The EU’s Basel III framework updates define Acquisition, Development, and Construction (ADC) exposures as those related to financing land acquisition and property construction. Due to increased risk, these are assigned a 150% risk weight under the CRR. However, institutions can
apply a 100% weight to residential property ADC exposures if specific risk-mitigating conditions are met. EBA’s new Guidelines, part of the credit risk roadmap, specify these conditions. Published on July 1st, they incorporate public and stakeholder feedback and insights from the 2024 Quantitative Impact Study (QIS).
Key takeaways from the new Guidelines
The EBA is in this regard mandated under Article 126a(3) of the CRR to specify the following terms identifying the credit risk-mitigating conditions listed under paragraph 2 of the same article related to substantial cash deposits, financing ensured in an equivalent manner, appropriate amount of obligor-contributed equity and significant portion of total contracts.
Substantial cash deposits
With respect to the definition of the substantial cash deposit, two separate threshold levels have been established for, on one hand, pre-sale contracts (i.e., not lower than 10% of the sale price) and, on the other hand, for pre-lease contracts (i.e., not lower than 3 times the monthly rent) to assign the 100% risk weight.
Financing ensured in an equivalent manner
With respect to the term “financing ensured in an equivalent manner”, the GLs specify that equivalents to the cash deposit are to be exclusively considered as instalments paid and cash held in a segregated account, both subject to forfeiture if the contract is terminated.
Appropriate amount of obligor-contributed equity
Regarding the appropriate amount of obligor-contributed equity, the GLs define a closed list of 5 elements that can be considered as forms of equity:
• Cash invested in the project and segregated from other assets of the obligor, available to cover the projected cost of the project, measured in the currency of the financing for the obligor and at the moment of the calculation of capital requirements.
• Subsidies and grants already invested to cover the incurred costs of the project or segregated from other assets of the obligor available to cover the projected cost of the project, measured in the currency of the financing for the obligor and at the moment of the calculation of capital requirements.
• Unencumbered readily marketable assets directly linked to the project and available to cover the projected cost of the project, should be measured in the currency of the financing for the obligor and valued at the market value of these assets at the time of calculating capital requirements. These assets should be easily sold or traded in the market. These assets should be contractually bound to be used for paying development or construction expenses linked to the project, and should be free from any legal claims, liens, or restrictions.
• Expenses for development or construction, paid out-of-pocket by the obligor in direct connection to the project, measured in the currency of the financing for the obligor and at the moment of the calculation of capital requirements.
• Land or improvements paid out-of-pocket or already owned by the obligor, in direct connection to the project, measured in the currency of the financing for the obligor and at the market value at the moment of contribution of the obligor into the project.
The GLs require the ratio not to be below 25%, in order to apply the risk weight of 100% to ADC exposures to residential property.
Significant portion of total contracts
Finally, in order to determine whether the portion of total contracts is significant, the CP introduces two separate ratios for pre-sale/sale and pre-lease/lease contracts, proposing a 50% for both thresholds:
• Pre-sale/sale – Credit facility based: (sum of the sales price of the ‘eligible’ contracts signed) / (credit facility including the drawn amount and undrawn amount, granted to the borrower to finance the ADC project).
• Pre-lease/lease – Simple number: (Number of ‘eligible’ contracts signed) / the total number of potential contracts.
This percentage should be calculated in accordance with paragraphs 14 to 16 of the Guidelines
In addition, the Guidelines now offer more flexibility for public housing projects, allowing them to meet the first condition if applicant demand exceeds unit supply, even at municipality level.
Furthermore, the equity requirement for public housing has been reduced to 20%, and the scope ofeligible equity broadened to include committed subsidies, grants, and preferential junior loans.
These changes aim to better reflect the specific characteristics of public housing while maintaininga prudential approach.
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