government measures have since focused on reducing this form of activity whilst allowing the sector to develop in a sustainable way. Going forward, the development of the mortgage market has been preferred rather than allowing the majority of credit to flow to developers as happened in the past.

Concerns that rising credit growth may ignite another property bubble

Since 2012 the banking system has gradually recovered from the real estate crash in 2011 and has gradually become able to increase loan growth as a result. While the system was slow to resolve NPL issues, the sector as a whole was effectively able to “grow out” of the problem given that high growth rates of new credit meant that problem assets became a lower percentage of the overall system. Some market commentators have raised concerns that credit growth is once again outstripping nominal GDP growth, with the excess potentially finding a home in less productive sectors such as real estate.

Stable real estate market

Despite the high levels of credit growth, we have yet to see any obvious signs of overheating in the property sector. Speculation appears limited as the composition of buyers in the primary condo market appears healthy with only 14 per cent deemed to be speculators in the first half of 2017. Buyers who intend to live in the property make up 51 per cent of the total demand, suggesting meaningful end-user demand. Absorption rates also remain comparatively high at around 50 per cent, suggesting that a supply glut is not on the horizon. Meanwhile price gains of condos in Ho Chi Minh City remain moderate, suggesting that the market is in overall balance and does not display signs of excess as with the previous real estate cycle.

Recent macro-prudential measures

Following the wake of the previous property market crash, Circular No.36/2014/TT-NHNN was issued in 2014 and reduced the risk weighting of real estate loans from 250 to 150 per cent.

However, more recently, the government deemed it prudent to raise the figure once more to 200 per cent through the provisions of Circular No.06/2016/TT-NHNN. The implementation date was at the start of 2017.

Additionally, as of December 28, 2017, State Bank of Vietnam (SBV) issued Circular No.19/2017/TT-NHNN on amending and supplementing a number of articles of Circular 36 on tightening credit for the real estate sector. Specifically, the proportion of short-term capital to be used for medium- and long-term lending by banks in 2018 will be 45 per cent instead of the 50 per cent stated in Circular 06, and this ratio will be further reduced to 40 per cent in 2019.

While disclosure is sporadic, we estimate that the banking system used less than 35 per cent of short-term funds for longer-term lending in 2016. Since then the figure has edged down even more. Therefore, the cap that is applicable in 2018 should not be a constraint for the system as a whole.

We view these changes as proactive macro-prudential measures which should help dampen the potential extremes of the current real estate cycle whilst reducing the probability of another crisis. While it is extremely difficult to isolate the impact of these measures, they will certainly have some moderate cooling effect on the real estate market. Even though the real estate market continues in an uptrend with moderate price gains in the affordable and mid-range segments, transaction volume remains stable. In the event of a cyclical slowdown, it also means that the government has some dry powder available should they wish to provide some support to the sector.

Source: CBRE Vietnam, Savills Vietnam, and Viet Capital Securities Note: Price CAGR for three years from Q3/2014-Q3/2017; Prices are in USD/sq.m and exclude VAT and maintenance fees, based on net selling area (NSA) and fully-fitted handover condition

Lack of NPL resolution a longer-term structural threat to real estate lending

A pressing structural concern is the lack of an effective mechanism that resolves bad debts within the system. Until now, it has been challenging for banks to go through the process of writing off loans, seizing and selling the real estate collateral backing them. As a result, banks were left with burdensome and lingering NPL problems after the last cycle. This is in part down to a hazy legal structure that tends to undermine this process.

In 2017 the National Assembly issued Resolution No.42/2017/QH14 which aims to address this problem and we have since seen some anecdotal signs of improvement, including the high-profile example of the sale of Saigon One Tower in District 1, Ho Chi Minh City. However, we remain skeptical that enough progress has been made to make a material impact.

Protecting a nascent industry

During the last property cycle, property transactions were completed with cash and even gold, while mortgage financing was unheard of. It was only more recently that mortgage products have started to emerge and outstanding mortgage debt still only accounts for a relatively small portion of the GDP. As with all early stage markets, growth tends to be very strong given the low base which can lead to difficulties given that the market infrastructure will most likely be lacking in the initial stages. This is therefore another reason why the government has acted to cool the growth rate at this stage in the cycle.

Improving asset allocation across the economy

Overall, Vietnam has a healthy level of investment in relation to the GDP, with the figure coming in at 33 per cent in 2017. Having said this, investment has been higher and peaked at 42.7 per cent of the GDP in 2007 before gradually declining until 2013 and settling at the current level. Meanwhile the effectiveness of investment, as measured by the Incremental Capital Output Ratio (ICOR), has averaged around 6. This means that for every six units of investment, only one unit of output is generated.

Real estate is a comparatively non-productive asset in relation to other sectors of the economy, such as manufacturing and infrastructure. However, economies that generate excess credit growth tend to see it flow into real estate assets, given that it can act as the path of least resistance. Therefore, by disincentivising real-estate lending, this may improve the allocation of scarce resources in the overall economy.

Has real estate lending been affected?

We currently see no noticeable impact on the availability of lending to the real estate sector. Furthermore, we believe that the measures contained within Circular 6 as well as Circular 19 provide the government with breathing space should they wish to stimulate a lagging real estate market in the future by reducing the risk weighting back to 150 or even 100 per cent. However, we do note that capital buffers are comparatively low in the Vietnamese banking industry, especially when considering Basel II requirements. Further capitalisation is required and if this fails to materialise, then the ability of banks to extend credit may be affected. In the event, cutting back on real estate loans first would make sense. In other words, credit availability to the real estate market will act as the canary in the coal mine when it comes to a potential contraction in system-wide credit availability.

Conclusions

We believe that the Vietnamese government has learnt from the lessons of the past and has taken a number of proactive measures to keep a reasonable pace of growth in the real estate market. In the event of future stress this allows for lending conditions to be eased when necessary. With little to no anecdotal evidence of restrictions on real estate lending, we believe the property market will continue to develop in a measured and more controlled way.