SBP as a REIT Promotion Authority.
Ali Jameel (TPL) and SBP REIT regulations: a conflict of interest or an interesting coincidence
If you have read my post Construction Financing and Goodhart's Law: Part Deux, you can skip the Background section below.
Before getting upset, if you do get upset, do read the caveat.
On April Fool’s day 2021, SBP released the following circular
Mandatory Targets for Housing and Construction Finance
Please refer to IH&SMEFD Circular No. 10 of July 15, 2020 whereby banks and DFIs were advised to achieve mandatory financing targets for housing and construction of buildings (Residential and Non-Residential) equivalent to at least 5 percent of their domestic private sector advances by December 31, 2021.
In order to increase funding for housing and construction through capital markets and microfinance banks (MFBs), State Bank has decided to allow counting of following exposures of banks/DFIs towards achievement of their housing & construction finance mandatory targets:
a. Direct financing to/or investments in bonds/TFCs/Sukuk issued by Real Estate Investment Trusts (REITs) Management Companies.
b. Investments in units/shares issued by Real Estate Investment Trusts (REITs) subject to compliance with all other applicable regulations.
c. Investment in Sukuk/bonds issued by Pakistan Mortgage Refinance Company (PMRC), however, investment in PMRC’s Sukuk/bonds and amount of refinancing availed from PMRC shall be netted off towards counting the mandatory target.
However, the above exposures will be considered on aggregate basis up-to a maximum of 15% of mandatory targets for housing and construction finance of a bank/ DFI on a given date.
Put a pin on point 3 above. The raison d'être of this post is point 3 above.
In an earlier post, I gave a few hypothetical examples of how the above SBP regulations allow the banks to meet the construction financing mandate without meeting the objectives of increasing affordable residential construction.
The REIT can issue shares or bonds or borrow from banks to acquire existing buildings. The purpose of the mandate is to encourage construction but if a bank acquires shares/bonds that are issued by the REIT or lends money to it to acquire an already constructed building, this will still be counted towards meeting 5% of mandatory construction targets.
REITs are in the rental business. The rental yield on residential properties is nominal around 4% in Karachi. There will not be many investors for such low-yielding REIT shares. It is highly likely that REITs launched, if any, will be focused on commercial or office space. The mandate is for both residential and non-residential. However, only non-residential or high end residential will get built or bought. Not the end of the world but also not going towards the objective of the mandate.
Investment in PMRC Sukuk/bond has the potential to be double-counted. Say Bank Al Falah (BAFL) writes Rs.1 billion of mortgages. These mortgages will be counted towards the 5% target. Now Bank Al Falah gets these mortgages refinanced by PMRC which issues a bond to finance the refinance. Assume Habib Bank Limited (HBL) buys that Sukuk. Now for measuring the mandate, SBP will count both BAFL’s mortgages and HBL’s investment in PMRC Sukuk to measure performance towards meeting the mandatory targets. A case of double counting.(not relevant for this post) The circular says that exposure will be netted-off (i.e. counted once) if it is the same bank getting its mortgages refinanced from PMRC and then investing in PMRC bond. But as this whole post has shown, when push comes to shove, SBP isn’t above counting/not counting stuff to achieve its targets.(not relevant for this post)
If the bank acquires some outstanding shares or Sukuk/TFCs of the REIT from the secondary market, this will also be counted towards meeting the new construction and housing finance mandate.
There was one more hypothetical example (No. 5) that I will reproduce later below.
On June 2, 2021, SBP issued another circular.
Basel Capital Adequacy Framework: Investment in Real Estate Investment Trusts (REITs)
Please refer to Chapter 4 “Investment in the Units of Mutual Fund/ Collective Investment Scheme” of BPRD Circular No. 6 of August 15, 2013 regarding instruction for Basel III implementation in Pakistan.
2. In this regard, based on the representation of REIT Management Companies and to facilitate the development of Housing Finance as well as Capital Market in the country, capital adequacy treatment for banks/ DFIs’ (banks) investment in Real Estate Investment Trusts (REITs) has been revised as under:
a. Considering the nature of underlying exposure of REITs, banks’ investment therein shall be categorized in the “Banking Book” instead of “Trading Book”.
b. Banks’ investment in REITs will attract a uniform risk weight of 100%. However, SBP may review this revised treatment after a period of five years based on the banks’ exposure and performance of REITs sector."
REIT shares are sensitive to interest rates on account of high leverage. The latest budget exercise has made it clear that GoP is aggressively targeting consumption-financed growth. There is a possibility that this will lead to an increase in interest rates rising in the near future. This will put downward pressure on REIT share prices. In addition, shares listed on PSX can exhibit volatility for unknown reasons. Investments in listed instruments such as REIT shares are usually categorized in the "Trading Book" and are to be marked-to-market (MTM) on a daily/weekly/monthly basis. Due to the volatility and interest rate sensitivity, banks may not be too keen on investing in REIT shares, even if it allows them to meet the construction target as per April 1, 2021, circular, because MTM may make their profitability unpredictable. With this latest circular, SBP is removing this obstacle. Investment in REITs is now to be categorized in "Banking Book" and hence MTM is not required. They will be held on the books of the banks at book cost. It is amazing that how far SBP is willing to bend to help the banks achieve the 5% mandatory target.
If that is not enough, SBP has also reduced the risk weight from 200% to 100%. As per the SBP press release accompanying the circular. (Emphasis in bold - mine)
With the aforesaid changes in capital adequacy regulations, banks/DFIs will now be able to increase their investments in REITs without the need to allocate relatively large amount of capital. This will, in turn help banks to promote development of real estate sector in the country. The enhanced participation of financial institutions, backed by regulatory initiatives, would also encourage REIT Management Companies to launch new REITs, providing further boost to the Government’s agenda for development of housing and construction sectors.
It may not be out of place to mention that SBP has been taking a number of regulatory steps to enhance banks/DFIs’ participation in such sectors through their financing and investment activities, In line with Government of Pakistan’s various initiatives for the development of housing and construction sector. Earlier, SBP amended certain provisions of its existing Prudential Regulations for Corporate & Commercial Banking to encourage enhanced participation and investment of banks/DFIs in the REITs that enabled banks/DFIs to make higher investments in REITs to the tune of 15% of their equity as against the previous limit of 10%. Moreover, SBP has allowed the banks to count their investments in shares/units/bonds/TFCs/Sukuks issued by REIT Management Companies towards achievement of their mandatory targets for housing and construction finance. The amendments in SBP’s capital adequacy regulations will further incentivize banks to contribute towards a well-functioning capital market for real estate sector.
Now SBP has announced increasing the exposure limit to 25% from 15%
KARACHI: The State Bank of Pakistan (SBP) has announced increase in the exposure limit on eligible investments/financing up to 25 percent of the mandatory targets for housing and construction finance.
With a view to promoting housing and construction of buildings (Residential and Non-Residential) in Pakistan, State Bank had advised mandatory targets to banks.
As per previous directives, issued in April, exposures will be considered on aggregate basis up to a maximum of 15 percent of mandatory targets for housing and construction finance of a bank/DFI.
Now, the SBP Wednesday further increased the exposure limit by 10 percent. The exposure limit on eligible investments/financing has been increased to 25 percent of mandatory targets for housing and construction finance from 15 percent of the same.
SBP has relaxed the regulations i.e. raised the ceiling to 25% from 15% for investment in shares/sukuks or direct financing of REIT, to help the banks achieve construction financing mandate. This is weird. Regulators only relax the ceilings when the banks are approaching that ceiling with their current exposure.
There is no way that the banks’ REIT exposure is touching the ceiling unless all the banks are meeting their construction financing targets by investing in Dolmen REIT and have reached the 15% ceiling. If that is truly the case, SBP's credibility with respect to construction financing, which already wasn't much to begin with, is taking another hit.
The purpose of the construction financing mandate is to finance the construction of new housing (the spirit of the mandate) but SBP by allowing such loopholes is helping the banks achieve the targets (letter of the mandate) by investing in existing buildings __ a perfect example of Goodhart's Law.
This brings me to the hypothetical example that I skipped above, which was:
Ali Jameel of TPL is a close friend of Abdul Hafeez Shaikh and is on the board of SBP. He had bought Katrak Mansion for a large sum and is about to spend a good chunk of change on renovating it. It is assumed that he will launch a REIT to finance/refinance it. This is pure speculation: a reason that SBP is issuing this circular to make it easy for him to launch that REIT.
The banks wouldn’t have reached the 15% ceiling by investing in Dolmen REIT shares (there aren't enough Dolmen REIT shares to go by). It is an interesting coincidence that SBP (on whose board Ali Jameel sits) is relaxing the commercial bank's limit to invest in shares/bonds of REIT or provide financing to REITs on the same day that SECP gives a nod for the largest REIT in Pakistan.
In a major development for the real estate sector, TPL Properties Limited (TPLP) Wednesday announced that the Securities and Exchange Commission of Pakistan (SECP) has given its nod for selling the company’s developmental assets to its wholly-owned subsidiary, TPL REIT Management Company Limited, paving way for the REIT to raise Rs80 billion funding.
TPL Properties in a filing to the Pakistan Stock Exchange (PSX) stated: “We are pleased to announce that the Securities and Exchange Commission of Pakistan, by way of its Consent Letter dated, November 30, 2021, in terms of Regulation 3(c) of the REIT Regulations 2015, has accorded its approval to TPL REIT Management Company Limited… for the registration of the proposed trust deed “TPL REIT Fund I” under the Sindh Trust Act, 2020.”
Under the proposed deed, an initial fund size of Rs18.35 billion will be raised from local investors and ultimately, the target fund size of Rs80 billion will be raised from local and international investors, informed TPL Properties.
SBP as REIT Promotion Authority
Let’s list the steps taken by SBP in 2021 (after Ali Jameel assumed the position of director on SBP board):
Direct finance to or investment in Shares/Sukuks/TFC of REITs, by the banks, to be counted towards construction financing mandate.
Ceiling of 15% : banks can meet up to a maximum of 15% of the prescribed mandate by investing in shares/Sukuks/TFCs of REITs or providing financing to them.
Investment in REIT shares by banks to be categorized in “banking book” instead of “trading book”.
Risk weight of banks’ investment in REIT shares reduced from 200% to 100%.
As per SBP press release, Prudential Regulations revised to allow banks/DFIs to invest up to 15% of their equity (as against the earlier limit of 10% of their equity) in REIT shares.
Ceiling raised to 25% of the mandate.
Doesn’t it make you wonder if SBP is playing the role of REIT Promotion Authority?
Lest it is misconstrued, this post isn’t implying malfeasance or corruption or wrongdoing on the part of SBP or TPL.
If we believe that ends justify the means, there is a possibility, that this is a positive for the capital markets of Pakistan by promoting REITs and bringing real estate projects into the corporate sphere.
However, I wouldn’t hold my breath, as we all know that no general benefits were achieved by bringing Naya Nazimabad into the corporate sphere.
DMKM @2paisayArif Habib, Yunus Brothers, Dolmen and Silk Bank: Land mafias, conflict of interest and questionable track record behind Pakistan's most awaited REIT., by @2paisay https://t.co/XLYCnw6zTq
The only question this post is asking is that is it SBP’s role to promote REITs by encouraging banks to invest in REIT shares/sukuks/TFCs to meet their construction financing targets? TPL is clickbait./