Home loan lenders must tread carefully in developer loans as they look for margin boost

The results of the first quarter of FY23 for large- and mid-sized HFCs have shown that pain in the non-individual book is yet to recede.

For instance delinquencies at the largest mortgage lender, HDFC, from its non-individual book have risen to 5.5 percent in the June quarter from 4.7 percent five quarters ago.

At LIC Housing Finance Ltd, there was a modest improvement;  gross bad loans, or stage 3 assets, were down to 4.96 percent of the total loan portfolio and stress was largely from project finance.

Niche lenders such as Can Fin Homes Ltd had more luck in reducing  stressed loans. The HFC’s delinquencies were down to 0.65 percent of its portfolio, a sharp fall from 1 percent a year ago.

Given that only a few of them were successful in reducing stress,  HFCs also resorted to write-offs to prune their non-individual developer book and refrained from fresh lending.

As analysts at Kotak Institutional Equities noted: “...large HFCs continue to grow loan book at a muted pace of 10-16% due to the run-down of the developer book even as individual home loans growth accelerated to high-teens.”

In a nutshell, home loan lenders saw loan growth as well as asset quality pressured by the performance of their developer loan book.

Getting good fellas 

To be sure, project and construction finance is less than a third of the total loan portfolio of HFCs. A large part of real estate housing projects are largely funded by the buyers themselves and the remaining is brought in by the firm as equity and debt capital. That said, realty firms also finance projects through bank borrowings where lenders are willing to fund based on the returns they can get.

As such lenders cannot shun non-individual loans and stand to miss out on a high-yielding segment of the economy.

The key is to price risk appropriately which is where lenders need to be careful.

Anand Dama, analyst at Emkay Global Financial Services Ltd, believes that sticking to developers with robust balance sheets can help lenders with margins as well as thwart future stress. “Not all developers are risky. They can lend to the good names and avoid the bad apples, and that would help in improving margins as well,” he said.

Necessity may push lenders towards riskier developer funding though. HFCs have had a good run on loan spreads and margins owing to the sharp drop of interest rates to decade lows in the wake of the pandemic. Funding costs haven’t been this low for HFCs, resulting in fatter margins for them and a boost to interest income as well.

But this is coming to an end as the Reserve Bank of India (RBI) has begun its policy rate hiking cycle along with withdrawal of surplus liquidity. Together, this has resulted in bond yields surging and banks hiking loan rates. The window to earn margins by sticking to safe retail home loans is gone and HFCs would be tempted to cater to developers as their riskier nature allows lenders to seek higher interest rates.

Healing sector 

That brings us to the next issue of whether real estate developers have healed their own balance sheets. Here, it gets tricky to assess, but analysts point out that there has been significant consolidation in the sector.

Large and established developers have either swallowed smaller ones or decimated them. Troubled companies have righted their balance sheets somewhat with the help of the government’s help as also due to recovery in demand.

Property registrations have bounced back and even exceeded pre-pandemic levels in the case of metropolitan cities. Large realty firms have shown an increase in revenue and even commercial real estate is looking up. This means that the enthusiasm drummed up for developer financing from HFCs is not misplaced.

“The project finance now it is sitting around 5% but in the base account we are very sure that this definitely will increase and we are also focusing on more smart cities where we can give the very good project loans even to the range of Rs. 100 crore or so,” LIC Housing Managing Director Y. Viswanatha Gowd told analysts in a post-earnings call on August 5.

Analysts warn though that lenders must be on the watch for any stress and some realty firms are not yet out of the woods. For instance, the Mumbai Metropolitan Region’s unsold inventory is still elevated and this does not augur well for sales.

“Mid-sized and small developers should be avoided. Big names such as Oberoi or Godrej would be a good addition for a lender as they not only have a good track record of delivering but also have strong cash position,” said a real estate analyst requesting anonymity.

Investors are taking an optimistic view on HFCs, both on the growth front due to housing market revival, and on asset quality, with troubled project loans getting resolved. Lenders must deftly navigate the rising interest rate cycle and risk pricing to justify their current valuations.​