Bangalore/Mumbai: Just as it seemed that banks had curbed lending to the real estate sector, a study shows that they actually lent more—a significant chunk of it being risky loans to firms that are not listed on the stock exchanges.

Between October 2010 and September 2011, according to a December report by IDFC Securities Ltd, lending by banks and non-banking financial companies (NBFCs) to real estate developers grew 14% to 1.6 trillion.

Unlisted developers account for 62% of this sum, says the report titled Unlisted Developers: The bigger black hole.

Banks lent .15 trillion.

Experts warn that such a fast pace of lending will only lead to an increase in loan defaults, especially with realty firms struggling to sell properties.

“With the next six-nine months expected to remain difficult (for the realty sector) and a significant portion of debt due for repayment, defaults by some unlisted players are unavoidable," analysts Nitin Agarwal and Vineet Chandak of IDFC Securities wrote in the report.

Financial strain: A residential project under construction in Gurgaon. The IDFC report says real estate firms may be forced to slash prices by 10-25% due to poor sales. Mint

Given that operational cash flows of many developers are strained due to low sales, they could be forced to cut prices, the IDFC report says, predicting a much-anticipated 10-25% correction in property prices in the near to medium term.

The implications of heavy borrowing by unlisted realty developers are multi-fold, said Amit Goenka, national director-capital transactions, Knight Frank India, a property advisory.

Of the incremental lending of about 20,000 crore between October 2010 and September 2011, 67% went to unlisted firms, according to the IDFC report.

“These are unprecedented leverages for them and chances of defaulting are high," Goenka said. “Going forward, we may see consolidation in the form of distressed sales of assets, taking private loans or private equity money to pay off other loans and consummation in discounted sales."

Unlisted borrowers offer more attractive returns or agree to higher interest rates, Goenka said, explaining perhaps why banks lent to these firms ignoring the regulator’s warnings.

IDFC’s Chandak said that in some instances, banks have asked the unlisted borrowers for “almost twice the collateral because the sector risk profile has gone up".

Most bankers agree that loans to unlisted developers can be riskier since the corporate governance standards of these firms are not satisfactory in many cases.

“It is a serious issue as there is a higher chance of default as they are not following corporate governance," said the chief financial officer of a foreign bank, who did not want to be identified.

“Real estate business itself is largely unorganized... It is not true to say that listed companies are always safer and unlisted ones are not in terms of credit quality, although they may not have corporate governance standards as good as listed ones," said B.A. Prabhakar, who is set to take over as the chairman and managing director of state-run Andhra Bank from 1 January.

The bank has not seen any defaults from real estate companies so far, he said.

Growth in gross debt for the top 25 listed real estate firms largely remained unchanged between October 2010 and September 2011. For DLF Ltd, the country’s largest developer by sales, however, net debt rose by nearly 1,000 crore in the quarter ended September to 22,519 crore, which the firm said was due to delays in receiving payments from its sales of non-core assets.

Buckling to the pressure from equity investors, listed developers have sought to manage or reduce their debt-equity ratio by curbing aggressive land acquisitions, by raising equity, or selling non-core assets, among other measures, the IDFC report said.

Developers, typically, get money from banks to finance projects at 12-14% interest rates and from NBFCs at 18-20%. About 30-35% of the funds a developer needs typically come from banks.

Demand for funds by unlisted realty firms is huge, particularly with the market for initial public offerings (IPOs) drying up due to stock market volatility. The last public share sale by a real estate firm in India was by Prestige Estates Projects Ltd in October 2010, after which nearly $4 billion of fund-raising largely meant for acquisitions and debt repayment was called off because developers didn’t think the market conditions were conducive.

Two large IPOs planned by realty firms Emaar MGF Land Ltd and Lodha Developers Ltd were put on hold.

Sunil Mantri, chairman, Sunil Mantri Realty Ltd, said listed developers have access to more fund-raising channels such as pledging of shares, while unlisted developers have few options to choose from and have to battle the increasing costs of borrowing.

“We have got bank loans for mid-sized residential projects, with all approvals, but they aren’t keen to lend to long-gestation projects," said a Bangalore-based developer, who didn’t want to be named. “We have also raised money from NBFCs for other corporate purposes at very high rates but sales have been good in Bangalore and, therefore, we will be able to pay back."