Case Study On Housin Finance

CASE STUDY ON INDIA’S HOUSING FINANCE INDUSTRY Current Market Scenario: India’s housing finance industry, which comprises of banks and housing finance companies, has registered a compounded annual growth rate of over 30 per cent for the last three years. Banks have garnered a larger share of the business, and today they meet more than three-fourths of the incremental housing finance requirements. Housing loan industry started to pick up from early 90’s with banks concentrating on housing loans to salaried customers. In India still the market is dominated by salaried customers and there is a huge potential on the self employed segment which is still underserved. Slowly and steadily the average tenor of the person taking a loan showed a declining trend as more and more salaried customers opted for housing loan at a very young age. Now with the property prices on the peak major banks have made a shift from housing loans to Loan against property and are concentrating on self employed segment too. Hence with this the country has also witnessed a big surge in home equity, primarily known as loan against property. The booming economy has added up a lot of avenues to self employed segment to expand or diversify their existing business on a larger scale and to meet the fund requirement, a lot of institutions have come up with the product called Loan Against Property. The ratio is highly skewed toward the self employed in this segment. The market is witnessing a dramatic shift in borrower profile: the age mix of the borrower is tilted towards the youth, and the income levels of borrowers are on the rise. The underwriting standards have also seen a change, and the industry has moved towards higher loan-to-value ratios and longer tenors and higher debt equity ratio. However, the consistent rise in both property prices and interest rates is increasingly threatening the affordability of housing for the Indian middle class. The asset quality of the lenders is being questioned, especially in light of the weaker credit profile of borrowers as a result of the change in underwriting standards.

Loan against property The loan against property market in India has just started establishing itself with major banks entering this segment around 2 years earlier. The Indian consumer is in general averse to the idea of mortgaging his home and this explains the very low level of mortgage as a percentage of GDP that is a characteristic of India.

The low penetration of mortgages as a percentage of the GDP points out to an enormous potential in this market. The market size currently is 1000 crores per month in India which translates to about 9000 to 10000 units per month, which is a disturbingly small figure. The loan against property product is mainly aimed at the self employed, especially SMEs who would require cash for business expansion. A personal loan would be inadequate to provide for such a borrower’s needs, as typically personal loans are of the size of 10 lakhs. Personal loans prove to be costly for the customer too, since it would be lent at rates as high as 18-20%, and would be typically lower in tenor. This translates into higher EMI’s for the borrower and hence a LAP would appeal to him/her. LAPs prove to be profitable from point of view of the banks and financial services providers too. The cost of financing would be around 9-11%, while on an average the lending rate is around 14-15%. This means an average spread of 3-4%, more

than in home loans. With the home loan market slowing down, the loan against property would be a point of focus for many banks.

Key Drivers to business: 1) 2) 3) 4)

Portfolio Quality/ Stability Quality of Distribution Price for risk. Risk reward proposition. Working as a cohesive business unit for overall growth

Industry Fundamentals: 1) 2) 3) 4) 5)

Data, Data, Data!! Property Price Information Do we have accurate valuations at originations Originator default history Most accurate predictor of default in India. LTV, Debt Burden, Location etc.

Typical SEMP Non professional customer profile: A normal customer profile is a retailer or a trader, who has been in business for the last 3 to 5 years. Comes from business family background and owns his shop in a business area. Majority of his transactions happens by cash and a large of money saved is invested back into business towards expansion.” • Normally deals with Local banks thru current or saving account. • Would have some small overdraft/CC facility. • Would own an ancestral property or would have bought a property in self and spouse’s name. • Would have distributed his family income into various ITRs of Family members • Would have purchased the property at low agreement value to save on the stamp duty and have paid the balance portion in cash. • Would have a loan on the property/CC/OD from Nationalized bank/ Coop bank.

Risks/ Challenges on Lending these Profiles: 1) Rising property prices: Due to increase in prices of property, an

individual’s intangible value on the asset has increased resulting into a higher eligibility on LTV front. Though Collateral value being the parameter for lending the challenge is to establish one’s affordability of the loan as well as his ability to service the EMI. At present Purchase money mortgage market is showing signs of slow down and slight correction on the property prices is anticipated. This in turn affects the current portfolio which may be exposed to higher risks on the LTV front. Hence there has to be a constant watch on the property prices in a way to develop a proper property price index which helps us to understand the trends as well as to identify areas for lending. Also property price index helps as a check on the valuations done by valuers and take necessary actions on the product w.r.t locations where there is a lot of variance in prices. 2) Self Employed segment: More and more banks are concentrating on the self

employed segment. This is an underserved market in India with a huge scope of lending. These segments have average financials and bank statements. Challenge in lending to these profiles is to establish their cash flows and giving them the right loan amount. This can be established through various surrogates. Majority of the customers fall under the surrogate category due to low declared and high cash income for most of SEMPs. Also most of the customers have car loans, personal loans, housing loans which can act as surrogates to establish customer’s cash flows. 3) Rising Debt burden: Due to Easy availability of loans, and intense

competition amongst various financial institutions, a lot of self employed customers have raised debt for acquiring various assets like cars, houses, expansion/diversification of business, etc. This has resulted into a higher debt burden and over leveraging. More and more customers are now opting for consolidation of debts. Challenge is to identify the right affordability of the customer w.r.t his cash flows.

4) Tenor: There is risk involved even in the higher tenor loans. The increment

in the tenor might spill over in the period when the borrower no longer has stable cash flows. The normal industry average in case of mortgage loans is in the range of 5 to 7 years. 5) Legal System: Still in many places in India we do not have proper legal

records. Hence there is a risk on lending as we might not be able to trace out title records of the property with the registrar for past 13 years. 6) Credit Bureau on a nascent stage: CIBIL has just being introduced in

India. All details of a customer are presently not available with CIBIL and hence there is a risk of over leveraging a customer. 7) Retail property: In case of retail property there is no clear defined zones of

commercial properties. This can be mitigated by stability of the business, Shop license etc. 8) Business Cycle: Normally average tenor of the loan is 10 years. During the

entire tenor the customer may run thru various business cycles. All businesses will not have the same growth pattern for the entire loan tenor. During his slump period, chances of default are high. This can be mitigated as seen from the general market trend typically customer’s foreclose these loans in a span of 7 years approx. Also by this time the company would have built a book sufficient enough to digest such kind of risks. 9) Customer Behavior: Different customers behave differently but the same

can be classified w.r.t ticket sizes and locations. Normally a customer with a loan of Rs 5 – 10 lacs in a metro cities are more vulnerable to default as they typically tend to over leverage them selves thru some personal loans, unorganized sector lending’s etc. Also there is not much difference between their ITR income and their regular cash flows. These people would have been in business for about 5 years. They lack normal banking habits. Collateral offered to the institution as mortgage is difficult to sell. Hence these customer’s can be categorized as more risky customers Customers with a loan of Rs 10 – 30 lacs would have gone thru some ups and down in business as his business would typically be a second generation business. These customers’s would have proven track record and hence would have proved their intension as well as ability to a certain extent. These customers will normally have good cash flows compared to their IT returns and hence would be able to service our Emi’s regularly. These people tend to take a term loan with a targeted end use like getting cash discounts, diversifying their existing business etc.

Customers with a loan of Rs 30 – 50 lacs would have a business experience of more than 10 year + with multiple track records and a proven credit history. These customers would typically have made investments in various stocks, MF, LIC, Property etc. Also underwriting these customers tends to be safer as they have audited financials, business stability, Good investments, and decent collateral. Customers with a loan of Rs 50 – 100 lacs would have a stable business, if not family business with good cash flows but would have disclosed low ITR income in order to save taxes. Also collateral offered would be good with a good margin on LTV. He would have good banking habits and would bank with few foreign banks. These customers typically run a CC/ OD at a higher rate of interest and look at a term loan for consolidating these facilities. Hence lending to these profiles would be more or less for debt consolidation. Financial institution should look at these profiles after building a sizable book size with an appetite to absorb some unforeseen circumstances.

CHALLENGES 1. Product proposition: During start up challenge is to have a product

proposition which is competitive enough in the market and also enable to build a book size with lower delinquencies and a proper portfolio mix. Surrogate products should cover about 80 – 85 % of the portfolio. 2. Underwriting Standards: Set up various underwriting standards which are

capable enough to identify right customer as well as able to deliver the right loan amount to him. Underwriting standards should be made in a manner to understand cash flows of the customer well enough which could involve meeting up the customer by a local credit underwriter at his office. Also to set up branch based underwriting model is a challenge in addition to finding out right people on the job. Sourcing quality: This is mainly a sales function. The right quality of sourcing plays an important role initially. As all products are new and would have been tested in the market right king of sourcing would definitely play a critical role. 4 Portfolio Analysis. In order to have a good product portfolio we need to regularly track our portfolio performance w.r.t Ticket size, Product , Location wise , Underwriter wise, Loan amount wise, Channel wise performance, Income method wise, Ratio wise , Collateral value wise, Tenure wise, Property usage wise etc. This can be developed through various system enhancements 3

Regulatory Environment and External Factors: Increase in COF, RBI regulations, Competitors actions etc. 5

SUPPORT REQUIRED 1) Underwriting : Finalizing local credit underwriters for locations to be

started in phase 1 2) System developments: We need to develop an in-house system for the

entire mortgage process with detailed data so as to have a detailed data of customers readily available. This will in turn help to track our portfolio better. Also system should be able to do a de duplication check on the customer, property. All initiations of credit checks to be done through systems. We also need to have an access to CIBIL database for our customer. 3) Vendor Controls: Appointment of renowned vendors for the job. This

would involve some costs but would benefit in long turn. 4) Support required for analysis: Stronger systems with complete data

capturing of the customers in order to have a complete and a detailed analysis of the portfolio on a regular basis. 5) Quality Analysis: Support is required for analysis of file quality,

Underwriting quality, tracking vendor performance etc. 6) Customer service representative: In long run we need to have a dedicated

customer service representative sitting at the branch office catering to customer request and complains.

PLAN OF ACTION: Steps: 1) Collection of information of various banks with respect to location to be started in phase 1. This can take about 20 days 2) Making a policy document. Time frame of about 30 days

3) Visiting locations to be started in phase 1 to understand the market dynamics. Time frame 20 days 4) Identify local credit underwriters. Time Frame 30 days 5) Training underwriters on policy. Time Frame 15 days 6) Appointment of various agencies for credit checks. Time frame 15 days 7) Empowering local credit underwriters with credit authorities for approval of files. Time Frame: On going process with a minimum of 30 days. 8) Working with channel partners in order to understand their requirements as

well as to impart training to them on the policy. Time frame 20 days Simultaneously we need to develop robust end to end systems to take care of the entire mortgage business.