Housing FinanceRising Rates Of Housing Finance and Its Negative Impact on the Indian Economy

Let me start with the thoughts of Gurudev Rabindra Nath Tagore on owning a dream house reflecting the pangs of our teeming millions who do not own a house and wish to have one.

“Long did I cherish a desire,neither for wealth nor fame, but a tiny house tucked away

in a corner of the earth,

where I could be with my thoughts.” Rabindra Nath

What is housing finance?• Housing finance is generally understood to mean

government provision for housing through subsidized house building and subsidized rent……

• …….Also identification of sources of capital funds for construction dwellings and with the provision of private (mortgage) finance for housing consumers.

Why housing finance is needed?• Meets housing demand (Urbanization, Demographics).

• Prevents Slum proliferation.

• An engine of equitable economic growth – Investments, Savings, Wealth.

• Contributes to poverty reduction (asset building, retirement, empowerment, community strengthening, better quality of life).

Different Types Of Raising Housing Finance

Variable-rate • Here the interest rate charged fluctuates in line with the market

levels.

Fixed-rate • The interest rate is set for a specified term.

Mix Of The Two • The rate charged is often fixed or capped for the first year of the

loan and then it may become variable.

HOUSING FINANCE SYSTEM

A Diversified Housing Finance System

Central and state governments

Housing & urban development corporation

Insurance organizations /corporations

Commercial & cooperative banks

Housing finance institutions (HFIs)

National Housing Bank (NHB)

• Established in 1988 by an Act of Parliament

• 100% owned by Reserve Bank of India

• Headquarters at Delhi

• Financial and other support incidental

Objectives of NHB“To operate as a principal agency to promote housing and to provide to such institutions and for matters connected therewith …

… shall act on business principles with due regard to public interest.”

(National Housing Bank Act, 1987 finance institutions both at local and regional levels )

National Housing Bank (NHB)

Important Roles of NHB

Promotional Financial Regulatory

Central And State Governments

• Laying down broad principles

• Providing necessary advice

• Rendering financial assistance in the form of loans

• Providing equity support to HUDCO and guaranteeing bonds issued by it

• STATE GOVERNMENTS are the actual implementing agencies

Housing And Urban Development Corporation (HUDCO)

Established in April 1970

OBJECTIVES

1. To provide long term finance for construction of houses for residential purpose

2. To finance the setting-up of new satellite towns

3. To finance the setting-up of the building materials industry

4. To administer the money received from GOI and other such grants for purpose of financing and undertaking housing and urban development programmes.

5. To subscribe to the debentures and bonds to be issued by the state housing boards, improvement trusts, development authorities and so on.

Insurance Organizations/Corporations

• LIC and GIC support housing activity both directly and indirectly.

• LIC Home Finance LTD.- JUNE 1989

• GIC Housing Finance LTD.- JULY 1990

Commercial BanksIn terms of the RBI Guidelines, Scheduled Commercial

Banks are required to allocate 1.5% of their incremental deposits for disbursing home loan every year of which

a) 50% is for subscription to HUDCO and NHB Bonds.b) 20% is for DIRECT HOUSING LOANc) 30% is for INDIRECT LENDING by way of term loans

to HFIs, HFCs, and public housing agencies

Cooperative Banks

Finance Individuals, cooperative Group Housing Societies, Housing Boards and others who undertake housing projects foe Economically Weaker Sections, Lower Income Groups and Middle-Income Groups

Specialized Housing Finance Institutions

• They cater only to the needs of housing sector.

• They can be further classified as ~ HFCs in public/ joint/ private sector ~ Cooperative housing finance societies

Essentials of Choosing a Right HFC

Exact Loan Amount

Rate of Interest After-Sales

Service

National Presence

Foreclosure Benefits

Housing F Co.

What should be borne in mind?

Rising Rates Of Housing Finance And Its Negative Impact…..

Housing Finance Interest Rates High - An Overview

• Home loan rates have shot up from 7% in 2003 to 12% in 2007 with its impact massively following across the board including genuine buyers, speculators, real estate developers and bankers.

• It is expected that interest rates will further go up by at least 1.5% over the next 6-12 months.

• Slowly but relentlessly the floating interest rates for housing loans have soared by close to 200 basis points, from 7.25 per cent a couple of years back to over 9 per cent today.

• Default rates on installment payment of home loans have risen around 4.5%

• Indian real estate market estimated at US$ 14 billion is likely to be US$ 90 billion by 2015 as demand for both commercial and residential property is surpassing supplies.

Why home loan rates are rising??Aggressive Banks

• Reserve Bank of India (RBI) has called for stricter provisioning norms on home loans. This means that home loan companies will now have to provide for a larger sum of money against their home loan assets. Banks have passed on a portion of this burden to the consumer by hiking home loan rates.

• Several banks have been aggressively pricing their home loan products. While the Reserve Bank of India revised the repo and reverse repo rates by 25 basis points, most banks hiked housing loan rates by 50 basis points and above.

• Following RBI’s policy, most banks raised their deposit rates. The rising deposit rates and continuing credit growth have put pressure on the net interest margins of all banks.

• Home loans are among the most finely priced lending products and banks are unable to maintain the interest rates.

• The advent of Real Estate Mutual Fund is expected to heighten this interest further.

It’s Negative impact - An Overview • Any slow down in house building activities would have a cascading impact

on the overall economic development.

• Over 250 industries have forward or backward linkages with the housing sector, including such core segments as cement and steel, and economically vibrant paint, ceramic tiles, sanitary ware, plumbing, and electrical units.

• If initiatives in housing could generate varied demands and have a multiplier effect on the entire economy, a decline in housing demand could kindle economic recession as well.

• As most potential customers will be making lifetime investment, they would rather wait for the interest rate regime to stabilize or soften, rather than take a decision in haste. This would definitely lead to a piling up of the backlog of housing requirements of the country.

GET THE REAL PICTURE

Fixed rate (%) Floating rate (%)

Before Before NowNow BeforeBefore NowNowHDFC Bank 9.75 10.50 9.00 9.25IDBI Bank 9.50 10.00 8.50 9.00ICICI Bank 9.75 10.25 8.50 9.00

Please note that rates given above are only indicative. Companies are known to offer varying rates on case-to-case basis.

Negative Impact On Various Sectors

Rising home

loan rates

Infrastructure

Real Estate

Speculators

Housing Sector

HFCs

Banking Sector

Housing sector affected by rising home loan rates

• The sector has witnessed a massive fall of 26.6 per cent in 2006-07 from 29.1 per cent in 2005-06.

• And is expected to slow down further to touch between 17 and 20 per cent in the current fiscal.

• The real estate market has already seen a drop of 60 per cent in sales. It could further worsen if reversal in rising interest rates for housing is not addressed urgently.

• Several projects are being delayed from the developers end, because of the hesitancy shown by the buyers end, in depositing advance amount at the time of pre-launch bookings.

• The approximate change in EMI for housing loan of Rs.10 lakh works out to be Rs.3,250 and puts an additional burden of Rs.39,000 per annum on end-users.

HFCs Fear To Loose Market Share To Banks

• The profits of housing finance companies (HFCs) are likely to be majorly affected by the race among banks and rising home loan interest rates.

• Incremental net profitability margins of HFCs are believed to have fallen to 1.52% in the first half of 2006-07, from 1.76% in 2004-05.

• HFCs may loose against banks in gaining market share race. From 23% of the incremental market, the share of these companies is likely to fall to 20% at the end of the financial year.

• Banks seem to be on safer side this time because of their resource profile. They can easily attract deposits and also have current and saving accounts. Contrary to this, HFCs are largely dependent on wholesale borrowings.

• The ratings on HFCs do not show any significant changes.

• But the large companies like LIC Housing and HDFC are still in a better situation, concerning 70% market share among housing companies.

Hit To Real Estate Developers• Real estate companies are facing the brunt of a housing industry slowdown

caused by the high cost of mortgage financing.

• When home loan rates declined to the 6.5-7 per cent level, a lot of people borrowed money to invest in a second house. But with interest rates now becoming so burdensome, this will stop. Now only those who need a house for self-use will take a loan.

• Real estate shares fell after the policy of RBI of interest rate hike. Realty stocks like DLF, Puravankara Projects, Indiabulls Real Estate fell

marginally at about 1%.

• The hardest hit were companies such as Unitech, HDIL and Omaxe whose shares fell down 5.59%, 5.47% and 2.12% respectively. Sobha Developers on the other hand, closed at Rs 772.75, up 2.02% from the previous close.

Bank stocks, under pressure

• Higher interest rates means a higher price for home loan funds, plummeting the demand. For example, in June 2005, ICICI Bank’s floating interest rate for home loans was 7.25 per cent per annum. Today it is 11 per cent, with no guarantee of leveling off.

• Increasing interest rates are also bound to have an impact on loan recoveries, however small—a higher cost of funds always puts pressure on the marginal borrower, We can’t help but recall the old banking maxim ‘Good times make for bad loans.

In sum, the pain is far from over , for banking stocks.

Impact on Speculators

With the funds becoming dearer, there has been a significant

slow down in speculated

purchasing activities by Investors for

at least short term.

The speculators usually buy units

in bulk by paying margin money for creating an artificial shortage,

putting pressure on the prices.

Growth Framework Impact

The low interest rate regime had served

as a breeding ground for speculators

which included small property brokers,

big or small retail investors apart from big

players.

Impact on some other sectors

SavingsStock valuation

Paint industry

Cement Industry

when the capital values become unaffordable to the end users, they go for rental accommodation which in turn triggers demand and therefore rise in values.

Housing sector will not continue to drive demand for paints, as there is rise in interest rates for home loans.

Housing demand consumes almost 70% of the country's cement. If this support wanes, it could tilt the odds against the cement manufacturers.

Interest rate changes also affect the flow of financial savings. They have effects on retained profits and, thus, affect corporate sector savings

Recommendations

Rising interest rates are a concern to any economy's growth prospects. In the Indian context, the specter of rising interest rates is troubling the government, as well as the investor community……

RecommendationsFor the Government• The twin problems of affordability and accessibility that thwart the progress of

housing need to be addressed.

• Governments have to withdraw from direct participation in the housing and housing finance sector and instead need take on the role as facilitators to create the enabling environment to encourage private sector capital.

• Efforts of the government are required to strengthen foreclosure laws, land records need to be computerized and archaic land laws especially rental laws need a complete overhaul.

• Small steps such as encouraging credit bureaus, introducing mortgage insurance, allowing real estate mutual funds and creating a favorable environment to facilitate foreign direct investment in housing will help stimulate the housing finance sector.

• After dousing inflation, the Government should strive to ensure greater liquidity and smother rising interest rates in the ensuing Monetary Policy Reviews.

Else, the country's aspirations of inclusive development may remain a distant dream.

RecommendationsFor The Investors• He can also opt for a hybrid interest scheme

…………….that is part fixed and part floating - depending on his expectation about the future rate of interest, the ratio of loan taken under the two schemes can be varied.

• Home loan seekers should consider opting for a 2-in-1 loan …………….where the rate of interest is fixed for 3-5 years. This will protect them from a potential interest rate hike in the near term. At the end of this term, they have the option to either continue with the 'fixed' rate (if interest rates continue to rise) or migrate to a floating rate loan.

• They may consider selecting the ‘truly’ fixed rate loans …………………..Such loans have a fixed rate throughout the tenure of the loan. However, if interest rates were to decline going forward, the truly fixed rate loan will not reflect the fall in interest rates and the consumer will forfeit any chance of benefiting from a decline in interest rates.

Past Trends of Housing Loans in India …..

India : A Turnaround Story

• The housing finance sector in India has undergone unprecedented change over the past five years.

• For every Indian rupee (INR) invested in the construction of houses, INR 0.78 is added to the gross domestic product of the country.

• The real estate sector is submissive to the development of 269 other industries. The real estate sector is also the second largest employment generator in the country.

• The housing finance industry has been observed to have outperformed everyone's expectations in the previous years. Loan disbursements have grown at a CAGR of over 35% in the last five years.

• There are approximately 383 housing finance companies (HFCs) in the country now. This number does not include numerous banks that have also entered into the fray recently.

Traditional structure of the mortgage market in India

• In 1970, the central government set up the Housing and Urban Development Corporation (HUDCO) to finance housing and urban infrastructure activities.

• In 1977, Housing Development Finance Corporation (HDFC) was the first housing finance company in the private sector to be set up in India.

• The public sector insurance companies – Life Insurance Corporation of India (LIC) and General Insurance Corporation of India (GIC) were also mandated to support housing finance activities (both established in 1989).

• In 1988, the National Housing Bank (NHB) was established as a 100% subsidiary of the RBI, to promote housing finance through a refinance mechanism to banks, housing finance companies (HFCs) and other institutions.

• Several banks had set up housing finance subsidiaries which functioned as independent units with little support or interest from their parent bank.

The Trigger of Change• Towards the end of the 1990s, against the backdrop of lower interest rates,

industrial slowdown, sluggish credit off-take and ample liquidity, commercial banks recognized that if they had to maintain their profit margins, they needed to shift their focus from the wholesale segment and build their retail portfolios.

• The lower interest rate regime, rising disposable incomes, stable property prices and fiscal incentives made housing finance attractive business.

• Further, housing finance traditionally has been characterized by low nonperforming assets NPAs and given the vast demand for housing loans, almost all the major commercial banks plunged into the business of housing finance and thus began the rollercoaster ride!

Sufficient Room for All Players• The total number of houses that would be required cumulatively during the

Tenth Plan period (2002-2007) is estimated at 22.44 million dwelling units. However, this official estimate is based on the 1991 Census and unofficial estimates peg the current housing shortage in India at around 40 million.

• Further, the Tenth Five Year Plan has estimated an outlay of INR 7,263 billion to the housing sector, of which the contribution envisaged from public institutional sources are only INR 4,150 billion.

• Therefore, substantial contribution from private sector players would necessarily be required to tackle the growing housing shortage.

• Given the wide range of choice, customer retention is the greatest challenge for the Indian housing finance industry.

Global ExperiencesIndia’s Home Loan GDP Ratio 5%, versus 50% In US & UK

• With 90% of first timer home loans borrowers, home loans GDP ratio in India continues to be at meager 5% as against 50% in US and UK and therefore suggested that it can be more than  doubled in budget proposals for 2008-09.

• ASSOCHAM (Associated chambers of commerce and industry of India) findings:- Since buying a home requires huge investment, especially for first time buyers, higher

home loan GDP ratio is necessary as 90% of borrowers are the first time borrowers.

US Fed (the Federal Open Market Committee) reduced the interest rates by 75 basis points

• Because of the sub prime crisis in the US, US Fed (the Federal Open Market Committee) reduced the interest rates by 75 basis points. This naturally has created a wide gap between US and Indian interest rates, leading to arbitrage opportunities in the economy.

• US investors not only get the currency appreciation returns, but also higher interest income. If it happens, there will be substantial addition to liquidity in the Indian economy. This may in turn fuel further currency appreciation, hurting exports. Thus, this was a strong case in favor of curtailing interest rates.

Current Scenario Of Housing Sector And The Interest Rates

Present Housing Shortage

Factors Attributing To This Shortage

• Population growth rate- 1.6% p.a.

• GDP growth rate – 9%p.a.

• Per capita income is expected to quadruple by 2020.

• Average real income likely to grow by 2025 in Urban India: 5.7% Rural India:3.6%

• India’s middle class expected to expand from 50 million to 583 million in next 18 years.

Additional Burden To Customers• Referring to differentials between EMIs, prevailing at 7% to 12

%,approx.

• Change in EMI for hosing loan: Rs. 10 lakh Rs. 3250 costing Rs. 39,000 extra per annum.Rs. 20 lakhRs. 6520 costing Rs. 78,240 extra p.a.Rs. 30 lakh Rs. 9770 costing Rs. 1,17,240 extra p.a.

Highlights• Repo rate kept unchanged at 7.75%.

• Reverse repo rate unchanged at 6%.

• Bank rate unchanged at 6%.

• Cash Reserve Ratio increased by 50 basis points to 7.5% in its mid-term review of annual policy w.e.f. Nov. 2007.

Change In Repo And Reverse Repo Rate• These set the direction for other lending rates.

• The repo rate hike is indicative of more expensive credit.

• A rise in the reverse repo rate raises the cost of borrowing funds of banks, leading to a rise in lending as well deposit rates.

• It will hit banks to the extent banks are dependent on RBI for their borrowings.

• For protecting its net margin, a bank typically factors in a rise in the reverse repo rate by increasing its lending rates on all retail loans including housing loan.

• Ultimately, it is the customer who has to pay a higher price.

• Reserve Bank of India announced yet another hike in interest rates.• After its second revision since June, the reverse repo stands at 6 per

cent and the repo at 7 per cent. • The CRR has gone up by 30% in June 2007 over June 2006.• there was a 17% rise in the PLR in June 2007 over June 2006.• As expected, soon after this, SBI,HDFC, PNB, Oriental Bank of

Commerce, LIC Housing Finance and Bank of Baroda has hiked their home loan rates in the range of 0.25-1 percentage points.

• IDBI Ltd raised retail lending rates by 0.25 percentage points. ICICI Bank also raised its prime lending rate by 0.5 percentage points to 11.75 per cent.

• State Bank of India has hiked interest rates on its home loans by 0.25 to 0.75 percentage points, across all tenors in the floating and fixed interest rate category effective from March 1, 2006.

• Home loans earlier increased by 50 per cent in 2004-05.

• Real estate prices risen substantially.• Tax Benefits available on home loan interest and

repayment .• As per the current regulations, individuals can claim up

to Rs 1 lakh per annum as deduction for home loan principal repayment and additional deduction of Rs1.5 lakh towards interest payments.

A tete-a-tete with Mrs. Laxmi Kant Chanana , Manager of PNB

Housing Finance

Date of interview: 23 dec 2007

Some Excerpts::::

Q Impact of interest rate hikes on client volume?

Q . Do you expect an early rate cut this year? To what extent?

Q . With realty prices shooting up and then taking a steep plunge, can this be rated as a housing bubble? Was this correction reqd.?

Q Consumers generally complain that they never receive the benefits of falling rates even though banks are prompt in hiking rates at the drop of a hat. Do you agree?

Q Do all HFCs have same lending rates? Are they regulated by RBI?