Barriers to development of land mortgage crediting market in Ukraine and possible solutions.

Commissioned by the World Bank under the Project “Capacity Development for Evidence-Based Land & Agricultural Policy Making in Ukraine”

In order to identify existing issues and develop proposals for overcoming them, the study included the following expert-based work: a review of the current status of land-secured loans; an analysis of current legislation and the regulatory base of the National Bank of Ukraine concerning the turnover of land; an analysis of the activities and operational restrictions of the State Land Cadastre and the Registry of Property Rights for Real Estate including the organizational structure of the bodies associated with these registries, their functional purposes and competencies; an assessment of the level of protection of creditors’ rights; determining of land valuation issues; and selection of existing financial instruments that can be adapted for using on land market.

1. Current status
   The total area of land parcels which are subject to the moratorium is about 41 million hectares (96% of the total agricultural land in Ukraine). Despite free turnover of some land parcels (agricultural and non-agricultural) to the total area of about 2.2 million ha, there is no massive bank crediting secured by land as the sole or main collateral. Most mortgages are secured by the land lying under buildings and structures. According to the NBU statistics, as of 3 January 2017, land is used as the sole collateral for loans to the total of 3.9 billion UAH only, which is 0.36% of the total loan portfolio of the banking system. Of these loans, the loans pledged by land without any improvements make 2.8 billion UAH (0.26% of total loan portfolio in the system).
2. Obstacles for development of land mortgage crediting

   1. Low liquidity of land parcels and need for large reserves in case of land mortgage crediting
      Due to the moratorium on sale of agricultural land, the land sale market is currently undeveloped, therefore land is not considered by banks as liquid collateral. For the same reason, the NBU’s Resolution #351, dated 30 June 2016, “On approval of the Provisions for Estimation of Credit Risk for Active Banking Transactions by Banks in Ukraine”, applies the lowest liquidity ratio (0.35) for mortgages secured by land without improvements (except for land parcels under moratorium). Thus, only 35% of the value of land parcels used as collateral counts when reserves are estimated. The above-mentioned NBU resolution does not enable the use of land parcels under moratorium as collateral.
   2. Lack of sufficient informational base for valuators to implement expert assessment of land parcels
      Expert monetary valuation of land has to be done before it can be transferred into mortgage. The lack of public access to actual sale prices for real estate, including land parcels, significantly complicates adequate valuation and increases banks’ risks when using land as collateral for loans.
   3. High interest rates and lack of creditworthiness of many potential borrowers
      The rate offered by banks, based on the value of liabilities and taking into account the credit risks (about 20% in UAH and 11% in foreign currency), is too high for many potential borrowers (according to a survey conducted by the National Bank among heads of agricultural enterprises, only 33% of companies have stable financial standing). At the same time, the creditworthy borrowers are greatly over-indebted, and their most liquid assets already serve as collateral for loans. Therefore, banks are not able to actively extend the credit limits for such companies.
   4. Insufficient level of protection of creditors’ rights
      This is a common problem which hinders the development of all types of crediting, including land mortgages.

      1. Drawbacks in the foreclosure procedure via notary’s executive endorsement
         Although current legislation stipulates the complete list of documents to confirm the undesirability of creditor’s claims against the debtor (which is necessary for issuing an executive endorsement by a notary), the existing judicial practices do not consider the undesirability of the borrower’s debt as a proved fact and an executive endorsement cannot be applied in case of an ongoing judicial dispute concerning the amount of debt under the credit agreement at the moment of issuing an executive endorsement. It significantly restricts the applicability of foreclosure based on notary’s executive endorsements, which has an adverse effect on the level of protection of creditors’ rights.
      2. Conflicts between different legislative provisions regulating transfer of rights to land
         Thus, according to the provisions in Article 377 of the Civil Code of Ukraine, Article 7 of the Law of Ukraine “On Land Lease”, Article 6 of the Law of Ukraine “On Mortgage”, any suspension and origin of the rights to a land parcel on which immovable property is located are associated exclusively with the fact of transfer of ownership rights to such property to a new owner. At the same time, Articles 116, 131, 140, and 141 of the Land Code and Article 31 of the “Law on Lease” stipulate registering the transfer of rights to a land parcel in case of changing the owner of the property located on it.
      3. Drawbacks in the procedure of mortgage collateral sale
         The compensation of enforcement proceeding costs out of the mortgage sale income and imprecise legal norms regulating the procedure of reducing the sale price for the property at public auctions and the price at which the mortgagee has the right to buy the mortgage pledge after the second and the third auction trades adversely affect the protection of creditors’ rights.

   5. Operational deficiencies of the State Land Cadastre and the State Registry of Property Rights for Real Estate
      When implementing land parcel transactions, significant title risks arise related to incomplete information and a considerable number of inaccuracies in the State Land Cadastre. Unadjusted are also the time frames of information exchange between the State Registry of Property Rights for Real Estate and the State Cadastre when changing the owners of land parcels, which may cause discrepancies between the Cadastre and the Registry data. Thus, the Procedure for Keeping the State Land Cadastre stipulates that the data on the new owner / user of a land parcel is recorded in the Cadastre in compliance with the data on registered property rights in the State Registry of Property Rights for Real Estate (within 2 working days after receipt of such information from a public registrar). However, the Procedure for Keeping the State Registry of Property Rights for Real Estate does not specify the period within which a public registrar has to notify the State Cadastre registrar on the change of the land parcel owner / user.
   6. The Executive Service operational deficiencies
      The Executive Service also has certain shortcomings: the lack of clearly defined terms (periods) of preparatory actions and implementing the sale of land parcels, mechanisms of motivation for enforcement agents, and possibilities to recuse (disqualify) enforcement agents by the recoverer.

3. Measures proposed to develop crediting

   1. Preparatory phase arrangements
      To avoid further mass litigation risks and reduce the risks of appealing ownership rights, it is necessary to complete the inventory of state and municipal land, encourage correction of errors in the Land Cadastre and its subsequent completion.It is necessary to update the normative monetary valuation of land in compliance with the new methodology approved by Resolution #831 of the Cabinet of Ministers of Ukraine, dated 16.11.2016, as it should be used as a starting sale price for land at the initial stage of market development. Such valuation was last conducted as far back as 1995 followed by indexation, so its values are no longer correct for many regions at present.
   2. Improving the legislation
      Effective land mortgage lending is impossible without creation of a fully-operational sale market of land parcels. The creation of land market, in turn, is impossible without adoption of a law that will regulate the turnover of land. At present, several laws aimed at regulating these relations have been drafted. No matter which one is adopted, the main purpose of such a law is to clearly stipulate the conditions for land market functioning and create a mechanism of protection against raider attacks and corruption.

In order to remove existing conflicts in current legislation and raise the level of protection of creditors’ rights, it is proposed to:

1. Unify the rules of the Land Code of Ukraine, the Civil Code of Ukraine, the Law of Ukraine “On Land Lease”, and the Law of Ukraine “On Mortgage” with regard to transfer of rights to land in case of alienation of the property located on such land; and determine the procedure for registration of rights transfer.
2. At the level of the Law of Ukraine “On Notaries” or subordinate policy documents regulating issue of executive endorsements by notaries, improve the procedure of imposing a levy on real property via notary’s executive endorsement, stipulating that no judicial dispute affects the undesirability of the borrower’s debt, provided that the undesirability of the borrower’s debt is proved by the documents listed in Resolution #1172 of the Cabinet of Ministers of Ukraine, dated 29 June 1999.
3. Amend Article 49 of the Law of Ukraine “On Mortgage” with regard to unifying the concepts of “initial value of the property” and “initial sale price of the mortgaged property” and clarify the procedure for reducing the sale price for property at public auctions and the price at which the mortgagee has the right to buy the mortgaged property by offsetting the mortgagee’s secured claims towards the property price after the second and the third auction trades.
4. Amend the Law “On Enforcement Proceedings” in compliance with the provisions of the Civil Code and the Law “On Mortgage”. The latter legislative acts stipulate that mortgagees’ claims have priority over the claims of other creditors, while requesting recovery of executive enforcement fees by the debtor, not out of property sale income.
5. Establish a specific procedure for disposal of land parcels and rights to them including rights which are subject of mortgage in the Law of Ukraine “On Enforcement Proceedings”; define clearly time the frames for exercising by executive officers of all actions related to implying a levy on debtors’ property including land parcels; expand the list of grounds for claiming a disqualification of the executive officer in the executive endorsement procedure and for replacing the executive officer during executive enforcement proceedings.

In order to improve the activities of the Land Cadastre and the State Registry of Property Rights for Real Estate, it is proposed to

• Stipulate submission of the information about the change of land parcel owner or user to the State Land Cadastre on the same day when the corresponding registration act is done by a public registrar;
• Supplement the Procedure for Keeping the State Registry of Property Rights for Real Estate with a provision for mandatory recording of prices for real estate transactions, including land parcel transactions;
• Add valuators on the list of agents who have the right of direct access to the State Registry of Property Rights for Real Estate.

The following financial instruments can be introduced to stimulate funding of land parcel transactions:

• The practices of installment payment when selling state and municipal land parcels (as complied with Paragraphs 8 and 9 in Article 128 of the Land Code and Resolution #381 of the Cabinet of Ministers of Ukraine, dated 22 April 2009). Extend such practices onto land sale via e-auctions by amending the Land Code and Resolution #381.
• Financial leasing for purchase of land parcels – by making amendments to the Land Code and the Law of Ukraine “On Financial Leasing” (adding land to the list of potential lease objects and allowing banks to acquire land parcels, including agricultural land). In addition, subordinate policy acts regulating such transactions should be drafted and approved.
• Institute of trust ownership as an alternative to collateral (under agreements of trust ownership, collateral property legally belongs to the creditor until loan repayment) – by amending the draft Law #4188, dated 10 March 2016, or the act drafted by the Ministry of Economic Development and Trade of Ukraine; amend the Civil Code and other policy documents regulating the relationship between creditors and debtors or foreclosure-related issues. It is also necessary to adopt policy documents to specify in detail the procedure of realizing the trust ownership right.

To stimulate the development of land mortgage funding, after the moratorium is lifted and fully-operational market is created, it is advised to consider increasing the liquidity coefficient for land parcels (including the one applied to agricultural land parcels) which is used for reservation (Appendix #6 to the NBU’s Resolution #351, dated 30 June 2016). Its value should be determined on the basis of actual land turnover statistics.