Japan's Financial Services Agency is investigating why the country's regional banks have not heeded a 2016 warning aimed at curbing lending for apartment construction.
The apartment-construction loans, while generating much sought-after interest income for banks, could lead to a housing glut in a rapidly saturating market, and potentially spark a rise in nonperforming loans.
A senior FSA official in charge of regional bank inspections told S&P Global Market Intelligence that the agency was in the process of looking into the increase in such loans by regional banks since it issued its warning in September 2016.
"We are concerned about the big increase and risks that the apartment loans will become NPLs in the near future," said the official, who spoke on condition of anonymity.
New real estate-related loans by Japanese banks rose 15% to ¥12.281 trillion in 2016, the highest level since 1977, according to Bank of Japan figures. Of that amount, new loans for apartment construction jumped 21% year over year to ¥3.786 trillion in 2016, the highest level since BOJ monitoring began in 2009.
This is happening as vacancies are rising. Apartment vacancy rates in Tokyo rose to more than 35% in December 2016 from about 30% in early 2015, according to property research firm TAS Corp.
Property owners are seeking between ¥60 million and ¥100 million to build two- and three-story apartment buildings, with banks providing loans that carry higher interest rates than mortgages to individual homeowners, with future rental income expected to support loan repayment, said Kazuyuki Fujii, director of research and development at TAS.
But the supply of apartment buildings is outstripping demand in Greater Tokyo, and the situation is likely to be exacerbated as the Japanese population continues to decline over the coming years, Fujii added.
"The FSA is trying to cool this apartment loan fever," he said, while noting that the lending process itself is also cause for concern. "Japanese regional banks tend not to examine the profitability of the rental apartment business when they provide loans," he added.
Yet, getting real estate investors to steer clear of building apartments is a tall order. Land prices are high, particularly in Greater Tokyo, creating a powerful incentive for landowners to leverage the value of their property while also trying to get some tax breaks along the way, according to Ryoji Yoshizawa, senior director and Japan sector lead analyst at S&P Global Ratings.
A national inheritance tax that took effect in 2015 made leaving plots of land empty more costly for landowners. Building homes on vacant plots of land in that case can translate into a reduced tax bill.
"There is a sense that [the market for] apartment loans by regional banks is overheating because of a huge oversupply of new apartments," Yoshizawa said.
However, getting a firm grip on where lending is going is difficult given a lack of transparency in Japan's real estate sector, with little disclosure about transaction prices and volumes. Additionally, each regional bank has its own definition of what constitutes an apartment loan, according to Toyoki Sameshima, a senior banking analyst at BNP Paribas Securities (Japan).
"Some banks classify apartment loans as loans to individuals, while others treat them as corporate loans," Sameshima wrote in a February report on regional banks' apartment loans.
Meanwhile, banks from other, less dynamic parts of Japan are also flooding into the Greater Tokyo area, competing for borrowers.
"The problem is that some small regional banks and shinkin [or cooperative] banks are only extending apartment loans aggressively because they are not able to increase any other types of loans. Their loan criteria are very lax, much more so than other banks," said Takashi Miura, a vice president and bank analyst at Credit Suisse Securities (Japan).
Japanese regional lenders are facing low domestic loan demand due to weak regional economies, with the smaller regional lenders and shinkin banks hit harder than larger peers.
This has left lenders fighting for a share of a shrinking pie. "We may have a serious problem when the number of Japanese households begins to decline in 2020, which is only a few years off," Fujii said.
S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.
As of April 12, US$1 was equivalent to ¥109.48.