Delinquencies in India’s loan against property (LAP) portfolio, which have been modest till the last year, could significantly increase in the next four quarters, says a report.
Raising a red flag, it said delinquencies have tripled in 2-3 years. Delinquencies may even exceed 5 per cent on a static basis for a few non-bank financial institutions (NBFCs), about 3 times of those in FY14, according to India Ratings and Research (Ind-Ra) report. “The signs of early stress are clearly visible in the LAP business loan pools assessed by Ind-Ra, indicated by a sharp rise in 90 days past due (dpd) delinquencies for some of the large players,” it said.
The LAP lending is a business loan taken with an underlying property (commercial/residential) as the underlying collateral. While the property serves as collateral for recovery in case of a default, the loan should have ideally been given based on the cash flows of the borrower (mostly SME businesses) and not based on the collateral value alone. This doesn’t seem to be entirely true. Moreover, a substantial part of the growth in the recent past has come through churn when a bigger loan is given to the same borrower by a competing NBFC on the basis of higher property valuation.
In the last 2-3 years, there has been considerable concerns on the quality of LAPs in the system. Amongst the fastest growing segment, there are some concerns about the robustness and resilience of this segment to an economic downturn, especially in real estate. A combination of stagnant property prices especially in metros and large cities, which are the primary markets for medium and large ticket LAP, and squeeze on refinancing due to risk aversion building up in some financiers is bringing the stress to the fore, it said.
There is limited statistical correlation between delinquency rates and loan to value (LTV) ratios. Ind-Ra’s study on its LAP portfolio generated in the last five years, indicates that all loans, irrespective of their year of origination, are experiencing the highest level of delinquencies in 2016. “Slippages in LAP are rising concurrently across the years of origination, though LTVs of earlier vintage loans have reduced due to a secular rise in property prices and principal amortisation, indicating a cliff effect. Having said that, the portfolio with lower LTVs is likely to have a lower loss given default (LGD),” it said.
The LAP market is entering into a delicate phase, where though yields are shrinking, credit costs have started to build up. “High yields in the early part of this decade in the LAP segment (almost 500 bps higher than State bank of India’s (‘IND AAA’/Stable) base rate) and negligible credit costs (below 30 bps) offering a high risk adjusted return had attracted many players; some of which did not necessarily had a core competency in the segment. Nevertheless, intense competition has pulled the yields significantly which have shrunk to about 300 bps over State Bank of India’s base rate,” it said. After adjusting for yield reversals on NPAs and operating costs, yields may not, at least for few players with uncompetitive funding costs, leave enough buffers to absorb spikes in credit costs.
The quest to expand loan portfolio in the face of intensive competition has diluted the use of risk mitigation practices. Non-residential properties (including industrial, commercial, freehold land, unoccupied residential property, among others) are increasingly being accepted as collaterals. This proportion could go as high as 30 per cent of the portfolio for some players. While LTVs are lower for non-residential properties, realisation on liquidation is also lower for them. Ind-Ra’s study on the recovery of SME loans pool acquired by asset reconstruction companies (ARCs) through non-residential collaterals indicates a poor recovery at 25 per cent of principal outstanding, Ind-Ra said.
In a majority of cases, property valuation is outsourced to third-party valuation companies. The methodologies followed are not standardised yet. Also, the real estate market has limited depth and secondary sales, and hence involves a lot of subjectivity. In addition, history suggests the value of property values can fluctuate substantially and corrections may happen abruptly. This is in the light of the manifold increase in property prices in India in the last one and half decade. The illiquid nature of the real estate market also makes monitoring the prices of collaterals, on an ongoing basis, a challenging and costly affair and price movement data can come with a significant lag. “Newer markets, beyond metros and tier 1 cities, are offering growth avenues for the segment as incremental volume growth faces pressure in traditional geographies.
Competition in smaller ticket, newer markets is still moderate which allows lenders to price in the risk (yield are generally upward of 14 per cent in these segment),” it said. Also, the portfolio performance of low ticket LAP portfolio demonstrates better performance. Nevertheless, this product has only gained traction in the last couple of years and hence has low seasoning.
NBFCs constrained by the lack of infrastructure for direct sourcing of loans, found it easier and cheaper to build scale in the segment through third-party intermediaries. However, this form of loan sourcing could have moral hazard implications and may impact credit assessment. Also, a large presence of intermediaries has increased portfolio churn, resulting in inadequate seasoning for a part of portfolio.
Primary research suggests that over the last few quarters, portfolio churn among NBFCs has been the significant driver of incremental loan growth, with balance transfer driving the higher amount of borrowings. Higher loan amounts were supposedly supported by an increase in property prices, though the ability of a borrower (in terms of income) to repay a higher amount of loan instalment may not necessarily has kept pace. Thereby, the balance transfer masks the true stress. Also, recycling the collateral is becoming challenging as the incremental rise in property prices has subdued, Ind-Ra said.
Credits The Indian Express