CASE STUDY ON INDIA’S HOUSING FINANCE

INDUSTRY

Current Market Scenario:

India’s housing finance industry, which comprises of banks and housing finance
companies, has registered a compounded annual growth rate of over 30 per cent for
the last three years.

Banks have garnered a larger share of the business, and today they meet more than
three-fourths of the incremental housing finance requirements. Housing loan
industry started to pick up from early 90’s with banks concentrating on housing
loans to salaried customers. In India still the market is dominated by salaried
customers and there is a huge potential on the self employed segment which is still
underserved. Slowly and steadily the average tenor of the person taking a loan
showed a declining trend as more and more salaried customers opted for housing
loan at a very young age. Now with the property prices on the peak major banks
have made a shift from housing loans to Loan against property and are
concentrating on self employed segment too. Hence with this the country has also
witnessed a big surge in home equity, primarily known as loan against property.

The booming economy has added up a lot of avenues to self employed segment to
expand or diversify their existing business on a larger scale and to meet the fund
requirement, a lot of institutions have come up with the product called Loan
Against Property. The ratio is highly skewed toward the self employed in this
segment. The market is witnessing a dramatic shift in borrower profile: the age mix
of the borrower is tilted towards the youth, and the income levels of borrowers are
on the rise. The underwriting standards have also seen a change, and the industry
has moved towards higher loan-to-value ratios and longer tenors and higher debt
equity ratio.

However, the consistent rise in both property prices and interest rates is
increasingly threatening the affordability of housing for the Indian middle class.
The asset quality of the lenders is being questioned, especially in light of the
weaker credit profile of borrowers as a result of the change in underwriting
standards.
 Loan against property
The loan against property market in India has just started establishing itself with
major banks entering this segment around 2 years earlier. The Indian consumer is
in general averse to the idea of mortgaging his home and this explains the very low
level of mortgage as a percentage of GDP that is a characteristic of India.

The low penetration of mortgages as a percentage of the GDP points out to an

enormous potential in this market. The market size currently is 1000 crores per
month in India which translates to about 9000 to 10000 units per month, which is a
disturbingly small figure.

The loan against property product is mainly aimed at the self employed, especially
SMEs who would require cash for business expansion. A personal loan would be
inadequate to provide for such a borrower’s needs, as typically personal loans are
of the size of 10 lakhs. Personal loans prove to be costly for the customer too, since
it would be lent at rates as high as 18-20%, and would be typically lower in tenor.
This translates into higher EMI’s for the borrower and hence a LAP would appeal
to him/her.

LAPs prove to be profitable from point of view of the banks and financial services
providers too. The cost of financing would be around 9-11%, while on an average
the lending rate is around 14-15%. This means an average spread of 3-4%, more
than in home loans. With the home loan market slowing down, the loan against
property would be a point of focus for many banks.

Key Drivers to business:

1) Portfolio Quality/ Stability
2) Quality of Distribution
3) Price for risk. Risk reward proposition.
4) Working as a cohesive business unit for overall growth

Industry Fundamentals:
1) Data, Data, Data!!
2) Property Price Information
3) Do we have accurate valuations at originations
4) Originator default history
5) Most accurate predictor of default in India.
LTV, Debt Burden, Location etc.

Typical SEMP Non professional customer profile:

A normal customer profile is a retailer or a trader, who has been in business for the
last 3 to 5 years. Comes from business family background and owns his shop in a
business area. Majority of his transactions happens by cash and a large of money
saved is invested back into business towards expansion.”

• Normally deals with Local banks thru current or saving account.

• Would have some small overdraft/CC facility.
• Would own an ancestral property or would have bought a property in self
and spouse’s name.
• Would have distributed his family income into various ITRs of Family
members
• Would have purchased the property at low agreement value to save on the
stamp duty and have paid the balance portion in cash.
• Would have a loan on the property/CC/OD from Nationalized bank/ Coop
bank.
 Risks/ Challenges on Lending these Profiles:
1) Rising property prices: Due to increase in prices of property, an
individual’s intangible value on the asset has increased resulting into a
higher eligibility on LTV front. Though Collateral value being the parameter
for lending the challenge is to establish one’s affordability of the loan as
well as his ability to service the EMI.

At present Purchase money mortgage market is showing signs of slow down

and slight correction on the property prices is anticipated. This in turn affects
the current portfolio which may be exposed to higher risks on the LTV front.
Hence there has to be a constant watch on the property prices in a way to
develop a proper property price index which helps us to understand the
trends as well as to identify areas for lending.

Also property price index helps as a check on the valuations done by valuers
and take necessary actions on the product w.r.t locations where there is a lot
of variance in prices.

2) Self Employed segment: More and more banks are concentrating on the self
employed segment. This is an underserved market in India with a huge scope
of lending. These segments have average financials and bank statements.

Challenge in lending to these profiles is to establish their cash flows and

giving them the right loan amount. This can be established through various
surrogates.

Majority of the customers fall under the surrogate category due to low
declared and high cash income for most of SEMPs. Also most of the
customers have car loans, personal loans, housing loans which can act as
surrogates to establish customer’s cash flows.

3) Rising Debt burden: Due to Easy availability of loans, and intense

competition amongst various financial institutions, a lot of self employed
customers have raised debt for acquiring various assets like cars, houses,
expansion/diversification of business, etc. This has resulted into a higher
debt burden and over leveraging.

More and more customers are now opting for consolidation of debts.
Challenge is to identify the right affordability of the customer w.r.t his cash
flows.
4) Tenor: There is risk involved even in the higher tenor loans. The increment
in the tenor might spill over in the period when the borrower no longer has
stable cash flows. The normal industry average in case of mortgage loans is
in the range of 5 to 7 years.

5) Legal System: Still in many places in India we do not have proper legal
records. Hence there is a risk on lending as we might not be able to trace out
title records of the property with the registrar for past 13 years.

6) Credit Bureau on a nascent stage: CIBIL has just being introduced in

India. All details of a customer are presently not available with CIBIL and
hence there is a risk of over leveraging a customer.

7) Retail property: In case of retail property there is no clear defined zones of

commercial properties. This can be mitigated by stability of the business,
Shop license etc.

8) Business Cycle: Normally average tenor of the loan is 10 years. During the
entire tenor the customer may run thru various business cycles. All
businesses will not have the same growth pattern for the entire loan tenor.
During his slump period, chances of default are high. This can be mitigated
as seen from the general market trend typically customer’s foreclose these
loans in a span of 7 years approx. Also by this time the company would have
built a book sufficient enough to digest such kind of risks.

9) Customer Behavior: Different customers behave differently but the same

can be classified w.r.t ticket sizes and locations.
Normally a customer with a loan of Rs 5 – 10 lacs in a metro cities are more
vulnerable to default as they typically tend to over leverage them selves thru
some personal loans, unorganized sector lending’s etc. Also there is not
much difference between their ITR income and their regular cash flows.
These people would have been in business for about 5 years. They lack
normal banking habits. Collateral offered to the institution as mortgage is
difficult to sell. Hence these customer’s can be categorized as more risky
customers

Customers with a loan of Rs 10 – 30 lacs would have gone thru some ups
and down in business as his business would typically be a second generation
business. These customers’s would have proven track record and hence
would have proved their intension as well as ability to a certain extent.
These customers will normally have good cash flows compared to their IT
returns and hence would be able to service our Emi’s regularly. These
people tend to take a term loan with a targeted end use like getting cash
discounts, diversifying their existing business etc.
Customers with a loan of Rs 30 – 50 lacs would have a business experience
of more than 10 year + with multiple track records and a proven credit
history. These customers would typically have made investments in various
stocks, MF, LIC, Property etc. Also underwriting these customers tends to
be safer as they have audited financials, business stability, Good
investments, and decent collateral.

Customers with a loan of Rs 50 – 100 lacs would have a stable business, if

not family business with good cash flows but would have disclosed low ITR
income in order to save taxes. Also collateral offered would be good with a
good margin on LTV. He would have good banking habits and would bank
with few foreign banks. These customers typically run a CC/ OD at a higher
rate of interest and look at a term loan for consolidating these facilities.
Hence lending to these profiles would be more or less for debt consolidation.
Financial institution should look at these profiles after building a sizable
book size with an appetite to absorb some unforeseen circumstances.
 CHALLENGES

1. Product proposition: During start up challenge is to have a product

proposition which is competitive enough in the market and also enable to
build a book size with lower delinquencies and a proper portfolio mix.
Surrogate products should cover about 80 – 85 % of the portfolio.

2. Underwriting Standards: Set up various underwriting standards which are

capable enough to identify right customer as well as able to deliver the right
loan amount to him. Underwriting standards should be made in a manner to
understand cash flows of the customer well enough which could involve
meeting up the customer by a local credit underwriter at his office. Also to
set up branch based underwriting model is a challenge in addition to finding
out right people on the job.

3 Sourcing quality: This is mainly a sales function. The right quality of

sourcing plays an important role initially. As all products are new and would
have been tested in the market right king of sourcing would definitely play a
critical role.
4 Portfolio Analysis. In order to have a good product portfolio we need
to regularly track our portfolio performance w.r.t Ticket size, Product ,
Location wise , Underwriter wise, Loan amount wise, Channel wise
performance, Income method wise, Ratio wise , Collateral value wise,
Tenure wise, Property usage wise etc. This can be developed through
various system enhancements

5 Regulatory Environment and External Factors: Increase in COF,

RBI regulations, Competitors actions etc.
 SUPPORT REQUIRED

1) Underwriting : Finalizing local credit underwriters for locations to be

started in phase 1

2) System developments: We need to develop an in-house system for the

entire mortgage process with detailed data so as to have a detailed data of
customers readily available. This will in turn help to track our portfolio
better. Also system should be able to do a de duplication check on the
customer, property. All initiations of credit checks to be done through
systems. We also need to have an access to CIBIL database for our
customer.

3) Vendor Controls: Appointment of renowned vendors for the job. This

would involve some costs but would benefit in long turn.

4) Support required for analysis: Stronger systems with complete data

capturing of the customers in order to have a complete and a detailed
analysis of the portfolio on a regular basis.

5) Quality Analysis: Support is required for analysis of file quality,

Underwriting quality, tracking vendor performance etc.

6) Customer service representative: In long run we need to have a dedicated

customer service representative sitting at the branch office catering to
customer request and complains.
 PLAN OF ACTION:
Steps:
1) Collection of information of various banks with respect to location to be
started in phase 1. This can take about 20 days

2) Making a policy document. Time frame of about 30 days

3) Visiting locations to be started in phase 1 to understand the market

dynamics. Time frame 20 days

4) Identify local credit underwriters. Time Frame 30 days

5) Training underwriters on policy. Time Frame 15 days

6) Appointment of various agencies for credit checks. Time frame 15 days

7) Empowering local credit underwriters with credit authorities for approval of

files. Time Frame: On going process with a minimum of 30 days.

8) Working with channel partners in order to understand their requirements as

well as to impart training to them on the policy. Time frame 20 days

Simultaneously we need to develop robust end to end systems to take care of

the entire mortgage business.