Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Beware, the NINJAs are coming

The appraisal process of lenders in India has been very strong historically. Most of the lending is to individual home buyers rather than to developers

In the sub-prime real estate crisis in the US in 2008, one category of borrowers were called “NINJA" borrowers. There were borrowers who presumably had “No Income, No Jobs and Assets". The loans to these borrowers were called “liar loans" on account of the fact that the borrowers just had to feed in fancy numbers relating to their income in the application form without backing up the same with evidence. There was also a period where the repayments on these loans were very low and the equated monthly instalments (EMIs) would shoot up in later years.

The underlying assumptions were that real estate prices only go up; in any case, they do not go down. Hence, the loans are not risky.

It was also assumed that borrowers would see their income rise over the years and even if a loan was not affordable at present, the increased income would enable servicing of the loans in later years.

We all know what happened to those loans.

In India, the assumption all along has been that the real estate market and the mortgage finance sectors are very different. The reason for this has been:

The Reserve Bank of India (RBI) and the National Housing Bank (NHB) have strong supervision of the sector.

The “equity" of the borrower is significant, meaning that the loan to value ratios are low and the borrower has to pay big amounts upfront.

There is a cash component in many real estate deals, which reduces the loan to value ratios even further.

The borrowers are end-users rather than speculators.

The appraisal process of lenders in India has been very strong historically. Most of the lending is to individual home buyers rather than to developers.

These assumptions have been tested over the years and so far we have not seen any significant defaults in the mortgage lending. Indeed, some of the participants in the mortgage finance sector are well respected for developing the Indian financial sector.

However, there are early signs of trouble brewing in this space. There have been reports from various agencies operating in the real estate space stating two things: 1) sales volumes of apartments have slowed down significantly, and 2) real estate pricing has been stagnant to falling.

This data if further corroborated by data from property registration authorities, which report a slowdown in tax collection and volume of transactions. In light of this, it is perplexing that while property developers are seeing slow sales, and property prices as well as property registrations are down, mortgage lenders are seeing increasing disbursements and higher loan books. Some of this lending may be accounted for by loans against property, but this is still a trend that requires channel check.

Based on some preliminary inquiries, I came across some trends that seem disturbing. On paper, mortgage lenders are sticking to getting 20% contribution from the borrowers. However, there is an element of nudge nudge, wink wink. The remaining funding of 80% provided by lenders is based on “market value" and not “agreement value" for under construction properties. This market value can include the cash component and appreciation in property value till the time of possession.

An example that I came across at a trade fair would be illustrative. A flat buyer or speculator could book a flat costing 75 lakh in a project by a big brand developer by paying just 3.75 lakh (5% of the flat value). For the next three years, the big brand mortgage lender keeps funding the big brand developer for construction of the flat. Closer to possession, the flat buyer has to pay another 5.25 lakh (7% of the flat value).

Thus, the buyer’s equity in the loan is just 5% initially and never crosses 12% of the total value. The additional 8% funded by the lender over 80% is by taking the market value of the flat at 110% of the agreement value. The EMIs only start after possession of the flat. Initially, the only outflow from the borrower is the tiny interest amount on the stage-wise loans disbursed to the developer. (In some cases, an interest subvention is thrown in, so the developers pay the interest instead of the buyer). While calculating loan eligibility, the income growth of the borrower over three years is taken into account.

All said, these loans look quite dodgy. While they help keep up the facade of all is well and that loan book is growing, the true test will be when the full EMI payments hit the borrowers. These are effectively developer loans instead of loans made to individual home buyers. A lot of these properties are in the distant suburbs of cities, marked by oversupply and difficult commutes to places of employment. Many borrowers work with the private sector with uncertain job prospects. Warren Buffett said, “It is only when the tide goes out that one knows who has been swimming naked." There will be some interesting times ahead.

Rajeev Thakkar, chief information officer and director, PPFAS Asset Management Pvt. Ltd.

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