Housing finance companies are in a turmoil due to lack of demand as well as funding freeze

Affordable housing has been the lone bright spot in this doom and gloom and has contributed to both realty sales as well as to the AUM growth of banks and HFCs servicing this segment.

The Indian residential real estate market has been sluggish over the past few years due to continued demand slowdown and pile-up of unsold inventory. Additionally, post the IL&FS default, housing finance companies have been disproportionately impacted and have found growth challenging, both due to demand issues as well as the prevailing funding freeze.

Affordable housing has been the lone bright spot in this doom and gloom and has contributed to both realty sales as well as to the AUM growth of banks and HFCs servicing this segment.

The push for affordable housing commenced after a Technical Working Group constituted by the Ministry of Housing and Urban Affairs, Government of India, established that 96 percent of the shortage of supply for housing is in the Economically Weaker Sections/ Lower Income Groups (EWS/LIG). This was because, over time, private developers had started focusing entirely on the middle-income and luxury properties, given the higher potential for profits in these projects.

The Government of India launched the laudable ‘Housing for All’ programme, also known as the ‘Pradhan Mantri Awas Yojana’ (PMAY), in 2015 with a target of building 20 million affordable houses by 2022. Considering the magnitude of the target, the GoI has tried to co-opt the private sector by providing supply side incentives such as liberalised funding norms and changing the industry’s status as an infrastructure sector. There have been multiple demand incentives as well such as capital and interest subsidies (linked to cost and category of the houses) and increased tax benefits.

These measures have resulted in tangible improvement in the availability of houses in this segment.

• Eight million houses have been approved for funding under the scheme PMAY (Urban) till March 2019, of which 2.5 million have been constructed (nearly 10 percent of the target).

• As per a research by Knight Frank, 51 percent of all project launches in the top eight Indian cities between January and June 2019 were in the affordable category.

However, there are inherent challenges for housing finance players active in this segment.

Higher Credit cost: Fundamentally, low ticket-size loans are riskier given the volatility of income of EWS / LIG customers. Given that the demand is predominantly regulatory incentive-led, it is very likely that borrowers are currently overestimating their capacity to repay over the long term. With the high tenors inherent in this product, there could be high variations in income to instalment ratio.

Additionally, with stress in the broader economy and job losses in the key income generating sectors such as real estate and automobile, the NPA levels in the low income segment can increase significantly in the short to medium term. This trend is already visible in the books of large Housing Finance Companies (HFCs) which have also been increasing their affordable housing share.

Imperfect collateral: The prohibitive land cost at the core of the major urban agglomerations have meant that majority of the development has happened either at the fringes of major cities or in rural areas. This brings in the legal challenges of title verification, zoning violations and various approval related issues. Many HFCs, for example, have been funding plans sanctioned by gram panchayats, Laal Dora properties in and around Delhi and other such properties where legality under the SARFAESI Act is not clearly established. This is expected to result in repossession losses and higher eventual credit costs.

Unlike premium housing where land forms a dominant portion, in the case of affordable housing, construction cost forms nearly 60 percent of project costs. With passage of time, significant erosion of the property value is expected and hence the recovery value of the asset would be low. Thus, maintenance of relatively lower loan-to-value and a steady loan amortisation schedule will be critical.

Balance Transfers: The HFCs focusing on the affordable housing space have been lending to new-to-credit customers employing unconventional methods of income assessment. However, post a period of timely servicing and establishment of credit history, large banks and HFCs target these customers offering a significantly lower interest rate. Interactions with HFCs reveal that these ‘Balance Transfers’ account to anywhere between 10-25% of their portfolios. This substantially weakens their AUM growth potential, portfolio quality and profitability. Hence standalone affordable housing players will need to diversify into other income segments as well in order to grow their books profitably.

Developer funding: In a bid to grow the affordable housing book, many institutions have resorted to funding the developers engaged in this space. The credit profile of these developers are sub-optimal given the thin margins – price escalation of key inputs such as cement, steel and sand have a major impact on profitability as house prices cannot be increased without impacting demand drastically. Banks and HFCs which have a sizeable exposure to such developers as part of their housing book are expected to witness elevated NPA levels.

In summary, players focused in the affordable housing space have to focus on their income assessment skills, have tight control over the Loan-to-Value and legal / technical assessment of the properties and find ways to diversify their AUM either vertically (across the housing spectrum) or horizontally (other products addressing the same customers) in order to thrive in this market.