Extended Annual Review Report

Loan Number: 2057 February 2008

India: Private Sector Housing Finance Project (Dewan Housing Finance Corporation Limited)

In accordance with ADB’s public communications policy (PCP, 2005), this completion report excludes information referred to in paragraph 126 of the PCP.

CURRENCY EQUIVALENTS

Currency Unit – Indian rupee/s (Rs)

At Appraisal At Project Completion 26 September 2003 30 November 2007

Rs1.00 = $0.0118 $0.0251 $1.00 = Rs45.78 Rs39.76

ABBREVIATIONS

ACR – asset cover ratio ADB – Asian Development Bank bps – basis points CRISIL – Credit Rating Information Services of India Limited DHFL – Dewan Housing Finance Corporation Limited DMC – developing member country EROIC – expected return on invested capital GDP – gross domestic product HDFC – Housing Development Finance Corporation Limited HFC – housing finance company IFC – International Finance Corporation LMI – low and middle income LTV – loan-to-value NHB – National Housing Bank NPL – nonperforming loan PSOD – Private Sector Operations Department RBI – Reserve Bank of India RRP – report and recommendation of the President XARR – extended annual review report

NOTES

(i) The fiscal year (FY) year of the Government of India ends on 31 March. “FY” before a calendar year denotes the year in which the fiscal year ends, e.g., FY2004 ends on 31 March 2004.

(ii) In this report, “$” refers to US dollars.

Vice President L. Jin, Operations Group 1 Director General R. Bestani, Private Sector Operations Department (PSOD) Directors W. Willms, Capital Markets and Financial Sectors Division, PSOD J. Yamagata, Infrastructure Finance Division 2, PSOD Team leader C. Engstrom, Senior Investment Specialist, PSOD Team member R. Hernandez, Investment Officer, PSOD

CONTENTS

Page

EXECUTIVE SUMMARY i

I. THE PROJECT 1 A. Project Background 1 B. Project Features 2 C. Progress Highlights 3

II. PROJECT EVALUATION 4 A. Overview 4 B. Development Impact 4 C. ADB’s Investment Profitability 8 D. ADB’s Work Quality 9 E. ADB’s Additionality 10 F. Conclusion and Overall Evaluation 11

III. ISSUES, LESSONS, AND RECOMMENDATIONS 12 A. Project Issues 12 B. Lessons and Recommendations 13 C. Issues to Monitor 13

APPENDIXES 1. Basic Data 152. Project Description 173. India Housing and Mortgage Sector Overview 204. Financial Overview and Statements 255. Private Sector Development Indicators and Ratings: Financial Intermediaries 31

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EXECUTIVE SUMMARY

In December 2003, the Asian Development Bank (ADB) approved funding of up to $40 million equivalent in Indian rupees, consisting of two loans of up to $20 million each in Indian rupees, as presented to the Board in the report and recommendation of the President on proposed loans for the Private Sector Housing Finance Project in India in 2003 (the RRP). The Private Sector Housing Finance Project was created to promote market-based mortgage lending to underserved markets in India. The loans provided under this project were to support the expansion of two rapidly growing, well-capitalized housing finance companies (HFCs), Sundaram Home Finance Limited and Dewan Housing Finance Corporation Limited (DHFL). The focus of this extended annual review report (XARR) is DHFL (the Project). The review is based on the findings of the XARR Mission of 26–27 November 2007, as well as information gathered from legal and ADB Board documents, audited financial statements, and related operation and business reports. The mortgage finance market in India was quite underdeveloped at the time that the Project was approved; the RRP reported only about 2% of India’s gross domestic product (GDP). The market was primarily comprised of HFCs, commercial banks, and public sector banks. DHFL, founded in 1984, was the fourth largest HFC at the time the ADB loan was approved. Its target market was the lower- and middle-income (LMI) segment in predominately semi-urban and rural areas. ADB’s loan to DFHL came from ADB’s ordinary capital resources. The 10-year loan to DHFL was funded from ADB’s rupee bond issue.

The evaluation criteria used for DHFL are based on the Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations released in 2007 (the Guidelines). In this regard, ADB’s support of DHFL’s mortgage lending operations was evaluated against four criteria: (i) development impact, (ii) ADB’s investment profitability, (iii) ADB’s work quality, and (iv) ADB’s additionality. On the basis of the foregoing, the overall rating of the Project is satisfactory.

The development impact of ADB’s support of DHFL is rated satisfactory. The overall development impact was evaluated against four criteria: (i) development impact; (ii) business success; (iii) economic development; and (iv) environment, social, health, and safety performance. The Project’s contribution to the housing finance sector in India, while small as a percentage of total market share, has been important. DHFL has been able to provide mortgage finance to a market segment that had access only to debt, typically from moneylenders who offered very short-term finance at high costs. Moreover, DHFL has been able to operate profitably with low levels of nonperforming loans. It has provided a good example to the market with respect to its ability to originate mortgage loans to the LMI segment. DHFL’s underwriting standards, risk management, and corporate governance structure have made it an early leader in the industry.

With respect to the other evaluation criteria, DHFL’s business success is rated satisfactory. HFCs inherently have higher costs of funding. DHFL also has higher expenses than some of its peer HFCs because of increased operational costs associated with greater origination costs given the riskier client segment and geographic diversity needed to penetrate this market. With respect to economic development, no economic financial internal rate of return (expected return on invested capital, or EROIC) was presented in the RRP. Measuring EROIC prior to Project commencement and today, DHFL’s rating is partly satisfactory. DHFL has adhered to ADB environmental, social, health, and safety performance and is therefore rated satisfactory on this indicator.

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The investment outcome of the Project is satisfactory. Interest and principal payments have been made on time. Cumulative interest received so far totals Rs187.41 million ($4.76 million). The repayment of principal began on 5 November 2007 and the final repayment is scheduled for 5 November 2014. ADB’s work quality is rated excellent, and its monitoring and supervision, satisfactory. ADB’s Private Sector Operations Department (PSOD) staff identified and screened HFCs for development impact and profitability. The Project was part of an overall strategy not only to support housing finance in India but also to begin to expand this business throughout Asia. PSOD staff also engaged the Credit Rating Information Services of India Limited to assist with due diligence. With respect to monitoring and supervision, DHFL has been somewhat delinquent in its submission of reports and information; therefore, ADB’s monitoring and supervision is rated satisfactory.

ADB’s role and contribution is rated excellent. The Government’s 10th Five-Year Plan for 2002–2007 focused on improving overall human well-being throughout India, in addition to encouraging GDP growth. Growth and investment was to be led primarily by the private sector. This was particularly important, given the urgent need to improve infrastructure in the country, which was perceived to be a major impediment to growth. Thus, the provision of access to adequate housing supported the Government’s broader theme of improving overall human well-being and infrastructure throughout India.

ADB’s additionality is rated satisfactory. DHFL had limited options for raising long-term financing at optimal costs in 2003. Of DHFL’s total borrowings as of 31 March 2007, ADB’s loan comprised 2%. Despite the lower amount of funding that ADB provided as compared with DHFL’s total borrowings, ADB’s loan did positively affect DHFL’s profitability. Had DHFL not had the benefit of ADB’s loan, profitability would have been reduced by the differential rate of interest on outstanding loans as compared with the weighted average cost of capital.

The main variations from the original RRP primarily consist of projected market developments. The RRP discussed the changing mortgage finance market in India in 2003 with the entrance of the commercial banks. The market was growing as a result of rising personal incomes and was increasingly becoming more competitive. Commercial banks were more inclined to offer floating-rate loans, as their source of funds was deposits. This allowed commercial banks to undercut HFC pricing, particularly in urban areas. With the downward trend in interest rates during this period, borrowers also sought floating-rate loans. HFCs had traditionally offered fixed-rate loans. However, with the entrance of the commercial banks and the demand for floating-rate loans, HFCs also began to offer floating-rate mortgage loans. As a result, DHFL requested ADB to provide both fixed- and floating-rate funding. The Loan Agreement agreement between DHFL and ADB, dated 19 July 2004, was amended to accommodate this request. Another change in the outlook presented in the RRP was in the sources of funding for HFCs. The regulator, the National Housing Bank (NHB), provided long-term funding to HFCs. Over the past few years, the NHB has reduced the tenors of its funding, which has resulted in maturity mismatches on the balance sheets of HFCs. Additionally, external commercial borrowings have been restricted by the Government, which has further reduced the availability of long-term rupee funding for HFCs.

Two main lessons can be drawn from the Project. First, although more difficult,

specialized HFCs can offer loans to the LMI segment on a commercially profitable basis. In order to do so, HFCs must have highly trained, experienced staff, and sound credit underwriting

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and portfolio management policies. Most people in emerging market countries have a lack of credit history, which should not be an insurmountable barrier to obtaining long-term mortgage loans. Second, relying on a government regulator as a major source of funding may not be viable over the long term. Regulators are not typically stable sources of long-term funding, since funding is not the primary reason for their existence and may tend to diminish over time. In summary, the Project provides a good example of targeted mortgage lending to the LMI segment, which may be replicated in other countries.

I. THE PROJECT

A. Project Background

1. In December 2003, the Board of Directors of the Asian Development Bank (ADB) approved funding of up to $40 million equivalent in Indian rupees for the Private Sector Housing Finance Project in India. This project was created to promote market-based mortgage lending to underserved markets in the country. The ADB loans were being made to support the expansion of two rapidly growing, well-capitalized housing finance companies (HFCs), Sundaram Home Finance Limited and Dewan Housing Finance Corporation Limited (DHFL or the Company). As presented to the Board of Directors in the report and recommendation of the President on proposed loans for the project (the RRP), Sundaram and DHFL were each to receive a loan of up to $20 million equivalent in Indian rupees.1 The proceeds of the loans were to have been used for mortgage onlending, primarily targeting underserved markets. After Board approval, however, the loan to Sundaram was not disbursed.2 Therefore, the focus of this extended annual review report (XARR) is DHFL (the Project). Basic data and the project description are provided in Appendixes 1 and 2. 2. Historically, India has suffered from a shortage of housing for its rapidly growing population. In 2003, mortgage finance was only 2% of GDP, compared with mortgage penetration rates of 8% in the People’s Republic of China, 13% in Thailand, and 17% in Malaysia.3 In developed countries, mortgage penetration rates are typically 50% of GDP or higher. Despite the low number of mortgages in India, mortgage lending was a growing business in 2003. In FY2003, mortgage disbursements were estimated at Rs407.7 billion, 63% higher than in the previous fiscal year. Lower lending rates, at about 8%–9%, stabilized property prices, rising personal incomes, and tax incentives for home owners contributed to the increase in mortgage disbursements. 3. The mortgage market in India had been dominated for many years by the HFCs. The HFCs are a diverse group of finance institutions, with some focusing on regional areas in India and others targeting specific consumer segments. All HFCs are regulated by the National Housing Bank (NHB). At the time of the inception of the Project, the mortgage market was changing. Perceiving the large unmet demand and forecasts for robust growth, commercial banks became more active in the mortgage finance market. Approximately 52% of disbursements in 2002–2003 was from commercial banks.4 However, the two leading HFCs, the Housing Development Finance Corporation Limited (HDFC) and LIC Housing Finance Limited, represented one-third of the market. (See Appendix 3 for more details on the housing and mortgage finance sector in India.)

1 ADB. 2003. Report and Recommendation of the President to the Board of Directors on Proposed Loans under the

Private Sector Housing Finance Project in India. Manila. 2 ADB’s proposed loan of $20 million local currency equivalent was not disbursed to Sundaram as the Reserve Bank

of India did not approve Sundaram’s request to borrow from ADB via a swap. ADB had intended to provide local currency financing to both DHFL and Sundaram through an ADB rupee bond issue and a cross-currency swap. The proceeds from the rupee bond issue provided funding for ADB’s entire loan to DHFL but could cover only part of the proposed funding for Sundaram. Sundaram was later able to obtain cheaper funds from the National Housing Bank.

3 ADB. 2003. Report and Recommendation of the President to the Board of Directors on Proposed Loans under the Private Sector Housing Finance Project in India. Manila (page 1).

4 ADB. 2003. Report and Recommendation of the President to the Board of Directors on Proposed Loans under the Private Sector Housing Finance Project in India. Manila (page 16).

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4. The HFCs and the commercial banks differed with respect to target markets, business models, and products. Commercial banks focused predominantly on large urban areas and higher-income borrowers. Their business model included product cross-selling through large branch offices. Consequently, specialized mortgage lending skills were not widely developed. While some HFCs focused on urban areas, their target borrowers were more diverse. Typically, HFCs served lower- and middle-income (LMI) borrowers. Additionally, some HFCs, such as DHFL, specifically marketed to semi-urban and rural borrowers who had very limited access to traditional sources of credit. With respect to products, the HFCs tended to offer more flexible and creative products to attract customers. HFCs also traditionally offered fixed-rate products, while commercial banks offered floating-rate products. 5. One of the most fundamental differences between HFCs and commercial banks was with respect to their sources of funding. With the growth of commercial bank participation in the market, floating-rate loans were offered with regularity and became popular with borrowers. Commercial banks had access to floating-rate funds from their demand deposits; therefore, they were more likely to offer floating-rate loans to borrowers to reduce asset-liability mismatches. HFCs, on the other hand, could provide longer-term, fixed-rate mortgage loans because their funding primarily consisted of refinancing from the NHB and foreign commercial borrowings. HFCs also sourced floating-rate lines of credit from banks and, to a more limited extent, fixed deposits from the public. For larger, highly rated HFCs, limited amounts of funding could be accessed through securitization. In general, funding costs for HFCs were typically more expensive. The majority of their funds were provided through the NHB. In 2003, the NHB was lending at 6.5%–8.0%, and commercial banks, at 5.5%–6.0%. Despite these differences, the RRP showed that core profitability was comparable in 2003 between HFCs and commercial banks. 6. ADB’s Private Sector Operations Department (PSOD) chose to provide funding to HFCs, rather than commercial banks for a variety of reasons. HFCs were perceived to have a higher developmental impact, as some provided funding to underserved customers in semi-urban and rural areas. Moreover, they were considered to be better able to reach these customers and underwrite their risks. HFCs were also considered to have stronger asset and liability management positions, since their longer-term mortgage loans were matched by long-term funding from the NHB and, for some, external commercial borrowings from multilateral development banks. 7. DHFL was identified by PSOD as a good candidate for ADB funding. It was a growing, profitable HFC with low levels of nonperforming loans (NPLs). The Company was the fourth largest HFC in India in 2003. Established in 1984 by the Wadhawan family and listed on the Bombay Stock Exchange and the National Stock Exchange, DHFL provided loans to individuals in the LMI segment in semi-urban and rural areas throughout India. Previously, borrowers in this segment had access only to moneylenders, who provided very short-term loans at high interest rates. DHFL was known for its strong underwriting skills and its ability to offer creative products to its customers. Over 70% of the Company’s borrowers had self-constructed homes, which was representative of the typical markets in smaller towns and their surrounding areas. Moreover, the average size of DHFL’s loans in 2003 was $8,000, showing the Company’s commitment to the LMI segment.

B. Project Features

8. The Project entailed the provision of a 10-year loan to DHFL for the purpose of originating new mortgage loans. The loan agreement between DHFL and ADB of 19 July 2004

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(the Loan Agreement) provides for long-term, fixed-rate rupee debt, which would limit interest rate and maturity mismatches, and would not create currency risk. Subsequent to the signing of the Loan Agreement, ADB executed an amendment to the Loan Agreement to allow DHFL to draw both fixed and floating-rate disbursements from ADB (the Amendment). The term loan is secured by a first charge on all movable and immovable assets of DHFL, both present and future, shared pari passu with all the lenders. A covenant included in the Loan Agreement ensures that DHFL continues to focus on the LMI segment. The covenant states that, at all times, 70% of newly originated mortgage loans must be comprised of loans to the priority sector as defined by the Reserve Bank of India (RBI). In 2003, loans in the priority sector were limited to $22,000 in urban areas and $11,000 in semi-urban areas.

C. Progress Highlights

9. ADB’s loan to DHFL has been fully disbursed in the amount of Rs918,600,000. The first disbursement was made on 5 November 2004 and the final disbursement on 29 June 2005. The loan was disbursed on a floating-rate basis. 10. Today, DHFL is the third largest HFC and the second largest private sector HFC in India. Its overall share of the mortgage finance market in India, however, is small, at about 1.5%. In 2003, it had a branch network of 41 branches. Currently, the Company has 155 locations—53 main branches, 67 service centers, and 35 camps—across the country. In 2006, DHFL opened an office in Dubai, United Arab Emirates, to provide mortgage loans to Indians living in and around Dubai and other Gulf countries who wish to purchase homes in India. The Company continues to focus on serving the LMI segment and has steadily increased its disbursements to this segment, as Table 1 shows.

Table 1: Highlights of DHFL’s Operations

(Rs million)

Item FY2003 FY2004 FY2005 FY2006 FY2007 Loan Approvals 4,473.60 5,259.40 7,414.60 12,570.20 15,028.90 Loan Disbursements 4,186.50 4,685.40 6,337.60 11,103.00 14,728.70 Cumulative Disbursements 16,556.40 21,241.80 27,579.40 38,682.40 53,411.10 DHFL = Dewan Housing Finance Corporation Limited, FY = fiscal year. Source: Dewan Housing Finance Corporation Limited

11. DHFL has achieved solid growth through the years. It has registered strong profits yearly, and continues to pursue business growth aggressively (see Appendix 4 for more details on DHFL’s financial performance). The Company has effectively structured its products to respond to the rapidly changing macroeconomic scenario without changing its customer focus and long-term lending strategy. DHFL has maintained its current product offering, which comprises housing loans for the purchase or construction of homes, home improvement loans, home loans for women, and lease rental financing. DHFL continues to offer new products to respond to customer needs. A new product, the reverse mortgage loan introduced in FY2007, enables senior citizens to borrow against the value of their homes. DHFL also recently introduced the “cluster program,” whereby the Company educates and markets its products to low income groups in communities in or around Gujarat, Tamil Nadu, and Kerala. DHFL is also working with the NHB to formulate the first national housing price index to better regulate real estate prices.

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II. PROJECT EVALUATION

A. Overview

12. The assessment of DHFL’s development outcome is based on four categories: (i) development impact, (ii) ADB’s investment profitability, (iii) ADB’s work quality, and (iv) ADB’s additionality. Performance in the main categories and subcategories was rated according to ADB’s Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations (the Guidelines).5

B. Development Impact

13. The Project generally achieved the development impacts set forth in the RRP. They were identified as follows: (i) providing mortgage finance, thus stimulating construction and other industrial activities; (ii) expanding home ownership, thereby contributing directly to improved living conditions and quality of life; (iii) supporting a nonbank HFC by providing cost-effective matching funds; and (iv) encouraging new HFCs to enter the market by demonstrating a viable business model.

1. Development Impact

a. Direct Company Impacts 14. ADB’s loan enabled DHFL to increase its disbursements to the LMI segment in India. As shown in Table 1, cumulative disbursements increased 223% from FY2003 to FY2007. Additionally, the fact that the current average loan size is still small, at between $10,000 and $15,000, indicates that DHFL is maintaining its commitment to provide mortgage finance to borrowers in the LMI segment. Provision of mortgage finance by DHFL has raised home ownership rates in rural and semi-urban areas throughout India. The Company has also been involved in low income rural development projects. It participated in the Government’s Golden Jubilee Rural Housing project, providing loans for 1,440 housing units in rural areas. Moreover, the breadth of DHFL’s current geographic reach is impressive (Table 2).

Table 2: Geographic Distribution of DHFL’s Portfolio

(as of 31 March 2007)

Region Amount

(Rs in lakhs) Percentage

of Total North Central and East 33,855.15 10.14 South 103,329.22 30.96 West 196,588.20 58.90 Total 333,772.57 100.00 Note: A lakh is equal to 100,000 rupees. Source: Dewan Housing Finance Corporation Limited.

15. DHFL provides mortgages with tenors of up to 20 years. Therefore, the Company has benefited from long-term, matching funds provided by ADB. Longer-term funds at reasonable rates were difficult to obtain in India in 2003. HFCs could raise small amounts through the corporate bond market, but this was an expensive alternative and the tenor was typically shorter than what DHFL obtained from ADB. Thus, by providing long-term funds, the maturity mismatch 5 ADB. 2007. Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations. Manila.

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decreases and the Company is in a stronger position to provide long-term funding to its clients. Longer-term funding lowers the monthly installment thereby making the loan more affordable for the borrower. 16. The RRP indicated that fixed-rate funding would enable DHFL to lend to its borrowers on a fixed-rate basis without interest rate mismatches. However, as noted, DHFL requested ADB to provide both floating- and fixed-rate funding and the Loan Agreement was therefore amended to this effect. Interest rates were low in 2003 and most commercial banks were lending on a floating-rate basis. As competition in the mortgage market increased and borrowers became more interested in obtaining floating-rate loans due to lower interest rates, DHFL began to offer more mortgage loans on a floating-rate basis. The majority of DHFL’s portfolio is on a floating-rate basis. Thus, DHFL’s floating-rate lending was largely matched by ADB’s floating-rate loan.

b. Beyond Company Impacts

17. ADB’s support of DHFL has helped to promote the development of housing finance in India, an important factor in the country’s economic and social growth. With a healthy mortgage market a country can generate additional sources of employment. Jobs are created in the construction and home improvement industries, and in the real estate sector (such as in appraisal companies and in land titling or registration services). The housing industry is the second largest employment generator in India. 18. Besides its role in employment generation, mortgage financing has broader links to the economic development of a country. It boosts the consumption of consumer goods. Those who buy new homes may also buy refrigerators and other items needed for their new home. Moreover, mortgage lending creates one of the most important sources of capital for an individual or family. Capital for small- and medium-sized enterprises can be obtained through a mortgage on property. Finally, governments benefit from taxes on the properties and businesses. 19. Support for the development of a primary mortgage market can lead to the creation of a secondary mortgage market, which can help catalyze the development of a country’s capital markets. The primary mortgage market must be able to produce a large volume of good quality mortgages that have been originated according to standardized documentation. Thus, support for the establishment of a strong primary mortgage market will hasten the development of capital markets. India’s capital markets activities have increased over the last 5 years. An increase in the volume of mortgages originated in the primary market has helped boost the number of mortgage-backed securities (MBS) that have been issued in India (see Table 3). Issuing MBS creates another source of funding for some banks and HFCs.

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Table 3: Mortgage-Backed Securitization Market in India (Rs million)

Item 2002 2003 2004 2005 2006 2007 Total MBS Issued 0.80 14.80 29.60 33.40 22.05 21.05 Number of Transactions 3 10 15 15 5 7 MBS = mortgage-backed securities. Source: ICRA and Fitch Ratings, India.

20. One development impact noted in the RRP that was not readily evident was the entrance of new HFCs into the mortgage lending market, particularly in the LMI segment. While DHFL does demonstrate a viable business model for the LMI market, there is only one other HFC that operates in this segment, Gruh Finance, which was already active at the time of the RRP. The LMI segment is hard to reach and the risks are at times more difficult to underwrite because of a lack of information. An HFC or bank operating in this segment must have staff that are highly trained and located in several areas. Most HFCs and banks prefer to target the larger metro areas because of high demand from wealthier clients, ease of underwriting, and lower operational costs. 21. DHFL has provided a good example to the broader mortgage finance market with respect to its ability to originate loans to the LMI segment. Its underwriting standards, risk management, and corporate governance structure with strong management enabled it to become an early leader in the industry. In the future, DHFL’s success, as well as the growth opportunities seen for mortgage issuance in semi-urban areas, may attract more competition for the Company. There are early indications that public sector and larger commercial banks are slowly entering this market segment. 22. The contribution to private sector development is rated satisfactory overall and on several individual indicators. The individual indicators are assessed in detail in the private sector development impact checklist in Appendix 5.

2. Business Success

23. Mortgage financing activities in India have continued to grow since 2003. The Credit Rating Information Services of India Limited (CRISIL) estimates that newly originated residential mortgage loans grew at a compounded annual rate of 33% over the last 3 years. 6 Total incremental disbursements increased from about Rs768 billion in FY2006 to Rs1 trillion in FY2007. The expanding economy, rising personal incomes, and lower interest rates have raised demand for mortgage financing. As a result, the mortgage market has become competitive, especially for HFCs, whose continued growth depends on better services to borrowers at often higher funding costs. DHFL, however, has created a niche market in the semi-urban and rural parts of India. The Company’s strong distribution network has helped it develop and maintain a solid relationship with its customers and has supported its continued expansion. 24. DHFL has grown several times over, as evidenced by its asset growth from Rs2.41 billion (FY1994) to Rs36.24 billion (FY2007), for a consolidated average growth rate of 32%. Net profits increased from Rs.48.51 million to Rs.484.01 million over the same period, yielding a consolidated annual growth rate of 17%. Compared with original RRP projections,

6 Shanker, Rupali. 2007. Mortgage Finance: Declining Affordability and Rising Debt Burden, Mumbai: CRISIL

Ratings.

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which estimated that net profits would be Rs400 million for FY2007, DHFL has exceeded expectations. Return on equity (ROE) in FY2007 was 16.96%, an increase from 15.96% in FY2006. Key performance figures and financial ratios are summarized in Table 4. A more detailed assessment of actual performance, financial statements can be found in Appendix 4. 25. The quality of DHFL’s portfolio is good. Net NPLs for FY2007 comprised 1.23% of the Company’s portfolio. Only the industry leader, HDFC, has a lower level of NPLs. Strong asset quality is a result of stringent credit guidelines, sound credit appraisal standards, and rigorous servicing of the existing portfolio. DHFL’s collection-to-billing ratio for the aggregate portfolio on a monthly basis for the last 5 years has been about 96.75%. 26. DHFL maintains a rating of AA+ from CARE for its long-term paper and a AA rating from Fitch for its fixed-deposit programs. It has also received a rating of P1+ for its short-term paper from CRISIL.

Table 4: Key Financial Highlights

Item FY 2004 FY 2005 FY 2006 FY 2007Income Statement Income from operations - net (Rs million) 1,442 1,610 2,264 3,319 Other income (Rs million) 27 28 4 4 Total income (Rs million) 1,469 1,638 2,268 3,323 Interest and other charges (Rs million) 970 1,059 1,482 2,322 Other expenditure (Rs million) 224 241 336 407 Total expenditure (Rs million) 1,195 1,301 1,818 2,728 Profit before tax (Rs million) 274 338 450 595 Tax (Rs million) 50 67 83 111 Gain on sale of lease hold land (Rs million) 50 Profit after tax (Rs million) 224 271 417 484 Balance Sheet Equity (Rs million) 1,317 1,896 2,707 3,653 Borrowings (Rs million) 11,175 15,666 22,696 32,147 Total liabilities and equity (Rs million) 12,492 17,562 25,403 35,800 Housing and other loans (Rs million) 11,259 15,293 22,887 33,020 Investments (Rs million) 694 1,202 968 963 Other assets (Rs million) 538 1,067 1,547 1,817 Total assets (Rs million) 12,492 17,562 25,403 35,800 Key Financial Ratios Return on equity (%) 17.28 16.85 15.96 16.96 Net interest margin (%) 3.61 3.17 3.08 2.97 Capital adequacy ratio (%) 17.12 16.46 13.33 14.06 Return on risk assets (%) 3.68 0.02 0.02 0.02 Return on invested capital 11.00 9.30 8.99 9.53 Weighted average cost of capital n/a 8.25 8.19 8.79 Debt to equity/leverage 8.48 8.26 8.39 8.96 Cost of funds (%) 8.20 7.79 7.82 8.47 Net profit margin (%) 15.25 16.55 18.39 14.57

FY = fiscal year. Source: Dewan Housing Finance Corporation Limited.

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3. Economic Development

27. As noted, the mortgage finance industry contributes to many aspects of a country’s economy, including employment, and taxes and revenues for the government. The construction sector is the most direct link to the mortgage finance market. In India, the construction sector is the second largest contributor to GDP, directly behind the agriculture industry. It is estimated that for every Indian rupee invested in housing, Rs0.78 is added to GDP.7 28. In semi-urban and rural areas, most houses are built by the home owners themselves or by very small construction firms. Therefore, the Project’s impact on the construction industry would be in terms of the construction materials purchased. This indirect impact cannot be measured, as data is not available. The sole measurable contribution to economic development is the Project’s tax generation for the Government. Since the Project consists of a corporate loan, the Guidelines indicate that the real economic rate of return (expected return on invested capital, or EROIC) can be used to assess the Project’s contribution to economic output and growth. The RRP did not give the EROIC at the start of the Project; however, according to data presented and obtained from DHFL, the Project’s contribution to economic development is partly satisfactory.

4. Environmental Aspects and Social Guidelines

29. Compliance with applicable environmental policies is satisfactory. The Project is categorized as “FI” and was expected to have minimal or no environmental impact. This assessment has not been changed during project implementation. DHFL has a system in place to ensure that the houses financed comply with the local zoning requirements and that the building plans comply with the local code and are duly approved by the municipal authorities. The due diligence of each mortgage loan includes a technical appraisal by a qualified civil engineer, who inspects and examines the approved building plans and proper adherence to national guidelines and requirements. The Project does not entail land acquisition and/or involuntary resettlement.

C. ADB’s Investment Profitability

30. ADB’s loan to DHFL was funded by a local bond issuance and priced at a spread over the fixed-rate swap equivalent of a 1-year government security for the relevant maturity. Once the floating rate was determined, it would remain in effect for two subsequent interest periods. The interest rate margin charged on ADB’s loan was based on DHFL’s AA rating for its unsecured fixed deposit program, as well as prevailing market pricing in 2003. The loan was specifically benchmarked to the loan made by the International Finance Corporation (IFC) to DHFL in the same year. 31. DHFL has been paying the interest on the loan in a timely manner. Cumulative interest received to date totals Rs187.41 million ($4.76 million). The repayment of principal started on 5 November 2007 and the final repayment is scheduled for 5 November 2014. DHFL is not expected to encounter any difficulty in meeting its payment obligations on the loan. ADB’s investment profitability is therefore rated satisfactory.

7 Source: Housing Development Finance Corporation Ltd. of India.

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D. ADB’s Work Quality

32. ADB’s performance is rated satisfactory based upon the following three categories: (i) screening, appraisal, and structuring of the Project; (ii) monitoring and supervision; and (iii) ADB’s role and contribution.

1. Screening, Appraisal, and Structuring

33. PSOD staff was responsible for screening, appraising, and structuring the Project. PSOD staff screened and selected banks on the basis of developmental impact, management capability, sector experience, and financial soundness. The proposal was well prepared and focused, and was generally supported by the Board because of the large unmet demand for housing in India, particularly, among lower-income households. DHFL was deemed to be a well-qualified, experienced company with good management and a relatively sound financial structure with a local currency rating of AA. DHFL’s average loan size was appropriate for the purchase of housing units at the lower end of the price range offered by private sector developers, in semi-urban and rural areas. CRISIL, a leading credit rating agency in India, was commissioned by ADB to conduct due diligence on DHFL, as well as to perform a study on the mortgage industry. DHFL’s performance has been good and has validated PSOD staff’s screening and appraisal. 34. ADB’s performance in project screening, appraisal, and structuring is rated excellent.

2. Monitoring and Supervision

35. PSOD has closely monitored DHFL’s performance since the loan was approved by the Board. The first annual review of DHFL for FY2005 and the interim results for the 9 months up to 31 December 2006 was completed in June 2006. Aside from the annual review, PSOD prepares quarterly Private Sector Investment Management Notes on DHFL reflecting the latest information on the Company. 36. ADB’s performance related to supervision and administration is thus rated satisfactory.

3. ADB’s Role and Contribution

37. The Government’s 10th Five-Year Plan for 2002–2007 (the 10th Plan) emphasized that development in India must not refer solely to GDP growth. It noted that “there is a growing impatience in the country at the fact that a large number of our people continue to live in abject poverty and there are alarming gaps in social attainments even after five decades of planning”. Thus, the Government noted, the goal of development should be more comprehensive and focused on improving overall human well-being. The 10th Plan was therefore aimed at the following objectives: high growth, equitable growth, human development, and the implementation of reforms to support the development of India. Growth and investment were to be led primarily by the private sector. This was particularly important, given the urgent need to improve infrastructure in the country, which was perceived to be a major impediment to growth. 38. ADB’s Country Strategy and Program for 2003–2006 (the CSP) complemented the 10th Plan.8 The CSP outlined three pillars of ADB’s strategy in support of poverty reduction in India: (i) good governance; (ii) pro-poor growth; and (iii) social development. Pro-poor growth was to be achieved through fiscal consolidation (better tax administration and public resource 8 ADB. 2003. Country Strategy and Program (2003─2006): India. Manila.

10

management), private sector development, infrastructure development, and agricultural and rural development. ADB’s private sector development strategy in India was to focus on supporting financial sector and infrastructure projects, creating an enabling environment for private sector infrastructure investments through reforms and public-private partnerships, and providing funding for other private sector projects that would support India’s growth. 39. The Project was consistent with the strategy of both the Government and ADB. The provision of access to adequate housing supported the Government’s broader concern with improving overall human well-being. It also supported the high priority assigned by the Government to improving infrastructure throughout India. Moreover, DHFL has had success in reaching borrowers in the North Central and Eastern regions of India (see Table 2)—underdeveloped areas which the Government had identified as needing more support.9 The Project’s links to other areas of the economy, such as tax revenue generation, also contributed to growth in the economy. 40. The Project was also consistent with ADB’s private sector strategy. On 20 March 2000, ADB’s Board of Directors approved the Private Sector Development Strategy.10 The strategy refers specifically to ADB’s role in strengthening the capital markets of developing member countries (DMCs), including the housing finance sector. It underlines the importance for DMCs to strengthen their financial institutions and create diversified financial markets so as to develop the domestic capacity to finance private sector–led growth. Thus, the Project was an integral part of the PSOD financial services strategy. Apart from the fact that it supported a company active in the financial sector, the Project was important because it supported the development of India’s domestic capital markets. There had been strong interest both from ADB and from DMC governments in local currency initiatives, particularly local currency bond issuances. ADB’s loan was the first to be financed from local currency bond proceeds. 41. ADB’s performance related to its role and contribution is rated excellent.

E. ADB’s Additionality

42. Additionality refers to the extent to which ADB’s financing was a necessary condition for the timely realization of the Project, as well as to ADB’s contribution to the design and functioning of the Project to improve development impact. Of DHFL’s total borrowings as of 31 March 2007, ADB’s loan represented 2%. Despite the lower amount of funding that ADB provided as compared with DHFL’s total borrowings, ADB’s loan had a positive effect on DHFL’s profitability. Had DHFL not had the benefit of ADB’s loan, its profitability would have been reduced by the differential rate of interest on outstanding loans as compared with the weighted average cost of capital. 43. More broadly, the support that ADB provided helped DHFL raise additional funds from sources other than the multilateral development banks. ADB’s presence enhanced the Company’s credibility when it raised additional equity capital. Furthermore, DHFL has tapped the capital markets twice since ADB’s loan. While the assessment of additionality is somewhat more subjective in this instance, DHFL believes that ADB’s participation also helped to raise DHFL’s profile, thereby generating more investor appetite for DHFL bonds. 44. ADB’s additionality is therefore rated satisfactory. 9 Approximately 6.7% of DHFL’s portfolio in 2005 was represented by loans in the Northern Central and Eastern

regions. In 2007, 10.1% of the Company’s portfolio was in this region. 10 ADB. 2000. Private Sector Development Strategy. Manila.

11

F. Conclusion and Overall Evaluation 45. In conclusion, the Project is rated satisfactory. A summary of the individual category ratings is provided in Table 5. 46. As discussed, the Project’s contribution to development impact is excellent. While DHFL represents only 1.5% of the total mortgage market in India today, its contribution to the housing sector has been important. It has demonstrated that a company can successfully target a market segment that has been traditionally underserved by banks and other HFCs, as the borrowers were deemed difficult to reach and, often, too risky to underwrite. DHFL has not only given people access to housing but has also educated borrowers through its extensive marketing and outreach activities. In addition, DHFL has participated in community programs, such as the Government’s Golden Jubilee Rural Housing Project, that have helped provide housing to the rural poor. 47. Measured against its peer group of HFCs, DHFL has performed quite well. Given its size, the Company is considered a second-tier HFC, particularly as measured against HDFC, which leads the HFC market in size and performance and is also one of the primary competitors to the commercial bank market. As mentioned, asset growth for DHFL on a consolidated average annual basis was 32% from FY1994 to FY2007. This growth rate is attributed not only to growth in the housing market, but also to DHFL’s successful efforts to penetrate the semi-urban and rural areas of India. Net profits have yielded a consolidated annual growth rate of 17%. DHFL has outperformed the original RRP projections. Its expenses, however, are higher than those of its peer group, partly because of the higher costs of operating in semi-urban and rural areas. Relative to the broader housing finance market including commercial banks, DHFL has been somewhat hampered by the inherent funding disadvantages associated with HFCs. Therefore, its cost of funds has been higher and longer-term funding has become more difficult to obtain. Commercial banks have also been able to gain an increasingly larger share of the market as a result of their ease of access to funding and their ability to cross-sell products, thereby reaching more customers. Thus, overall, DHFL has had satisfactory business success. 48. ADB’s role in the Project was consistent with the Government’s priorities, as well as ADB’s strategy for private sector development in India and throughout the DMCs. With these goals in mind, the original mission team identified and screened the Project very well. DHFL is one of the most well-established HFCs in India. Its management is respected and known for its ability to provide innovative products to the market. Due diligence was augmented through work done by India’s leading credit rating agency, CRISIL. ADB’s loan provided reasonably priced long-term funding to DHFL, which was important factor, given that such funding was less accessible to HFCs than to commercial banks.

12

Table 5: Evaluation of the Dewan Housing Finance Corporation Limited Project Item

Unsatisfactory

Partly Satisfactory

Satisfactory

Excellent

A. Development Impact x 1. Private Sector Development X 2. Business Success x 3. Economic Development x 4. Environment, Social, Health, and Safety Performance

x

B. ADB Investment Profitability x C. ADB Work Quality x 1. Screening, Appraisal, and x Structuring 2. Monitoring and Supervision x 3. ADB’s Role and Contribution x D. ADB Additionality x ADB = Asian Development Bank. Source: Asian Development Bank.

III. ISSUES, LESSONS, AND RECOMMENDATIONS A. Project Issues 49. The main variations from the original RRP pertain primarily to projected market developments, as follows:

(i) The RRP identified that the mortgage finance market in India was changing in 2003 with the entrance of the commercial banks. The market was growing as a result of rising personal incomes and was increasingly becoming more competitive. Commercial banks were more inclined to offer floating-rate loans, as their source of funds was deposits. This allowed commercial banks to undercut HFC pricing, particularly in urban areas. With interest rates on a downward trend during this period, borrowers also sought floating-rate loans more often. HFCs had traditionally offered fixed-rate loans. However, with the entrance of the commercial banks and the increased demand for floating-rate loans, HFCs also began to offer floating-rate mortgage loans. DHFL accordingly requested ADB to provide both fixed- and floating-rate funding. The Loan Agreement was amended to accommodate this request and all of DHFL’s disbursements were done on a floating-rate basis.

(ii) Another change in the outlook presented in the RRP was with respect to sources

of funding for HFCs. The regulator, NHB, provided long-term funding to HFCs. Over the past few years, NHB has reduced the term of its funding to about 5 years, in the process producing maturity mismatches on the balance sheets of HFCs. Government restrictions on external commercial borrowings have also further reduced the availability of funding for HFCs.

13

B. Lessons and Recommendations 50. Commercial Viability of Underserved Segments. One of the most important lessons that can be learned from the Project is that mortgages for customers in the LMI segments can be commercially viable. This borrower segment can be more risky, but, if underwritten and priced appropriately, the risks can be adequately contained. HFCs or commercial banks must have highly trained and experienced staff, and sound credit underwriting and portfolio management policies to successfully generate business in this market segment. 51. Funding Sources. Another lesson to be learned is the need to carefully assess the long-term viability of sources of funding for a project. Relying on a government regulator as a major source of funding may not be viable over the long term. Regulators are not typically stable sources of long-term funding, since funding is not the primary reason for their existence and may tend to diminish over time. 52. Mortgage Industry Restrictions. With respect to recommendations, to further reduce risk for ADB, standard mortgage industry guidelines could have been included in the Loan Agreement. The Loan Agreement does have standard and comprehensive financial covenants, but other covenants pertaining specifically to the mortgage industry, such as limiting DHFL’s ability to offer loans on a higher loan-to-value (LTV) basis, could have been included as well. While NPL levels have been low in India’s mortgage industry, as they have been in DHFL, restrictions on LTVs can reduce the likelihood and severity of future NPLs. C. Issues to Monitor 53. Mortgage Market Growth. As India’s housing market continues to grow and mature, it will be important to monitor the market. During the rapid expansion of the mortgage market from about 2003 to 2006, many commercial banks eased their lending standards as they pursued heightened demand in the market spurred by low interest rates and rising personal incomes. With demand outpacing housing supply, property prices in urban areas doubled in some neighborhoods. Prices were also bolstered by some speculative activity in the market in from mid-2005 to about early 2006. Thus, some commercial banks pursued aggressive growth strategies, offering loans as high as 100% of the cost of the property. As a result, gross NPLs in this sector have increased although they are still low. Gross NPLs were at 1.8% in 2005 and had increased to 2.2% by March 2007. CRISIL projects a further increase to about 2.7% in 2008.11 54. From 2003 to 2006, HFCs were under more intense competitive pressure from the growth of commercial bank activity in the mortgage business. In response, some HFCs moderately relaxed lending standards. As a result, NPLs increased slightly; however, they improved in 2007 and, among five of the leading HFCs, are under 2%. Lower core profitability for some HFCs, which is suppressing ROE, is becoming apparent. An analysis undertaken by CRISIL indicates that the incremental net profitability margins of some HFCs declined to 1.52% in the first half of 2006–2007, as compared with 1.76% in 2004–2005.12 (See Appendix 3 for more details.)

11 The Economic Times. 2008. CRISIL Sounds Caution in Retail Loans. 8 January. 12 Nayak, Prashant, and Tarun Bhatia. 2007. Housing Finance Companies Face Profitability Pressure, Mumbai:

CRISIL Ratings.

14

55. There are signs that the unprecedented growth in the mortgage market is slowing. The growth rate for 2006–2007 was 18% and the growth rate for 2007–2008 is projected to be at about 10% (footnote 13). As affordability has deteriorated due to higher interest rates and property prices, it has become more difficult for home borrowers to obtain mortgage financing. Additionally, some mortgage lenders are starting to tighten standards, which will further suppress market growth and lead to more comfortable growth levels. The RBI has taken several measures to reduce bank exposure to real estate and to curb non-prudent commercial bank lending. Should interest rates rise rapidly without income growth or higher prepayments13, the risk of delinquencies will increase. 56. DHFL’s position in its niche segment is strong in view of the continued growth in the market. CRISIL notes that for those HFCs like DHFL that operate in niches or specific regions where larger HFCs do not operate and banks are not competitive, profitability is unlikely to deteriorate substantially in the medium term. However, should commercial banks, as well as public banks, begin to aggressively enter the LMI segment, it will be important to monitor DHFL’s financial position. 57. Compliance with ADB Financial Covenants. DHFL is current in its principal and interest payments to ADB. The Company is not expected at this time to have difficulties meeting its obligations to ADB. ADB will continue to closely monitor DHFL’s compliance with the financial covenants as set forth in the Loan Agreement.

13 HDFC notes that between 10% and 12% of its loan portfolio has traditionally been prepaid every year.

15 Appendix 1

BASIC DATA

Dewan Housing Finance Corporation Ltd. A. Investment Identification 1. Country India 2. Loan Number 7189/2057 3. Loan Type Local Currency Financing 4. Type of Business Housing Finance 5. Project Title Loans under the Private Sector Housing Finance

Project 6. Name of Borrower Dewan Housing Finance Corporation Limited 7. Amount of Approved ADB Assistance Direct loan of up to $20 million equivalent in Indian

rupees 8. Extended Annual Review Report Number 1007 ADB = Asian Development Bank. B. Investment Data 1. Concept Clearance Approval 15 April 2003 2. Date of Board Approval 19 December 2003 3. Signing Date of Loan Agreement 19 July 2004 4. Date of Loan Effectiveness In Loan Agreement 19 July 2004 Actual 19 July 2004 Number of Extensions None 5. Loan Closing Date (end of availability period) In Loan Agreement 19 July 2006 Actual 19 July 2006 Number of Extensions None 6. Disbursements Initial Disbursement Final Disbursement Time Interval 5 November 2004 29 June 2005 238 days Effective Date 19 July 2004 Amount Disbursed: Rs918,600,000 7. Loan Repayment Initial Repayment Date 5 November 2007 Final Repayment Date 5 November 2014 bps = basis points, LIBOR = London interbank offered rate.

Appendix 1

16

C. Data on Asian Development Bank Missions

Name of Mission

Date

No. of Persons

No. of Person-Days

Specialization of Members

Loan Reconnaissance 28 Apr–2 May 2003 4 5 Head, financial sector and private sector, India resident mission; head, risk management; head, capital markets; project specialist

Due Diligence 26–31 Jan 2004 1 6 Senior restructuring specialist Loan Negotiations 19–20 Apr 2004 1 2 Senior restructuring specialist Investment

Administration 12 Aug 2004 1 1 Senior counsel

Investment Administration

25 Apr 2006 2 1 Investment Officer, Senior Investment Specialist

Investment Administration

12–13 Sep 2006 2 1 Investment Officer and Head, Financial Sector and Private Sector, India resident mission

Extended Annual Review

26–27 Nov 2007 2 2 Senior Investment Specialist; Investment Officer

Sources: Asian Development Bank mission authorization requests and back-to-office reports.

Appendix 2 17

PROJECT DESCRIPTION

A. The Project

1. On 18 December 2003, the Board of Directors of the Asian Development Bank (ADB) approved a loan of up to $20 million equivalent in Indian rupees to Dewan Housing Finance Corporation Limited (DHFL or the Company). ADB’s loan supported the expansion of DHFL’s mortgage lending operations in India. ADB provided long-term, fixed-rate debt to enable DHFL to fund its mortgage loans with limited interest rate and maturity mismatches, and no currency risk. The term loan is secured by a first charge on all the movable and immovable assets of DHFL, both present and future, shared pari passu with all the lenders. The terms and conditions of the loan are shown in Appendix 1. 2. DHFL was established in 1984 by the Wadhawan family and is listed on the Bombay Stock Exchange and the National Stock Exchange. The Company provides loans to individuals in the lower- and middle-income (LMI) segment, a segment that has been traditionally underserved. Over 70% of DHFL’s borrowers have homes they built themselves, as is typical of markets in the smaller towns and their surrounding territories. Today, DHFL is the third largest housing finance company and the second largest in the private sector. The Company has 155 locations—53 main branches, 67 service centers, and 35 camps—across the country. In 2006, DHFL opened an office in Dubai, United Arab Emirates, to provide mortgage loans to Indians living in and around Dubai and other Gulf countries wishing to purchase homes in India. DHFL has a rating of AA+ from CARE for its long-term paper and a AA rating from Fitch for its fixed deposits. DHFL has also received a rating of P1+ for its short term paper from CRISIL. 3. DHFL has a good management record, according to a review of key processes and systems and customer acquisition strategy. Kapil Wadhawan, Vice Chairman and Managing Director, assumed daily management of the Company in October 2000 after the death of his father. Mr. Wadhawan is widely recognized as a mortgage finance expert in India. He leads a company with over 500 staff members, about 18% of whom are women. (See Figure A2.1 for DHFL’s organizational chart.) DHFL management recognizes the importance of staff training to the maintenance of high credit quality. The Company’s staff members are widely dispersed over many locations and must uniformly underwrite a population that is generally perceived to present more risk. Yet, DHFL has been able to maintain low levels of nonperforming loans and will be introducing an internal credit scoring system within the next year to aid staff in determining the credit risk of individuals. 4. As of 31 March 2007, DHFL had eight Directors on its Board —seven nonexecutive Directors and a full-time Managing Director, Kapil Wadhawan. Mr. Wadhawan is the only executive Director on the Board. Rakesh Wadhawan is Chairman of the Board. Five Directors are independent and are from the finance, banking, and insurance sectors, among others. DHFL has four Board Committees—Audit, Remuneration and Compensation, Shareholders Grievance, and Finance Committees. There are three Directors each on the Audit and Remuneration and Compensation Committees. All are independent. 5. DHFL has achieved solid growth through the years, registering good profits year on year. It continues to pursue business growth aggressively. (See Appendix 4 for more details on DHFL’s financial performance.) DHFL has effectively structured its products to respond to the rapidly changing macroeconomic conditions without changing its customer focus. For instance, in FY2007, DHFL introduced a “cluster program” whereby the Company is able to focus,

Appendix 2

18

educate, and market to low income groups in Gujarat, Tamil Nadu, and Kerala. DHFL is also helping to formulate the first national housing price index, to better regulate real estate prices. B. Shareholders 6. DHFL was founded by the late Mr. Deewan Kuldeep Singh Wadhawan and promoted by the Wadhawan family. In 2003, the family owned 45% of DHFL. The other primary shareholders of the publicly listed company were the Unit Trust of India (14%), the Union Bank of India (9%), and smaller institutional investors (32%). 7. Today, DHFL is a widely held company. (Table A2 presents DHFL’s shareholding structure as of 30 September 2007.) The five largest shareholders are Wadhawan family members, who own 35.13%, and Caledonia Investments PLC (Caledonia) with 11.67%. Caledonia had an investment of only 2.2% in DHFL as of 31 March 2007, but converted its preferential shares into equity in August 2007. 8. Caledonia was incorporated in 1928 as the Foreign Railways Investment Trust Ltd. It was acquired by the Cayzer family in 1951 to hold diverse investments and renamed Caledonia Investments Ltd. Caledonia was listed on the London Stock Exchange in 1960 and, once again, renamed in 1981. Caledonia Investment PLC has a global investment portfolio. As of 31 March 2007, it had investments totaling £71.8 million in India, including Varun Shipping, DHFL, and Alok Industries, and £13.6 million invested in companies in the People’s Republic of China. It had total equity of £1,323 million and a return on equity of 10.5%. Investment income was £40.1 million. Profit after tax was £136.1 million, and profit after losses/gains was £137.7 million.

Table A2: DHFL Shareholding Structure

(as of 30 September 2007)

Category Number of Shares Percentage Promoters 12,863,655 21.25 Promoters Acting in Concert 19,780,234 32.68 Bodies Corporate 9,319,087 15.40 UTI and Mutual Funds 66,501 0.11 FIIs/NRI 9,819,961 16.23 Banks 495,830 0.82 Resident Individuals 8,177,707 13.51 Total 60,522,975 100.00

FIIs= foreign institutional investors; NRI = nonresident Indians; UTI = Union Trust of India. Source: Dewan Housing Finance Corporation Ltd.

Appendix 5 19

Appendix 2

19

AGM Credit Admin.

and Receivables

Vice Chairman Managing Director

Kapil Wadhawan

Chief Executive Officer

Chief Operating Officer

Executive Secretary

Secretary

Finance Dept.

Marketing Dept.

Accounts Dept.

HR Dept.

Corp. Plan Dept.

Audit and Inspection

Dept. IT

Dept.

Project Finance

Dept.

GM-Zones

South West North,

Center and East

Credit Dept.

Company Secretary

and Legal

New Product Dev’t.

AGM Technical

AGM Administration

Note: In each department, the designations are the following: 1. General Manager / Head of the Department 2. Assistant General Manager 3. Senior Manager 4. Manager 5. Assistant Manager 6. Officer

Source: Dewan Housing Finance Corporation Ltd.

Figure A2.1: DHFL Organization Structure (as of 1 March 2007)

20 Appendix 3

INDIA HOUSING AND MORTGAGE SECTOR OVERVIEW

1. Overview. India has one of the most severe housing shortages today in Asia. With a rapidly urbanizing and growing population, the housing stock is under pressure. The National Housing Bank (NHB) estimates that as of 31 March 2007, there was a housing shortage of 31.1 million units. The shortage is most acute in the rural areas of India, at a deficit of 24 million units, while urban areas lack an estimated 7.1 million units.1 India is remarkable for its low mortgage penetration of about 4% of gross domestic product (GDP). 2. A number of issues have prevented and continue to challenge the growth of affordable housing stock in India. First, as noted, urbanization has increased at a rapid pace. Housing stock is unable to keep pace with demand. Over 60% of people in Mumbai live in slums. Second, the legal framework, consisting of about 100 laws (some of which date from the 19th century), has created an artificial scarcity of land through poor planning and zoning, and protracted approval processes or lengthy litigation. Compounding this issue, regulation of real estate is at the state level. Thus, while there has been some impetus for reform at higher levels, implementation at the state level has been sporadic. Third, high transaction costs associated with registering a home have prevented home purchases. These costs are in the form of stamp duties, some of which can be as high as 15% of the value of the property. Finally, over 70% of new housing units are built by the informal building sector. A builder may require more than 50 approvals, thus delaying the approval process in some areas to between 120 and 450 days and prohibiting formal construction. Only recently have there been nationwide builders that are able to undertake large construction projects. 3. Market Structure. The housing finance sector in India was dominated by direct government participation for a number of years. The first housing finance company (HFC), the Housing and Urban Development Corporation (HUDCO), was established in 1971. HUDCO provides funds to developers and also refinances primary institutions in the public sector. In 1977, the Housing Development and Finance Corporation Limited (HDFC) was established to provide retail mortgage lending. In 1988, the NHB was established to regulate HFCs. With the adoption of the Housing and Habitat Policy in 1998, the Government recognized that it should withdraw from direct participation and become a facilitator of the industry, thereby allowing the financial sector to directly participate in the market. 4. The mortgage market in India today comprises HFCs, commercial banks, and public sector banks. It is dominated by three players—HDFC, ICICI Bank, and the State Bank of India. In 2003, the HFCs made up 45.5% of the market.2 With rising demand for mortgages and growing incomes, banks began to focus on rapidly building their mortgage portfolios and now have the larger market share, providing funding to about 75% of the market.3 With the greater involvement of commercial banks, the mortgage market has become increasingly competitive. 5. Housing Finance Companies. There are over 45 HFCs currently registered with the NHB. Approximately 25 are licensed to accept public deposits. As noted, HFCs traditionally had a large market share until commercial banks entered the market about 5 years ago and started to lend aggressively. The largest HFCs are HDFC and LIC Housing Finance Corporation Limited. HDFC is the market leader. It has 219 locations with several distribution channels at

1 National Housing Bank. 2007. An Overview. New Delhi. 2 ADB. 2003. Report and Recommendation of the President to the Board of Directors on Proposed Loans under the

Private Sector Housing Finance Project in India. Manila. 3 CRISIL Ratings. 2007. Mortgage Finance: A Safe Haven for Lenders?. Mumbai.

Appendix 3 21

each location. LIC has 116 locations with several mortgage desks in its parent company offices. LIC has aligned itself with state-owned providers of residential units and has corporate tie-ups with state-owned corporate housing. Dewan Housing Finance Corporation Limited (DHFL) is the market leader for providing mortgages to rural and semi-urban borrowers. 6. The greatest challenge for HFCs has been obtaining and sourcing funds at reasonable costs and at adequate tenors. Banks have a natural competitive advantage over HFCs in terms of funding sources, with access to low-cost savings and current accounts. HFCs are prohibited by the NHB from offering checking accounts. With respect to deposits, which are a natural source of funding for bank retail portfolios, HFCs are only allowed to raise term deposits for a tenor of between 1 and 7 years. These deposits do not have deposit insurance. Thus, the sources of funding for HFCs have included deposits, institutional borrowings (both domestic and international), commercial banks, refinance from NHB, and their own capital. 7. Funding has become increasingly more limited, costly, and shorter in tenor. Public deposits were traditionally a major source of funding for HFCs; however, as interest rates declined (until recently), interest earned on competing government instruments was more attractive than that offered by HFCs. Additionally, the costs of funds for public deposits were higher because of higher administration costs. Some of the larger HFCs have been able to gain access to multilateral and bilateral agencies, as well as the syndicated bank market, for funds. In November 2003, however, the Reserve Bank of India (RBI) issued a notification preventing financial intermediaries from borrowing from external commercial sources. Additionally, the Government withdrew the exemption on withholding taxes that had been previously offered to HFCs that used international borrowings. NHB has also curtailed the tenor of its funds. 8. Lower core profitability for some HFCs (and banks), which is suppressing return on equity (ROE), is becoming apparent. An analysis undertaken by CRISIL indicates that the incremental net profitability margins of some HFCs declined to 1.52% in the first half of 2006–2007, as compared with 1.76% in 2004–2005. However, CRISIL notes that for HFCs like DHFL that operate in niches or specific regions where larger HFCs do not operate and banks are not competitive, profitability has not deteriorated.4 As Table A3 shows, HFCs have a higher yield than banks on average funds deployed because banks must maintain a large share of their deposits in government securities and cash to meet regulatory requirements. However, private sector banks still have a higher yield than HFCs and public sector banks. Private banks earn more interest spread than both public sector banks and some HFCs, since their operating expenses tend to be lower. Furthermore, some smaller HFCs and public sector banks have higher NPLs, resulting in higher provisioning costs and therefore lower overall net profitability.

4 Nayak, Prashant, and Tarun Bhatia. 2007. Housing Finance Companies Face Profitability Pressure. Mumbai:

CRISIL Ratings.

22 Appendix 3

Table A3: Profitability Comparison for HFCs on Fresh Disbursals

Item PSU

Banks Private

Sector Banks HFCsa Yield on housing loans 10.0% 11.0% 11.0% Yield on housing loans (adjusted for 9.7% 10.6% 10.8% loss of income on NPLs) Yield on SLR and CRR (SLR at 7.5) 6.2% 6.2% 7.5% Average Yield/Total Funds Deployed 8.7% 9.5% 10.5% All inclusive cost of borrowings (including 8.1% 8.1% 10.0% estimated impact of operating expenses incurred to source deposits and other funds) Interest Spread 0.5% 1.4% 0.5% Fee income/Funds deployed 0.1% 0.1% 0.1% Operating expenses/Funds deployed 0.8% 0.4% 1.0% Net Profitability Margin (0.2%) 1.1% (0.4%) Estimated lagged delinquencies on individual 4.6% 5.2% 2.7% housing loans (2-year lag) Loss given default 40.0% 40.0% 40.0% Total loss on NPLs 1.8% 2.1% 1.1% Duration of housing loan 5 5 5 Annualized credit cost (i.e., spread over loan duration) 0.4% 0.4% 0.2% Net Profitability Margin after Credit Losses (0.5%) 0.7% (0.6%) ( ) = negative, CRR = cash reserve ratio requirements, NPL = nonperforming loan, SLR = statutory liquidity ratio. a HDFC was excluded from the analysis of HFCs because its size is almost twice that of other selected HFCs.

HDFC's operating expenses, all inclusive of borrowing costs and credit costs are superior to those of smaller HFCs and would have skewed the numbers.

Source: CRISIL.

9. HFCs have taken a variety of actions to improve profitability. Some HFCs have opted for short-term borrowing against long-term lending to improve margins. This has widened liquidity and interest rate gaps. Other HFCs have focused on high-yield products. Smaller HFCs have been providing funds at curtailed interest rates to be competitive in the market. HFCs have been lending at rates below their retail prime lending rates, increasing the costs for existing, rather than new, borrowers. Some of these banks and HFCs have passed on the higher funding costs to their borrowers by extending loan terms and increasing internal rates of return (IRR). As a result, portfolio yields, in some instances, are below retail prime lending rates. 10. Current Trends. Mortgage financing activities in India have continued to grow, despite the challenges mentioned above. CRISIL estimates that newly originated residential mortgage loans grew at a compounded annual rate of 33% over the last 3 years.5 Total incremental disbursements increased from about Rs768 billion in 2005–2006 to Rs1 trillion in 2006–2007. The expanding economy and lower interest rates have increased demand for mortgage financing. Couples with combined incomes are also boosting demand for adequate housing. Salary increases for individuals in metropolitan areas have averaged about 20% per year over

5 Shanker, Rupali. 2007. Mortgage Finance: Declining Affordability and Rising Debt Burden. CRISIL Ratings.

Appendix 3 23

the last 2 years (footnote 6).6 Until the past year and a half to 2 years, property prices were also relatively steady. Tax concessions for owner-occupied homes, among other factors, also contributed to the growth rate. 11. Movements in interest rates and increases in property prices have started to affect the mortgage market. There has been a steep escalation in home prices in metropolitan areas over the last 2 years. Home prices have increased at a compounded annual growth rate of between 30% and 40%. Interest rates on new homes have increased by 175–200 basis points over the last 1.5 years. Several trends have emerged as a result of the competitive environment for mortgage lending, and changes in the macroeconomic environment and property sector. Some of these trends have led to a higher risk profile for certain HFCs and banks operating in this sector. 12. The most evident trend is the deterioration in affordability. Although salaries have increased by an average of 20% per year over the last 2 years, the affordability index has declined from 4.4 times to up to 5.5 times in certain urban areas.7 Thus, some buyers will simply not be able to afford homes and others will have a higher debt burden upon obtaining a mortgage loan. Consequently, some banks and HFCs have offered mortgage loans at higher loan-to-value (LTV) ratios to accommodate more borrowers.8 HFCs have generally been more prudent lenders. As a result, their NPLs are generally low. The average LTV on total outstanding loans increased to 75% at the end of March 2007 from 70% at the end of March 2004.9 Higher interest rates have also contributed to larger debt burdens for new borrowers, as well as for existing borrowers who have floating-rate loans. CRISIL estimates that the average mortgage loan installment (IIR) has increased from about 42% to between 47% and 59% of monthly income (footnote 9). Loans over 60% IIR increased from 1% in March 2004 to 9% in March 2006. Lenders have also extended the tenor of the mortgage loans to allow borrowers to reduce their monthly payments.

6 Shanker, Rupali. 2007. Mortgage Finance: Declining Affordability and Rising Debt Burden, CRISIL Ratings. 7 The affordability index is calculated as the property cost divided by the average net annual income. A lower

affordability index indicates that a property is more affordable to the buyer. 8 Market commentary noted that some banks were offering loans with LTVs of up to 90% and 100%. 9 Business Standard, India. 2007. Home Loan Disbursements May Slow Down in 2008. (28 November, page 2,

Section II).

24 Appendix 3

13. The aforementioned risks can be mitigated by rising personal incomes as the economy continues to expand, as well as higher prepayment rates, which are customary in the Indian market.10 Should interest rates rise rapidly without income growth or prepayments, the risk of delinquencies will increase. The current level of nonperforming loans (NPLs) in the market is quite low. However, loans offered over the last 3 years compose 71% of India’s total outstanding portfolio, and have thus not had a chance to age (mortgage loans typically will default after the third year). Banks and HFCs have tightened underwriting and monitoring standards to further reduce risk. 14. There are signs that the unprecedented growth rate in mortgage financing has already slowed. The growth rate for 2006–2007 was 18% and the growth rate for 2007–2008 is projected to be at about 10%.11 As the affordability index has deteriorated with higher interest rates and property prices, it has become more difficult for home borrowers to obtain mortgage financing despite lenders’ past efforts to relax underwriting standards. Additionally, some mortgage lenders are starting to tighten standards. This move will further suppress market growth and lead to more comfortable growth levels. The RBI has taken several measures to reduce bank exposure to real estate and to curb non-prudent commercial bank lending.

10 HDFC notes that between 10% and 12% of its loan portfolio has traditionally been prepaid every year. 11 Nayak, Prashant, and Tarun Bhatia. 2007. Housing Finance Companies Face Profitability Pressure., Mumbai:

CRISIL Ratings.

Appendix 4 25

FINANCIAL OVERVIEW AND STATEMENTS

A. Overview 1. Dewan Housing Finance Corporation Limited (DHFL or the Company) is a profitable company that has grown rapidly since inception, as evidenced by its asset growth from Rs2.41 billion (1993–1994) to Rs36.24 billion (2006–2007). Net profits have increased from Rs48.51 million (1993–1994) to Rs484.01 million (2006–2007). Consolidated average growth rate on assets and net profits over the last few years (from 2003–2004 to 2006–2007) was 28.5% and 26.5%, respectively. As of 31 March 2007, DHFL’s net profit had grown by 16% to Rs484.0 million, and operating income had increased by 46.5% to Rs3,322.9 million. DHFL’s financial statements are provided in Tables A4.7 and A4.8. B. Portfolio 2. Portfolio Growth and Concentration. As of 31 March 2007, DHFL’s loan portfolio was Rs33,020 million. About 85.87% consisted of housing loans, and the remaining 14.13%, of lease rent finance and nonresidential property loans. 1 Cumulative loan approvals and disbursement from inception up to 31 March 2007 reached Rs58.6 billion and Rs53.4 billion, respectively. Cumulative disbursements comprised 91.13% of cumulative approvals. 3. Portfolio Characteristics. DHFL offers longer-term mortgage loans, providing borrowers with funding for up to 20 years. The current average loan size is small, at between $10,000 and $15,000. DHFL’s portfolio is well distributed geographically throughout India, as can be seen from Table A4.1. The Company provides loans primarily in semi-urban and rural areas.

Table A4.1: Geographic Distribution of DHFL Lending

(as of 31 March 2007)

Region Amount

(Rs in lakhs) Percentage

of Total North Central and East 33,855.15 10.14 South 103,329.22 30.96 West 196,588.20 58.90 Total 333,772.57 100.00

Note: A lakh is equal to 100,000. Source: Dewan Housing Finance Corporation Limited.

1 Lease rental financing refers to loans advanced to the lessor in the form of discounted lease rentals. Nonresidential

home loans are extended to doctors, architects, and other professionals.

26 Appendix 4

4. DHFL’s loan-to-value (LTV) ratios are shown in Table A4.2. Over 70% of DHFL’s loans are provided to borrowers who use the funds to purchase a house, rather than land. Typically, land in the rural and semi-urban areas is already owned by the borrower. Thus, DHFL’s actual LTV ratios are more conservative than traditional LTVs in the housing industry.2 The weighted average LTV ratio as of 31 March 2007 was 68%.

Table A4.2: Loan-to-Value Ratios (%)

(as of 31 March 2007)

Loan-to-Value Ratio 2004–2005 2005–2006 2006–2007 ≤ 60 23.74 21.59 35.37

61–75 38.11 33.86 28.17 75–85 30.64 31.33 26.87 >85 7.51 13.22 9.59

Total 100.00 100.00 100.00 Source: Dewan Housing Finance Corporation Limited.

5. In 2003, most HFCs offered fixed-rate loans and were able to obtain fixed-rate funding. At the time the report and recommendation to the President (RRP) was prepared, commercial banks had started to originate mortgage loans and were doing so on a variable-rate basis. Borrowers were interested in these loans, expecting that interest rates would continue to move downward. Consequently, HFCs began to follow commercial banks and offered floating-rate loans. DHFL’s portfolio has accordingly altered to contain a higher percentage of floating-rate loans than in 2003. As seen from Table A4.3, over 64% of DHFL’s portfolio as of 31 March 2007 was comprised of floating-rate loans.

Table A4.3: Interest Rate Mix in the DHFL Portfolio (as of 31 March 2007)

Item

Amount (Rs in lakhs)

Percentageof Total

Fixed-rate loans 119,444.84 35.79 Floating-rate loans 214,327.73 64.21 Total 333,772.57 100.00

DHFL = Dewan Housing Finance Corporation Limited. Note: A lakh is equal to 100,000. Source: Dewan Housing Finance Corporation Limited.

C. Asset Quality and Collection Efficiency 6. Gross nonperforming loans (NPLs), at 1.48%, and net NPLs, at 1.23% in FY2007, compare well to those of other HFCs. DHFL has adhered to the prudential guidelines for NPLs issued by NHB and has made adequate provision for the assets on which installments are

2 Higher LTV-ratio loans result in a higher frequency of default and a higher severity of loss, as evidenced by

international data. A study published by Housing Finance International shows that default probabilities increase more rapidly for LTV ratios over 80%. The default probabilities were found to be 2.2% for LTVs below 40%, 2.8% for LTVs of 40%–50%, 3.3% for LTVs of 50%–60%, 3.7% for LTVs of 60%–65%, 4.3% for LTV of 65%–70%, 4.9% for LTVs of 70%–75%, 6.0% for LTVs of 75%–80%, 7.0% for LTVs of 80%–85%, and 8.7% for LTVs of 85%–90%. The data covered Australia, Germany, the Netherlands, Spain, United Kingdom, and United States. Klopfer, E. 2002. A Mortgage Insurer’s Look at Basel II and Residential Mortgage Credit Risk. Housing Finance International 17 (1). London.

Appendix 4 27

overdue for more than 3 months and on other assets, as required. As of 31 March 2007, loans that were more than 90 days overdue amounted to Rs438.71 million. 7. DHFL’s collection efficiency has improved since FY2004 despite the growth in disbursements, as seen from Table A4.4. In 2007, DHFL further strengthened its information technology infrastructure and systems to support its operations. New application software was installed to improve information flow to branches and to further support the collection system.

Table A4.4: Collection Efficiency

Item 31-Mar-04 31-Mar-05 31-Mar-06 31-Mar-07 A. Housing Loan 121,269 152,927 233,794 333,773 B. Overdue Loans at the Beginning of the Year 554 655 796 918 C. Demand during the Year 20,105 24,413 31,008 45,382 D. Total Demand (B+C) 20,659 25,068 31,804 46,300 E. Recoveries During the Year 20,004 24,272 30,886 44,914 F. Recoveries as % of Total Demand (E/D) 96.83 96.82 97.11 97.01 G. Overdue Loans at the End of the Year (D−E) 655 796 918 1,386 H. Overdue Loans % (G/A) 0.54 0.52 0.39 0.42 Source: Dewan Housing Finance Corporation Limited.

8. Profitability. Since DHFL’s target market of lower- and middle-income (LMI) borrowers is inherently a more risky segment, its gross spread has been typically higher than the industry’s. The weighted average coupon of the loans in DHFL’s portfolio as of 31 March 2007 was 11.69%.

D. Liquidity 9. In the past, DHFL has used the NHB, banks, multilateral institutions, and fixed deposits to fund growth. However, as described in Appendix 3, long-term funding sources for HFCs have become more limited over the past 3–4 years. The Government has controlled access to external commercial borrowings since 2003. Thus, long-term funding from multilateral financial institutions is no longer available. DHFL now raises funds largely from banks and financial institutions. 10. Funding costs have also increased for DHFL, as they have for all HFCs. Rising interest rates, as well as asset prices, forced the financial regulator to raise key benchmark rates of banks and financial institutions. DHFL’s funding costs were higher than the industry average in 2003; however, the higher funding costs were mitigated by the competitive rates on long-term funds borrowed from multilaterals. DHFL has been largely successful in containing its cost of borrowings. Diversification of funding sources and optimization of the tenor and interest rates and timing of borrowings were some of the measures taken by the Company to contain the cost of borrowed funds with reference to its interest rate benchmarks.

28 Appendix 4

E. Capital Adequacy 11. For FY2007, DHFL reported a capital adequacy ratio of 11.05% for Tier I capital and 14.06% for total capital, which represented an increase from FY2006 where DHFL's Tier 1 capital adequacy ratio was 10.41% and 13.33% for total capital. Capital adequacy is well within the NHB guidelines, which set a 12% minimum capital adequacy ratio for total capital. DHFL increased its capital in FY2007 by issuing 6.5 million 1% redeemable preference shares of Rs10 each to ICICI Bank Ltd.

Appendix 4 29

Table A4.7: Profit and Loss Statement (Rs. million)

2003─2004 2004─2005 2005─2006 2006─2007 Item Actual Plan Actual Plan Actual Plan Actual Plan A. Income 1. Income from Operations 1,363 1,574 1,527 2,038 2,079 2,648 3,189 3,339 2. Fees and Other Services 79 104 83 125 185 154 130 166 3. Other Income 27 19 28 17 4 16 4 18

Total 1,469 1,697 1,638 2,180 2,268 2,818 3,323 3,523

B. Expenditure 1. Interest 970 1,121 1,059 1,487 1,482 2,029 2,322 2612 2. Payment and Provision of Employees 67 82 82 98 93 113 116 130 3. Operational and Other Expenses 108 144 122 172 199 197 215 225 4. Depreciation 8 8 11 6 15 6 19 4 5. Provision for Contingencies 41 14 27 19 29 31 57 39

Total 1,195 1,369 1,301 1,782 1,818 2,376 2,728 3,010 6. Net interest income 393 453 468 551 598 619 868 727 7. Profit Before Tax 274 328 338 398 450 442 595 513 Less: Provision for Taxation 50 72 67 88 83 98 111 113 8. Add exceptional item(Capital gain) 50 Profit after Tax 224 256 271 310 417 344 484 400 C. Appropriation 1. Proposed Dividend and Dividend Tax 10 54 114 54 143 57 149 60 2. Preferred Share and Tax 0 5 4 5 0 5 19 5 3. Retained earnings 213 197 153 251 274 282 316 335 Total 224 256 271 310 417 344 484 400 Source: Dewan Housing Finance Corporation Ltd.

30 Appendix 4

Table A4.8: Balance Sheet (Rs million)

2003─2004 2004─2005 2005─2006 2006─2007 Item Actual Plan Actual Plan Actual Plan Actual Plan A. Source of Fund 1. Net Worth 1,317 1,397 1,896 1,648 2,707 2,183 3,653 2,768 2. Tier - 2 Bonds 0 0 500 450 1,000 800 1,000 3. Loan Funds 4. Secured Loans 8,569 11,420 13,758 15,710 20,527 20,418 28,877 27,088 5. Unsecured Loans 2,605 1,989 1,908 2,535 1,719 3,259 2,470 3,543 6. Current Liabilities and Provisions 313 306 371 364 386 433 440 529 Total 12,805 15,112 17,933 20,757 25,788 27,293 36,240 34,928 B. Application of Fund 1. Net Fixed Assets 128 116 301 123 444 129 446 138 2. Housing Loans 10,912 13,681 13,732 19,091 18,904 25,461 28,168 32,888 3. Other Loans 110 138 1,343 193 3,783 257 4,666 332 4. Securitized Home Loans 238 177 218 168 200 160 186 152 5. Investments 694 344 1,202 306 968 295 963 323 6. Current Assets, Loans, and Advances 725 653 1,143 874 1,513 989 1,850 1,091 7. Miscellaneous Expenditures 3 3 6 2 0 2 0 4 8. Deferred Tax Assets (5) 0 (12) 0 (24) 0 (38) 0 Total 12,805 15,112 17,933 20,757 25,788 27,293 36,240 34,928 ( ) = negative. Source: Dewan Housing Finance Corporation Ltd.

Appendix 5 31

PRIVATE SECTOR DEVELOPMENT INDICATORS AND RATINGS: FINANCIAL INTERMEDIARIES

Indicator Ratingsa Justifications 1. Wider Sector and Economy Impact Beyond Intermediaries and Sub-Borrowers

1.1 Private sector expansion and institutional impact:

1.1.1 Contribution to an increased private sector share and role in the economy, and to sustainable jobs or self-employment.

Satisfactory Mortgage finance is a highly developmental activity that has many linkages to the broader economy with respect to the provision of jobs, such as the construction industry and the consumer goods sector. The RRP notes that the property sector can contribute up to 15% of a wealthy country’s GDP. With respect to DHFL, job creation as a result of its mortgage finance activities is in predominately semi-urban and rural areas. DHFL operates in over 150 locations in second and third tier cities in India. In general, private sector mortgage lending has increased in India since this project was approved as a result of growing demand and income levels. The Credit Rating Information Services of India estimates that newly originated residential mortgage loans grew at a compounded annual rate of 33% over the last 3 years, while salary increases for individuals in metro areas has been approximately 20% per annum. Total incremental disbursements have increased from approximately Rs768 billion in 2005–2006 to Rs1 trillion in 2006–2007. However, DHFL remains one of the few lenders that target the lower and middle income (LMI) market segment in India.

1.1.2 Contribution to expanded mortgage lending with good portfolio and sub-borrower performance.

Satisfactory In financial year 2006–2007, mortgage loan disbursements in India totaled approximately $22 billion. DHFL, now the second largest HFC. While having a small share in the broader mortgage market containing commercial banks and public sector banks, DHFL is the leader in the LMI market segment, which is typically a more difficult segment in which to underwrite and

32 Appendix 5

Indicator Ratingsa Justifications originate loans. Moreover, DHFL’s ability to originate market loans in this segment with low levels of nonperforming loans has served as a model for those companies that have sought to enter this market, albeit on a limited basis.

1.1.3 Contribution to institutional change by: i) improved supply and access generally

to formal mortgage lending. ii) influencing a more enabling

environment for mortgages via lobby activity, policy dialogue, or otherwise in which the participant bank(s) become more engaged.

Excellent For over 20 years, DHFL has provided access to formal mortgage lending to areas which have been ignored by the larger commercial banks. People living in the second and third tier cities only had access to money lenders who lent in small amounts at exorbitant interest rates. As one of the first participants in the housing market in India, DHFL has maintained an active dialogue with its regulator, the National Housing Bank (NHB), to encourage more proactive pro-poor housing policies.

1.2 Competition: Contribution to new competition in mortgage business among local banks (including new product and service offerings, local-currency products) and/or contribution to increased competition in key sub-borrower markets.

Satisfactory Competition in the LMI market remains limited, given the difficult nature of originating loans to these customers. Abundant opportunities for commercial banks and HFCs in the upper and middle class income segments have also contributed to the lack of competition in the LMI segment. However, there are some early indications that public sector and larger commercial banks, such as HDFC, are slowly entering this market segment.

1.3 Innovation: Contribution to new ways of offering effective banking services to mortgages (including new products, services, and technologies) in ways that are replicated by other banks and in the financial system. See 2.2 below.

Excellent DHFL has been a pioneer in offering innovative “inclusive” products for its customers. For instance, DHFL has just introduced to the market a “reverse mortgage,” which allows senior citizens over the age of 60 to obtain loans against the value of their homes. Introduction of these products are valuable for the entire mortgage market in India. Additionally, DHFL’s origination skills have often served as a model for other banks.

1.4 Linkages: Contribution to local savings and deposits mobilization via networks of participant bank(s), and/or relative to size of sub-portfolios; contribution to notable upstream or downstream link effects to sub-borrowers’ businesses in their industries or the economy.

Satisfactory DHFL is a deposit taking housing finance company. Linkages to borrower’s businesses are also limited, as this segment does not typically take loans against their homes to start new businesses. However, mortgage financing in

Appendix 5 33

Indicator Ratingsa Justifications second and third-tier cities does encourage new construction and supports the consumer goods industry.

1.5 Catalytic element: Contribution to mobilization of other local or international financing to mortgages, and by positive demonstration to market providers of debt and risk capital to mortgages.

Excellent DHFL has mobilized financing through the use of securitization. By doing so, DHFL has demonstrated that LMI loans can be originated and securitized.

1.6 Affected laws, frameworks, regulation: Contribution to improved laws, regulation, and inspection affecting formal mortgage lenders and banking services in the local financial system.

Satisfactory As noted, DHFL was one of the first HFCs in the market. It maintains a constant dialogue with its regulator, the NHB, to provide input on regulations impacting HFCs.

1.7 Wide demonstration of new standards: Contribution to raised standards in the financial sector or in sub-borrower industries and sectors in corporate governance, transparency, and stakeholder relations.

Excellent DHFL has provided an excellent example to the market with respect to its ability to originate loans to the LMI segment. Its underwriting standards, risk management, and corporate governance structure with strong management have made it an early leader in this industry.

2. Participant Banks and Sub-borrower impact 2.1 Skills with wider impact potential: (i) Contribution to improved mortgage credit approach at all stages in the participant bank(s) in ways that will be replicated by other providers of mortgage finance and banking service; (ii) contribution via the participant bank(s) to improved sub-borrower skills in operation of their businesses, e.g. via good appraisal, and monitoring by the bank(s).

Excellent There are no participating banks in this project. DHFL is the only entity which is undertaking the onlending of mortgages. Given the wide geographic coverage of DHFL and its customer base, DHFL provides extensive training to its branches and service center employees. DHFL provides a broad framework of policies with respect to “Know Your Customer”, credit screening, and appraisal systems that are followed on a uniform basis. The training that DHFL provides to its local employees greatly increases their skills base.

2.2 Demonstration and new standards-setting potential: - As evident in affected and achieved standards in corporate governance and transparency, stakeholder relations, and in ESHS spheres.

Excellent DHFL has achieved business success in a difficult market by developing strong underwriting criteria and risk management practices combined with good management. It has established itself as an industry leader in this market segment.

Overall Project Rating Satisfactory While DHFL currently comprises 1.5% of the total mortgage market in India today, its contribution to the housing sector has been significant. It has demonstrated that a company can successfully target a market segment that has been traditionally underserved by banks and other

34 Appendix 5

Indicator Ratingsa Justifications HFCs. Measuring DHFL against its peers group of HFCs, DHFL has performed quite well. Asset and net profit growth has been strong. DHFL has outperformed original RRP projections. Expenses, however, are higher than its peer group and can be partially attributed to the higher costs of operating in semi-urban and rural areas. Relative to the broader housing finance market containing commercial banks, DHFL has been somewhat hampered by the inherent funding disadvantages associated with HFCs. Therefore, cost of funds has been higher and obtaining longer-term funding has grown more difficult. Thus, overall, DHFL has performed satisfactorily with respect to business success. ADB’s role in the Project was consistent with Government priorities, as well as ADB strategy for private sector development in India and throughout DMCs. ADB’s loan provided reasonably priced long-term funding to DHFL, which was important given that HFC’s access to such funding was more limited than commercial banks.

ADB = Asian Development Bank; DHFL = Dewan Housing Finance Corporation Limited; DMCs = developing member countries; ESHS = environmental, social, health and safety; LMI = low and middle income; NHB = National Housing Bank; PSD = private sector development; RRP = report and recommendation of the President; SME = small and medium enterprise. a Ratings scale: excellent, satisfactory, partly satisfactory, and unsatisfactory. The rating is not an arithmetic mean of

the individual indicator ratings, which have no fixed weights. Consider already manifest actual impact (positive or negative) and the potential impact and risk to its realization.

Source: Asian Development Bank Staff.