Private Sector Housing Finance Project (Dewan Housing Finance ...
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Extended Annual Review Report
Loan Number: 2057 February 2008
India: Private Sector Housing Finance Project (Dewan Housing Finance Corporation Limited)
In accordance with ADBs public communications policy (PCP, 2005), this completion report excludes information referred to in paragraph 126 of the PCP.
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
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
(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
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. ADBs Investment Profitability 8 D. ADBs Work Quality 9 E. ADBs 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
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 2627 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 Indias 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. ADBs loan to DFHL came from ADBs ordinary capital resources. The 10-year loan to DHFL was funded from ADBs 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, ADBs support of DHFLs mortgage lending operations was evaluated against four criteria: (i) development impact, (ii) ADBs investment profitability, (iii) ADBs work quality, and (iv) ADBs additionality. On the basis of the foregoing, the overall rating of the Project is satisfactory.
The development impact of ADBs 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 Projects 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. DHFLs underwriting standards, risk management, and corporate governance structure have made it an early leader in the industry.
With respect to the other evaluation criteria, DHFLs 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, DHFLs rating is partly satisfactory. DHFL has adhered to ADB environmental, social, health, and safety performance and is therefore rated satisfactory on this indicator.
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. ADBs work quality is rated excellent, and its monitoring and supervision, satisfactory. ADBs 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, ADBs monitoring and supervision is rated satisfactory.
ADBs role and contribution is rated excellent. The Governments 10th Five-Year Plan for 20022007 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 Governments broader theme of improving overall human well-being and infrastructure throughout India.
ADBs additionality is rated satisfactory. DHFL had limited options for raising long-term financing at optimal costs in 2003. Of DHFLs total borrowings as of 31 March 2007, ADBs loan comprised 2%. Despite the lower amount of funding that ADB provided as compared with DHFLs total borrowings, ADBs loan did positively affect DHFLs profitability. Had DHFL not had the benefit of ADBs 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
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 Peoples 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 20022003 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 ADBs proposed loan of $20 million local currency equivalent was not disbursed to Sundaram as the Reserve Bank
of India did not approve Sundarams 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 ADBs 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).
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 mo...