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Impact of NBFC crisis on real estate sector in India

NBFC crisis, real estate, real estate sector in India, Impact of NBFC crisis on real estate, RERA, demonetisation, GST

The debacle of one of the largest NBFCs in the country which surfaced in September 2018 after a few consecutive defaults in repayments of maturing commercial paper with corpus under Rs 500 crore, way smaller than the entire debt portfolio of $12 billion, shook the entire Indian capital markets. The prime reason behind default being cost overrun due to delays in various long-term infra projects funded by the NBFC eventually resulting in defaulted repayments of even short-term money market instruments like commercial papers majorly invested by banks, insurance companies and mutual funds. This is a classic case of Asset Liability Mismatch which in case of NBFC like IL&FS happened because of the nature of projects, i.e. capital intensive and prone to cost escalations due to market cycles, cumbersome approvals etc which started getting funded by liquid instruments like commercial papers due to their cost of borrowing being lower than term loans from banks. This resulted in aggressive borrowing using short-term finance and lending it to long-term infra projects.

On the back of the above event as well as rising NPAs in the banking sector itself, it became difficult for IL&FS to refinance its maturing CPs as banks and other investors became risk averse to the same and redemptions across the sector increased due to this escalating risk aversion. Because of the high redemptions of CPs by the investor and limited reinvestment by the banks, the NBFC s overall started facing liquidity crunch. This was seen amongst NBFCs funding consumption items too, including consumer durables, gold-loans, autos including two wheeler loans and retail home loans or loan against property etc. Although these NBFCs have a better asset quality as these loans are based on amortisation repayment structure and have a diversified retail level portfolio, however, the sources of funds got limited from NBFCs primary investors like banks and debentures (almost 85% of financer for NBFC as per as FY2018).

NBFCs depend upon the wholesale lending for their capital requirements since they cannot raise retail deposits from the general public. NBFCs book grew 14 per cent CAGR over FY13-18. They moved from 21 per cent of bank credit in FY10 to 34 per cent now. As per as June 2018 report, ICRA estimated that retail-focused NBFCs with an estimated portfolio size of Rs 7.5 lakh crore would need Rs 3.8-4 lakh crore of fresh debt funding in FY2019 to support their envisaged portfolio growth of about 20 per cent in FY2019. That math has gone for a toss now. In fact, as per as the report, about 50 per cent (NCDs-CPs) of NBFC borrowings are largely at a fixed rate, while ~35% of bank borrowings get repriced on a quarterly or annual basis. With the scarcity of refinance available for NBFC the overall cost of borrowing shot up as high as 150BPS in a matter of just one quarter i.e. Q3FY2019.

The NBFC crisis has been a tip of the iceberg of the ongoing headwinds faced by the real estate industry with receivables cycles getting stretched unreasonably causing developers to face the escalated heat of liquidity crisis on one side and managing delivery pressure under RERA on another side. In addition to already slowed sales momentum due to drastic steps taken by the government like demonetisation and implementation of GST at exorbitant rates impacting the affordability causing a dip in sales. In fact, as per recent reports from the IPC, MMR region experienced 7% drop in prices with inventory overhang hitting low of 2 years standing at 2.2 lakh units UNSOLD (down mere 3% Yoyo) with ~60,000 units launched in 2018 ironically of which 40% was in the affordable housing segment of Rs 50 lakh & less.

The main reason which has initiated this liquidity crunch is mismanagement by NBFCs, where they have been funding long-term asset with short-term borrowings. This has severely impacted developers because NBFCs and HFCs changed their asset portfolio mix with a higher share of long-term lending to builders against projects whereas the sources of fund remained short-term instruments largely. This portfolio shift from higher mix of retail home loans earlier as assets to higher construction finance to developers has resulted into a situation where NBFCs are not disbursing even loans which are smaller than Rs 20 – 30 lakh despite of sanctions received by the buyers for a home loan. Also, in some cases where there have been part disbursements, NBFCs are holding/delaying the disbursements.

This leads the home buyer and developer in a status quo situation as the transfer from NBFCs to banks takes easily 2-3 months. Also banks have a stringent framework when it comes to eligibility discarding a handful of cases leaving developers with cancellations. The sudden changes in business environment would result in customer defaulting on their dues raised by the developers and in turn the developer will face a liquidity crunch as he has to continue doing the construction on site.

Historically, Indian elections have always led to a slowed momentum of investments in asset classes like real estate or equity markets. This pattern is prominent especially in our country due to the fact that India has diverse political parties and formation of a Central government with a thumping majority or with various alliances causes an alignment or disaccord respectively in functioning and implementation of progressive policies, causing investors as well as buyers to take an overall cautious stand.

Considering the outcome of state elections in MP, Rajasthan, Chhattisgarh, Telangana, and Mizoram, the 2019 election is hinting towards an unstable alliance. Thus, cautiousness has increased all the more among investors and buyers. Definitely, 1HCY2019 looks slow and lacklustre for real estate markets with some revival expected may be in the last quarter.

In conclusion, it s a framework failure which was implemented on NBFCs & HFCs, allowing them as high as 40% of borrowing from money market instruments with maturity as short as quarterly to max annual with a dynamic repricing. With the recent rate cut of 25 bps by the RBI and further expected rate cuts to induce liquidity as the inflation is already in check, banks should start lending again to NBFCs as the assets are inherently strong for these NBFCs with diversified retail consumers and some tax-efficient investment vehicles should be devised by the RBI to increase the share of source of fund to long-term borrowings from the currently high short-term instruments.

(By Parth Mehta, Managing Director, Paradigm Realty)