Challenge for HFCs

It's no surprise that the non-performing assets (NPAs) of housing finance companies (HFCs) are on the rise. A recent news report, based on a sample of 17 HFCs, puts the average net NPAs at 2.4 per cent as at the end of FY 2004.

Nothing alarming, but disaggregated data show that there is sufficient cause for concern. That's because HFCs with the least amount of capital (up to Rs 150 crore) have the largest percentage of bad debts. Their net NPAs soared as high as 9.4 per cent.

HFCs with capital in the range of Rs 150""500 crore had net NPAs of 5.3 per cent, while those that were well capitalised (above Rs 500 crore) had NPAs of just 1.6 per cent. The net NPA levels of the first two groups are far higher than current bad debt levels for most banks' wholesale business.

The RBI would do well to look at these trends seriously since over half the HFCs registered with the National Housing Bank are bank subsidiaries. What affects these HFCs will ultimately affect banks themselves.

But the bigger note of caution should undoubtedly be reserved for non-bank HFCs, who labour under severe handicaps. The entry of banks into the mortgage business and aggressive rate-cutting have put HFCs on the defensive and the smaller ones are fighting with their backs to the wall.

In a way, HFCs are in a position similar to that of another dying breed""development finance institutions. Neither has access to low-cost deposits, making it difficult for them to compete with banks. The smaller the HFC, the higher its cost of funds.

They also face maturity mismatches since HFCs typically raise funds through three- or five-year bonds (or public deposits), while their mortgages run for longer periods.

The survival threat is not the same for all HFCs. HDFC continues to have access to low-cost, long-term funding. Smaller players have tried to build on the advantage of low operational costs.

However, as the new private sector banks become leaders in housing finance, and as public sector banks start leveraging their geographical reach better, HFCs will have to change more fundamentally: one obvious option is to position themselves as intermediaries between banks and borrowers, just as direct selling agents do now.

This way they can let banks do the funding while they themselves serve as loan-originating companies. This will shift the focus to fee-based income.

On the liabilities side, floating rate loans have helped avoid interest rate risks. And some HFCs have tried to diversify their portfolios by going in for loans against rent receipts. Nevertheless, the fact remains that second-rung HFCs are left with second-rate borrowers""as indicated by their high NPAs.

Going forward, there's no disputing the need for consolidation in the housing finance business. Those HFCs that have banking arms or are part of larger non-banking finance groups could merge with these entities, giving them access to low-cost funding.

Smaller, but viable, HFCs will gain much if the market for securitisation improves, which will reduce their capital constraints. Long-term lenders such as pension and provident funds must lend to or invest in HFCs. Their long-term sources of funds complement the HFCs' long-term liabilities.

Setting up real estate mutual funds will also help. With interest rates moving up and a new 90-day NPA recognition norm coming in, standalone housing finance companies have to rethink their business models.