Mumbai: Among Indian financial intermediaries, Housing Development Finance Corp. Ltd (HDFC) has been the least affected by the stock market meltdown that started in January.
Since the beginning of the year, the stock of the mortgage firm has lost some 14% in value, while the Sensex, the benchmark index of the Bombay Stock Exchange, has lost close to 26% and Bankex, an index of the banking sector, at least 34%.
For the quarter ended June, HDFC’s business growth had been around 30% in loan approvals and 28% in disbursements, but Deepak S. Parekh, 63, chairman of the country’s oldest mortgage firm, sees a slowdown in loan growth in August and says the growth will come down in the next few quarters.
Parekh, who predicted the real estate bubble two years ago, says there is still some pain left for developers, who bought land at record prices, and financial intermediaries that have recklessly loaned money. The maximum pain, according to him, will be in the retail segment, followed by the infotech and commercial segments, and, finally, the residential segment.
Long-term player: Deepak Parekh of HDFC Ltd, the country’s biggest mortgage lender, said his firm aimed at being around even 100 years later and, therefore, he was building a long-term business with a solid base. Ashesh Shah / Mint
He also says that there is a great opportunity for an asset reconstruction fund in real estate sector as many projects will get stuck and companies will need to be bailed out.
In a free-wheeling interview on Monday, Parekh touched upon a range of issues: interest rates; taking the insurance and asset management arms of HDFC to market; reforms in the insurance sector; and missed opportunities for the country. Edited excerpts:
You have been warning that the real estate sector has been over-heated. Is the correction over?
I personally feel that the developers have gone totally haywire. They were buying land as if there is no tomorrow. That was a big mistake.
The Reserve Bank of India (RBI) prohibited all of us from lending money to buy land. In fact, the RBI directive was repeated – first, it was meant for banks but later (it was) extended to housing finance firms too. It expected the asset bubble. RBI had said that banks can only fund the developers after the projects get the commencement certificate. We followed the RBI norms and most of us are safe today.
When we stopped lending, foreign equity flowed in. A host of private equity funds and venture capital funds came to invest in land and they all were promised the moon… phenomenal rates of interest. Most of the transactions were debt transactions from overseas in the garb of equity.
They came through the automatic approval route under FDI (foreign direct investment) and money came in quickly as equity deals do not need prior approvals. They are mostly convertible debentures and preference shares, with conditions that before three years they will be redeemed. The developers borrowed money from overseas to fund their land deals at 18-20% interest. The land prices have crashed but they have committed to pay high phenomenal interest rates. Overall, 60% of such deals could be debt and the rest equity, and my estimate is that between $12 billion and $15 billion (Rs53,160-66,450 crore today) has come through the FDI route.
Is there some more pain coming?
Yes. How will they (developers) pay back? Where is the liquidity? Sales have stopped. The developers have bought land when prices were at their peak. So, there will be some pain in the real estate sector. Even those financial institutions, who have disbursed money carelessly, will find themselves in trouble as a large number of builders will face difficulty.
We need to categorize developers’ investments in various segments — malls, shopping centres, commercial and residential complexes. The malls have been worst-hit and the residential units the least-hit.
The advantage with the residential segment is even if the prices come down, there is some demand because of the shortages, but the malls are going abegging and people are converting malls into offices.
The Maharashtra government last week issued circulars saying IT (infotech) includes commercial banks, investment banks, stock broking companies, asset reconstruction firms, private equity, venture capital, brokerages, insurance companies and so on and they can get 80% of the space meant for IT (in an IT development). As you know, IT buildings get higher FSI (floor space index, a measure of how much space can be developed on a piece of land), but demand for IT buildings has slowed down. So, a builder can get extra FSI in the garb of IT, build more and give it to the financial sector.
Isn’t this essentially a rescue operation?
Obviously. I don’t know how the Maharashtra government acted so fast but it’s a rescue operation. (But) I think it’s done in good spirit.
So, the correction phase is not yet over.
I don’t think it’s over as yet. How much pain is left depends on the locality. For instance, in south Mumbai, there is a shortage and hence prices will not come down drastically as you are not reclaiming more land, increasing FSI and redevelopment is not happening. Where are the new buildings? So, prices cannot go down. But in the suburbs, they can…
What about other cities?
I worry about Bangalore, Chennai, Hyderabad because supply was ten times last year.
Even in West Bengal, Kolkata was developing well and they were trying to create an extension of Salt Lake by building Rajar Hat, a new town, but I don’t think it will be fully utilized. This is because IT has slowed down and the West Bengal government has not supported the IT sector. When Wipro Ltd first went to West Bengal, it was assured that it would be a 24X7 operation but there have been many stoppages.
The maximum pain left is in the retail segment; followed by IT and commercial segments; and finally residential segment. I’d think that Mumbai will be relatively less affected because of lack of land here.
How do you make housing affordable?
I am pretty hopeful on slum development, particularly in Mumbai. We have taken up a massive programme for slum development.
I don’t have the figures ready with me but I know Unitech Ltd has hundred acres of slums and Lehman Brothers has taken equity in the project. There are 50 such projects across Mumbai. It may take five years for all these projects to complete but the work has started and contracts have been given to different developers.
I only hope that the implementation of these projects is well done. First, the developers build the housing for slum-dewellers, move the people there and then exploit the space. Two key things in slum development are governance and transparency. I am hopeful…
The land prices have gone very high and the only way to get cheap land is to do rehabilitate a slum and you can really move fast if there is political support. If a developer gets cheap land, it can make significantly higher profits but it helps the city, it helps the poor people…
Some realty stocks have seen huge correction. Do you see them going down further?
Yes, their prices have come down significantly. Look at some of the companies that are listed at AIM (alternative investment market) in London. Unitech is quoting there at 50% of its issue price, Hiranandani (Construction Pvt Ltd) at about 52% of its issue price and Raheja (Ishaan Real Estate Plc of K. Raheja group) is quoting at 80% of its issue price. All of them have lost money and transactions are few and far between. Five or six real estate firms got listed at AIM but the party is over. They all went there to raise money to buy land as it was not available here.
Banks are going slow in disbursing home loans. Isn’t that an opportunity for HDFC?
The slowdown is not good for the country and for HDFC. We have always grown at about 30% and our first quarter growth has been good but we do see a little bit of slowdown in August to around 24%. We will have to wait as August has traditionally been a difficult month because of monsoon.
There is a great opportunity for an asset reconstruction fund in real estate sector today. Some projects will get stuck and they need to be bailed out. Developers who have bought land need to make payments in phases and if they cannot do so, they will face litigation.
It’s a great opportunity for rehabilitation and asset reconstruction funds or venture capital funds and take advantage of the situation.
What about HDFC’s property funds?
We have two property funds – one is a $800 million foreign fund and another Rs4000 crore domestic retail fund which is managed by our asset management company. We have not invested more than 5-10% of that.
What about the foreign fund?
We have invested about $150 million of the foreign fund. We have taken a stake a very large project of Shapoorji Pallonji (and Company Ltd), spread over cities.
Aren’t you slow in your investments?
Yes. But we are not getting attractive deals. The pain is there but it’s not unbearable. When it becomes unbearable, prices will be more realistic. Today, every developer hopes that things will pick up. When I ask builders why aren’t they getting rid of their stocks, they say they don’t want to bring down the prices when the market is slow. I think they will give some incentives during the festivals – Dussehra and Diwali. For the time being, they are holding on…
Is it a bad time for HDFC?
We have always worked on four principles. First, our non-performing loans must be below 1% and we always maintain that. Second, our return on equity must increase by more than 1 percentage point every year. Third, the cost income ratio should always be below 15%. Last year, it was 9.2%. Finally, we must maintain a growth between 20% and 30% and we have always maintained that. I think the next two-three quarters will be bad but we will still end up growing above 20%.
What’s your take on interest rate and liquidity?
Liquidity today is not so much of a problem but the cost (of money) is. One can borrow (money) as market has not tightened to that extent and a triple-A rated borrower like us can get 1-year to 15-year loan easily but the cost (of borrowing) has gone up. RBI wants to bring down the inflation rate to around 7% by March next year and I think there is still pain left in interest rates… RBI may increase interest rates in next one month or so by another 100 basis points in order to contain inflation if it does not see food prices coming down after the monsoon
Will you also hike rates?
Yes, if interest rates go up, we will have to. I hope it doesn’t (happen).
Is Citigroup Inc. selling its stake in HDFC?
The Citi chief executive officer (CEO) has publicly said that non-core assets will be sold across the world and they have started selling them. They have sold real estate in Mumbai. They have put expensive flats on the block and more such deals are on the cards. But I can’t say at what stage the HDFC stake will be put on the block. I have been told by Citi that it’s strategic investment. As far as we are concerned, we have been doing businesses together. We used Citibank as our fund manager when we raised the international property fund. We want to give business to Citi and we want to work closely with the bank. We hope to do the initial public offers (IPOs) of our life insurance firm and the asset management company (AMC) sometime in 2009 and we will invite Citi to make a bid for the mandate and give them a little preference (over others) because Citi is a fairly large shareholder (in HDFC).
Currently Citi is saying HDFC stake sale is not on the agenda but since I don’t own the stock, I really don’t know what will happen in future.
People who do not have an exposure to India, and those who already have exposure but want to increase it, keep on calling us and telling us to keep them in mind if Citi actually sells its stake. They are Spanish, Italian and big Japanese banks.
Your life insurance business is growing at a very slow pace.
Yes. That’s because we do not want to have too many policies and let them lapse. We give special training to our agents and we don’t want them to go out in the market and start selling a product, which they don’t understand. There are other insurance firms who don’t even want 100 hours of training (for their agents). They stamp a certificate and send the agents for business. We have a different approach. Standard Life (Insurance Company Ltd), our overseas partner, says it is a long-term game and we shouldn’t worry where we are…
Where are you (in the business)?
On some ratios, we are third; on some other we are fourth and fifth. We don’t look at these as we need to be around 100 years later and build a long-term business and the base must be solid. All our actuaries are from Scotland; they are extremely conservative and cautious…
But Deepak Satwalekar, its CEO, is not from Scotland …
He has the HDFC culture. Deepak had grown up here in an atmosphere and environment of conservatism. We don’t worry about. We like it.
You plan to take the life insurance firm to market in 2009. Is it correct to say that IPO market will remain bad till that time?
We are not really concerned about the market conditions. We will raise a small amount and I believe that if you have a good track record, even in the worst phase of bear market you can raise money. We may raise Rs500- Rs1000 crore and that’s not difficult with out track record. We may get a little lower price but we always leave money on the table for the investors. That’s our philosophy.
What about your general insurance firm?
We have got new partner, new team and new CEO. We are very active in the market in the last two months and you need to give us one more year and we will become No 3. We had a couple of bad years and did not do anything. Chubb (Global Financial Services Corporation), wanted to buy us out but they could not find a partner and IRDA (Insurance Regulator Development Authority) did not give them permission. We lost one year this way and another year was lost fighting on valuation…
Will the government raise the ceiling on FDI in insurance to 49%?
It could work out. The government made this commitment many years ago and its credibility is at stake. The government was blaming the Left (Front, a former ally) for not being able to do this but now the Left parties are not there anymore, (so) we expect the government to go ahead.
What about your asset management business?
This will go to market before the life insurance company. We are now No. 2 in terms of assets under management but the most profitable AMC in India. We have a good track record and will get good value. We hope to do about 10% dilution in first phase and our stake will come down from 60% to 50% but it will maintain at that level.
Any plan to go for a holding company structure at HDFC group?
The biggest stumbling block for a holding company was dividend distribution tax at two levels. The government has removed the dual taxation in the Union Budget. Now a holding company concept can work.
We could look at the holding company concept. We have various options before us but first we want to take the AMC to the market in September-October next year and then the life insurance firm.
So, have you put the discussions on holding company on the back burner or are they fairly active?
I’d say, fairly active. There were talks about an intermediate holding company concept and ICICI (Bank Ltd) was planning to do that but the government was not encouraging this because of the lack of clarity on who will regulate the intermediate holding company. If we go for a financial holding company, then RBI can be the regulator and the different constituents can be looked after by different regulators. This kind of model can work under RBI, the super regulator — also the holding company of the regulators. Worldwide you have this — Citicorp and HSBC have hundreds of subsidiaries under them in different countries. We really need to see how it plans out in India.
It’s taking fair amount of our time and attention as we will have to go for model, which works well for us. It could be next year or after the IPO but we are thinking about different models.
The Indian economy has had a phenomenal growth till recently. Do you see any missed opportunities?
We didn’t do many things. Particularly, we did not start any large project. There are six steel mills under planning but not even one of them got the (required) approvals. There are problems of land allocation, environment, iron ore, lack of infrastructure…. The Mittals, the Tatas, the Essar group, the Jindals (JSW Group) and Posco, all have big plans but none of them has started construction as yet. All these projects have been on the drawing board for four, or five years. We are shooting ourselves because there will be short supply of steel and the prices are going to escalate.
Similarly, I know plans of a dozen-odd greenfield and brownfield cement plants are. For instance, LafargeSA has plans for four states – Himachal Pradesh, Karnataka, Rajasthan and Meghalaya, but not a single project has started. They all have been on the drawing board for last three years because the company is not getting mines, limestone, environment clearance or people want favours. But multinationals are not allowed to pay money (bribes).
If we don’t increase our domestic supply of cement and steel, it’s going to kill us in the long run. In every sector, I see the same thing.
Similarly, we will have to increase farm productivity and improve our distribution system. We have to reform Food Corporation of India (FCI), the biggest public sector body with maximum number of warehouses.
We have been hearing horrendous stories about FCI. Food is rotting there. Has anybody looked at reforms at FCI? Shouldn’t there be a public debate on it? These are all adding to our inflation.
We have killed our fertilizer industry by giving them unremunerative prices. The government subsidy comes after 18 months and banks do not give working capital to the fertilizer companies. I was a director on the board of fertilizer company but I left as the company was turning a defaulter. I could see this coming and resigned very quickly as otherwise RBI would have blacklisted me (for being a director of a defaulting company).
I can give you hundreds of such examples in every sector where things are in our hands and we are to be blamed for not doing anything.
You are setting up an office in Singapore.
Our international ambition is very limited and only time will tell whether we are right. When all those building societies were crumbling abroad, we were getting calls for making equity investments but we do not have the resources and have enough work to do in India. Our international operation is very modest. We have set up housing finance companies in Bangladesh, Sri Lanka and Egypt with local partners. We have made small investments and getting dividends from them.
We are interested in increasing the housing stock in India — the home ownership rate. So, we are opening small representative offices and source housing loans wherever there is a large Indian population. We have such offices in London and Dubai where we offer information on housing — price, availability etc.
The applications are processed in India and the loans are disbursed in India as the houses are in India, but the repayments come from overseas. We want to set up a similar office in Singapore.