As many as one-third of developer loans are categorised as sub-investment grade. Substantial delays and stranded projects have led to deterioration in the financial health of developers
Only 33 of the top 109 real estate developers received investment-grade loans (BBB and above) with aggregate sanctions of Rs 2.3 lakh crore, according to an analysis by Kotak Institutional Equities. Around 25 percent of loan sanctions to builders were below investment grade.
As per the analysis, as many as 32 out of the 109 developers having loan sanction of Rs 817 billion (16 percent) had their credit ratings suspended.
As many as one-third of developer loans are categorised as sub-investment grade. Substantial delays and stranded projects have led to a deterioration in the financial health of developers, as per the analysis.
“Investment-grade loans are loans mostly sanctioned to top-tier developers,” explained Sandeep Reddy, co-founder at Propstack.
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Also, larger loans actually take lesser security cover because these larger loans sanctioned to big builders comprise not only construction financing but also lease rental discounting which means that these are loans tied against office assets and have a consistent rental revenue stream attached to them.
Going forward, there is a likelihood of an increase in defaults, as well as credit downgrades for the weaker developers that may not be able to sustain the absence of incremental sales due to the current lockdown and ensuing economic weakness, it said.
Investment grade refers to the quality of a company's credit. To be considered an investment-grade issue, the company must be rated at 'BBB' or higher by Standard and Poor's or Moody's.
Anything below this 'BBB' rating is considered non-investment grade. If the company or bond is rated 'BB' or lower it is known as junk grade, in which case the probability that the company will repay its issued debt is deemed to be speculative. Higher grades are intended to represent a lower probability of default.
The analysis noted that absence of price increase, an increased perception of execution risk, and the tax differential under GST shifted the purchasing pattern of buyers towards the completion of the residential project instead of making the purchase decision at the launch of the project.
The shift in consumer pattern has required developers to fund a substantial proportion of construction cost that was previously funded by customer advances—thereby near-doubling the capital intensity of the development business.
Most real estate projects are stuck only for want of funds; consolidation imminent
Some of the projects may face challenges on achieving positive IRR or maybe stuck in regulatory approvals, which may drive most write-offs, the analysis said.
Apartments worth Rs 2.8 lakh crore are in limbo, due to stalled construction and/or sales, jeopardizing loans worth Rs 1.2 trillion. This constitutes 28 percent of developer loans. The turmoil caused by Covid-19 will further accelerate the pace of consolidation that has been underway since RERA and demonetization.
The stress in the real estate sector translates to severe asset quality pressure on select NBFCs/HFCs. Against this backdrop, a wave of consolidation appears imminent in real estate and housing finance companies.
Stranded apartments put to risk 28 percent of real estate loans in India; more to come. Stranded inventory worth Rs 2.8 trillion is expected to put debt worth Rs 1.2 trillion at risk, it said.
Recognition, restructuring and last-mile funding may ease the pain
The recent one-time restructuring window will immensely help the real estate sector, it said.
According to estimates, real estate developers need between Rs 390 bn and 650 bn of incremental funds to be able to complete current stranded projects under construction.
Going forward, too much pricing leeway from developers is not expected to stimulate demand or improve margins. Distressed developers may not attract any customer interest irrespective of price cuts for under-construction projects and strong developers may not venture into the same due to lower margins.
Funding of balance construction cost is a chicken-and-egg situation – the liquidity constrained lender does not want to fund the development of a project that will not be sold, while a consumer does not want to buy a residential unit that is stranded and may risk not being completed.
In the absence of incremental funding, no new buyer will be willing to look at the project putting to risk extant capital deployed, it added.
According to Reddy of Propstack, rating of loans to the real estate sector is not up to mark compared to other corporate loans.
It has been observed that top developers take larger loans and usually these larger loans take lesser security cover. Smaller loans--up to Rs 50 crore--have higher security covers at 1.79 times. In contrast, if the loan is for over Rs 500 crore, the security cover eases to 1.48 times, showed data from real estate data analytics arm, Propstack.
Some of the larger loans are also not construction financing but lease rental discounting which means that these are loans against office assets which get regular rental income.
Therefore, above investment grade loans are mostly taken by grade A developers and have a higher concentration of lease rent discounting loans.
During COVID-19 when execution and demand risk is high, several lenders are seeking higher security and receivables cover from companies seeking financial support.
The security cover for these loans has gone up to 1.66 times based on the funds sanctioned so far this year as against 1.62 times a year ago, Propstack noted.
The rise in these covers means that the recovery is likely to take longer, it said.Also, loans with shorter tenure of up to 12 months are attracting higher security cover of 2.1 times against 1.55 times for a 5-year term loan.