Real Estate Lenders: High Loan Growth & Low Seasoning Portend High Credit Cost

The market share of non-bank finance companies (NBFCs) and housing finance companies (HFCs) would continue to expand in the real estate financing space, believes India Ratings and Research (Ind-Ra), as banks have moderated their RE lending growth due to asset quality and capitalisation issues.

NBFCs' loan growth is attributed to regulatory arbitrage along with their ability to structure loans, attractive yields, collateral comfort and low credit costs. However, heightened competition has resulted in a yield compression of 150-250bp in the face of declining sales velocity in the residential real estate sector. Thus, the risk-adjusted pricing may come under pressure. High competition among real estate NBFCs results in frequent refinancing of the loan book. In many cases, the take-out happens even before the moratorium period is over, with additional moratorium being offered by the new lender and could result in the masking of stress as the underlying sales velocity has declined.

 

RERA and GST have changed the contours of business, necessitating complete financial closure of the project, since there is sales restriction before necessary approvals while taxation rules favour purchase of fully constructed properties. Lending is typically backed by a cash flow cover, based on the certain assumption of sales velocity, price appreciation, timeliness of various approvals and completion schedule. However, Ind-Ra's analysis shows that the cash flow cover falls significantly with adverse movements in these assumptions.

Real estate lending being mostly high ticket, results in a highly concentrated loan portfolio for developers with a moderate credit profile. In view of this, NBFCs are likely to maintain moderate leverage and higher liquidity buffers; however, in light of pressure on yields, there has been a dilution in the liquidity buffers maintained by NBFCs. Large liquidity chasing this asset class with significant private equity interest supported frequent refinancing. However, if market conditions were to deteriorate, the refinancing activity may be severely curtailed leading to a cliff effect, resulting in higher credit cost for loan portfolio.

Some of the prudent risk mitigants in the lending business would be ensuring complete financial closure with adequate promoter equity, a detailed micro market study to judiciously choose exposures, rigorous monitoring of the projects with an eye on sales velocity, construction cost, timely receipt of necessary approvals and maintaining adequate cash flow cover throughout the loan period by factoring in various stress case scenarios.

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