In the next five years the demand predicted for housing is 33 billion incremental i.e. 6.6 million per year as against the availability of 3 million houses at present. With successful improvement in infrastructure, there will certainly be few more million added to the above 33 millions. This gives an idea about the sheer enormous volume of the problem.
At the planning level, the monetary dimension of the requirement is 115 Lac crores of rupees and one third of it is available from the formal sector and the planning sources. The economy has to find out ways and means to organise the balance resources to succeed in its reform process. The national housing bank was established to create a system to provide funds and establish a network of housing finance outlets across the vast span of the nation to serve different income and social groups in different regions.
It is mandatory for the economic viability of the housing financial institutions to have a regular recovery of loans from the borrower. If default goes out of proportion, the whole system relating to lending would fail. In order to ensure growth of housing finance institutions on sound lines, recycling of funds is a must and this is possible only when the recoveries of outstanding mortgage due are prompt and regular.
Institutions providing housing finance in India
In India, the following types of institutions provide long term finance for housing:
Regional rural banks
Agriculture and rural development banks
Housing finance companies
Cooperative housing finance societies
Commercial banks are the largest mobilizer of savings in the country. the share of deposits comprising of bank deposits, non bank deposits and net trade debt has been showing an increasing trend and has continuously accounted for more than 54% of the household sector’s savings in the financial assets from the late nineties onward. The banking system has the largest branch network.
However, in the past, the savings mobilized were not ploughed backed to the households for shelter purposes. Banks have been reluctant to extent credit for housing for housing as a regular part of their business because they perceived their role to be limited to the financing of working capital needs of commerce, industry and trade. Another reason was banks did not want to tie up their short term resources in long term housing loans. However, after the nationalization of some of the banks in 1969, the banks became more responsive to the social needs of the community.
Today, it is mandatory for commercial banks in India to earmark a minimum of 3% of their incremental deposits for extending to the housing sector.
The state cooperative banks are apex level institutions of the state cooperative credit structure. There are at present 28 such apex state cooperative banks. While the cooperative banks and the regional rural banks are allowed to lend for housing, they have not been very active in the field.
The agriculture and rural developments banks are term lending institutions operating exclusively in the rural sector. Housing finance was not originally in the ambit of there functions. Followings the thrust given to the housing sector in the late 80’s and more particularly after the establishment of the NHB, several states have had their Acts amended to allow these institutions to lend to housing in rural areas.
Management of funds
Normal resources of funds for housing finance institutions are
Refinance from the regular and its own capital base.
The capital base of most institutions has generally remained weak and this is amply demonstrated by the fact that most institutions are struggling with its capital adequacy ratio. The main source of funds for the housing finance corporation (HFC) is long term funds. the deployment of these funds by its very nature are long term generally for 10 to 20 years. There is hardly any market for such a long liability. So, by compulsion the HFCs borrowed short for meeting long term needs. This unwittingly puts them into a mismatch trap.
One of the major constraints for the housing finance companies is the high cost of funds.
Sources of funds
In the post-1990 liberalization era, three distinct groups of HFIs have emerged:
Specialized HFIs set up by industrial groups or individual promoters
HFIs set up as subsidiaries of commercial banks and
HFIs set up by insurance companies
Funds flow from organisations such as the nationalised insurance companies and the provident fund organisation are ideally suited for the housing activity as they have a long maturity period. However, the flow of funds from these institutions have not been adequate. Specialised institutions like the housing finance companies have sought funds from the general financial institutions and public deposits. But these funds have been short term in nature and lead to the asset liability mismatch. After the establishment of NHB some of the companies got refinance assistance from the NHB which is co-terminus with the repayment period fixed by them to the ultimate borrower. However, the NHB cannot fund the entire portfolio of these companies and hence the need for other avenues for fund raising.
National Housing Bank (NHB)
The national housing bank is the apex refinance institution with a focus towards directing primary lending institutions towards serving as dedicated outlets for assistance to the housing sector. It finances some of the housing finance companies but is unable to fund their entire portfolio requirements.
The NHB has been mandated to establish a national network of housing finance outlets to serve different income and social groups in different regions. It also performs a regulatory role for the housing finance framework and has came out with a guideline for recognizing Housing Finance Companies for its financial assistance, guidelines for extending financial assistance as also the housing finance companies directions. Besides it has also issued guidelines for prudential norms for income recognition, asset classification etc.
NHB, refinances loans of upto Rs 1 million that are granted by commercial banks and HFIs to individual borrowers. It charges 11 percent interest for loans of upto Rs 50,000 and 15 percent for loans beyond that amount. However, the total amount of refinancing provided to an HFI cannot exceed 25 percent of NHBs net owned funds.
The Life Insurance Corporation (LIC) and General Insurance Corporation of India (GIC) support housing activity both directly and indirectly. LIC is statutorily required to invest 25% of their annual income in socially oriented schemes including housing. Hence LIC grants loans to state governments for their rural housing programmes and to the state level apex Cooperative Housing Finance Societies. LIC also finances HUDCO and the state housing boards by subscribing to bonds floated by them. It has also funded the National Housing Bank (NHB). LIC had promoted a housing finance subsidiary in 1989, and fund it as well.
It is also mandatory for GIC and its subsidiaries to invest 35% of their annual accretion to socially oriented sector in the form of loans. GIC, like LIC, also subscribes to bonds floated by HUDCO and state housing boards. GIC also floated a subsidiary as a retail lender of housing finance for individuals and refunded its operations.
Public deposits are an important source of funding for the corporate sector in India. The Reserve Bank of India regulates the acceptance of public deposits and imposes conditions relating to the amount of deposits that can be accepted, the minimum and maximum term of the deposits, and the maximum rate of interest. HFI deposits, on the other hand, are regulated by the NHB.
Public deposits are an important source of funding for the corporate sector in India. The Reserve Bank of India regulates the acceptance of public deposits and impose conditions relating to the amount of deposits that can be accepted, the minimum and maximum term of the deposits, and the maximum rate of interest. HFI deposits, on the other hand, are regulated by the NHB.
Public deposits are generally for a period of three to five years although laws permit it for seven years. The period of deposit for which the public place their funds is based on interest rate expectations. Public deposits cost are substantially high. Housing sector can not absorb this high cost without passing it onto the borrowers and also have a reasonable spread to survive.
The NHB has issued guidelines to the HFC’s for accepting deposits from the public in order to ensure orderly and smooth growth of HFC’s. It has for one prescribed the period for which these companies can accept deposits and the maximum amount they can borrow, e.g. the housing finance companies cannot accept deposits for period less than 12 months and more than 84 months. Similarly, to accept deposits from the public, they are required to have a minimum acceptable credit rating. Further the NHB has prescribed limits for the HFC’s borrowing/acceptance of deposits from the public in relation to their net owned fund. This has done to ensure the HFC’s not over stretching themselves.
Fiscal Concession to Facilitate HFI Resource Mobilisation
Section 36(1)(viii) of the IT Act allows charitable trusts to invest in deposits and bonds of approved HFI’s under, among other investments.
Capital Markets- Domestic
Corporate Bonds and Debentures
These are medium to long-term obligations issued by private sector companies, either through a public issue or more often through private placement, for their medium term working capital requirement or for project financing. The debentures are usually secured with a first or pari passu charge on assets of the issuing corporation. On the average, the maturity period of debentures ranges from three to seven years. Bonds and debentures with a maturity beyond 18 months must be rated.
Besides the traditional nonconvertible debentures, corporations also issue equity-linked debentures, which are popular with all classes of investors, especially individuals. A partly convertible equity-linked debenture, as the name implies, is convertible only in part in equity shares. The coupon rate paid on the debentures depends on their convertibility. Fully convertible debentures carry the lowest coupon rate, and nonconvertible debentures the highest coupon rate.
Recently, a variety of instruments such as set-up and step down bonds, deep-discount bonds, bullet redemption bonds, and other innovative instruments have been introduced to suit various investor profiles. Deep-discount bonds, which are long dated (20 to 25 year) bonds issued by DFIs and some large corporations, have proved to be very popular among individual investors who can expect to earn a considerable amount of money from an affordable investment of only about Rs 5000. The bonds usually come with call and put options exercisable every five years. Interest in compounded and paid with the principal at maturity.
HUDCO has been receiving a good market recognition for its resource mobilisation instruments, based on its successful performance. M/s CARE reaffirmed the rating assigned to HUDCO’s debt instruments after carrying out the annual surveillance and review of the same. The rating of the bonds programme has been reaffirmed as “Care AA” highlighting the high quality by all standards/high investment status grade.
Further, CRISIL and ICRA have rated HUDCO’s bonds program of Rs 1237.23 crores as “AA” and “LAA” respectively during 2000-01. The above ratings indicate high safety of timely payment of interest and principal.
Large quantities of PSU and corporate bonds have been issued through private placement, which is an invitation to qualified investors to invest. The maximum number of investors in a private placement used to be unlimited but has recently been set at one hundred. Private placements have emerged in recent years as an important means by which public and private sector companies can raise funds.
Privately placed bonds have emerged as the corporate sector’s fundraising instrument of choice. The popularity of private placements can be attributed largely to the lower issuance cost as well as the shorter time required to make an issue, compared with a public issue. Also, private placements can be tailored to the specific needs of large investors. From the issuer’s point of view, the most important advantage of private placements is that, unlike public issues, they are not strictly regulated. For example, an issuer of a privately placed bond does not have to set up a DRR. On the other hand, movements in the volatile short term money market can affect investor sentiment and pricing in the bond market, particularly private placements, which take atleast 15 to 20 days to complete. The book building or price discovery mechanism has begun to be adopted to get around this problem. The increasing popularity of private placements has made it necessary to deal with the matter of investor protection. Particularly for retail private placements issues, it would be advisable to augment the disclosure requirements in the memorandum of information and ensure greater transparency in the issue documents. In developed markets, the regulatory authorities set the parameters for private placements, including the maximum number of investors who can participate and the criteria for identifying the investors who are qualified to receive the private placement offer. With proper regulations and greater transparency, the private placement market can become an integral and important part of the primary market.
LIC Housing Finance (LICHFL), the second largest housing finance (HFC) company after HDFC, has raised Rs 280 crore for 15 years at 7%. The funds were raised through private placement. The issue was primarily subscribed by HSBC and Kotak Mahindra Bank. The other investors include UTI bank and general insurance company. The arrangers to the issue were HSBC securities and Kotak Mahindra Capital company.
The company will enter into an interest rate swap (IRS) transaction for sum of Rs 280 crore in order to hedge against adverse rate of movement.
LICHFL also recently raised Rs 250 crore through external commercial borrowing for five years and Rs 200 crores by securitizing its a part of its loan portfolio.
HUDCO had mobilized an additional equity of Rs 280 crores during 2000-01 from the government of India. The equity contributions during the year included Rs 180 crores from ministry of urban development and poverty alleviation, and Rs 100 crores from the ministry of rural development. In addition, a grant amount of Rs 24.26 crores had also been received from government of India for building centres, Night Shelters and Low Cost Sanitation schemes.
Capital Markets – International
The United States Agency for international Development (USAID) under the housing guaranty program of the US government permitted the housing development finance corporation Ltd., the premier housing finance company in India, to borrow from the US capital market a total of US $ 125 million under various tranches commencing from December 1981.
Similarly, NHB raised an amount of US $ 125 million from the US capital market with an agreement with USAID.
External Commercial Borrowings
The external commercial borrowing market can help HFI’s to abroad base the medium and long-term funding sources as also reduce the cost of funds.
In June 2003, HDFC sign a loan agreement of USD 200 million with international finance corporation, Washington (IFC). The loan comprised two tranches – loan A of USD 100 million (tenor of 8 years) which is a multilateral tranche lent directly by IFC and loan B of USD 100 million which is a syndicated tranche.
Agencies like United States Agency for international development (USAID), the Overseas Economic Cooperation fund (OECF) and the Asian Development Bank (ADB) have assisted Indian HFCs both technically and financially.
Overseas Economic Cooperation Fund (OECF) now Japanese bank for international cooperation (JBIC) assisted the Government of India with a loan assistance of Japanese Yen 2.97 billion under the housing programme for low and median income households through NHB.
ADB has extended a loan assistance of US $ 100 million each to NHB, HDFC & HUDCO for onward lending to borrowers.
The HFIs need continuous funding to match the demand for housing loans. The HFIs must be provided with continuing access to through innovative methods. Loan securitization is the only long-term solution to the problem of raising resources for HFIs, the main providers of housing loans in the country. Through securitization, the HFIs can recycle the amounts they have advanced by raising cash from their loan assets as soon as these are created. Mortgage backed securities (MBSs) can help increase the depth of the fixed income debt market while at the same time channeling resources from the capital market to the housing sector. Securitization will also improve the HFIs capital ratios and give them healthier balance sheet. Further, HFIs can alter their risk asset profile through securitization by disposing of the riskier assets in their portfolio.
Advantages of Securitization
Through securitization, the loan originator should be able to mobilize funds at a low cost, and thus reduce its lending rates and make housing loans more affordable to home buyers.
Securitization involves various specialists such as administrators, credit enhancers, issuers, and pool issuers. Specialization promotes efficiency and reduces the transaction cost as funds for housing finance come from a broader range of lenders, interest rates on mortgage will tend to decline, making the loans cheaper in the long-run.
The large investor base will give rise to special mortgage products for lower and middle income investor groups.
Securitization will help the HFIs to grant mortgages for longer maturity and to introduce alternative mortgage instruments based on higher loan to value ratio than at present.
Specialization, will make it possible to transfer risks between sectors and to minimize the cost of such risks.
The risks associated with housing finance, now limited to the housing sector, will be distributed among a greater number of players as securitization and a secondary market develop.
Future Fund sourcing of HFIs
Mortgage Backed Securities
HFIs can convert their primary assets, mortgages, into liquid assets to raise funds that they can invest in the new mortgage assets. Mortgage Backed Securities (MBS) are being sold in secondary markets abroad, specially in the west. The US originated the use of securitization as a financing technique about 25 years ago. However, in India, MBS is still to be launched due to substantial stamp duty on absence of foreclosure laws and other legal impediments, absence of liquid secondary debt market, besides the operational, administrative and marketing issues. The National Housing Bank is still struggling with a pilot of this nature for quite a few years now.
In India housing finance is indispensable because the housing shortage is massive and individuals cannot afford to buy a house merely with their savings. Institutions that speed up building activity by providing funds for the purchase of houses are therefore very much in need. Housing loans should also be made affordable. The housing finance system must ultimately be self-supporting. To this end, there should be a secondary market where individuals with surplus investible funds can buy the mortgages of HFI’s, Banks, the Unit Trust of India, mutual funds and the corporate sector could be the initial targets for the MBSs thus created. With some changes in the pattern of prescribed investments, insurance companies and provident funds could also be included. In the long run, however, MBSs must be targeted at retail investors.
Real Estate Investment Trust(REIT)/Real Estate management Investment Companies(REMIC) structures
REIT or a REMIC is a special purpose vehicle (SPV) which can be created to hold real estate assets. The SPV can be constituted in the form of a trust or a company. The SPV shall own the property and lease it to the company. The funds for the purchase of property can be provided by any bank, which can be serviced by the lease rental payments. Sometimes, it is necessary to use a structure involving two SPVs to meet the objectives of off-balance sheet treatment, stamp duty & tax efficiency and possession and control of the property in the hands of the lease. The transaction can include options to the company, which on being exercised can transfer the ownership of the property from the SPV to the company.
“Finance company” means a company engaged in the business of the financing, whether by making loans or advances or otherwise, of any industry, commerce or agriculture and includes any company engaged in the business of hire-purchase lease financing and financing of housing;
Private sector housing finance companies (HFCs) may soon be allowed to raise deposits from non resident Indians (NRIs), a funding route so far restricted to institution sponsored HFCs. The RBI has sought the finance ministry’s opinion on permitting NRI funds to flow to the private players as well.
In fact, for quite some time private sector HFCs such as Dewan Housing, Global Housing, Weizmann housing finance and home trust housing finance have been lobbying the national housing bank for permission to tap NRI funds, so that they are offered facilities at par with their “stronger” institutionalised partners like HDFC, LIC housing, GIC housing or SBI home finance.
The NHB, agreeing with the HFCs, had referred the matter to the RBI. The relaxation, if cleared, will come as major boost for the housing sector, which has been severely hit by a funds shortage. Housing shortages are estimated at over 32 million units and free flow of NRI funds to the private HFCs is expected to boost “priority-sector” housing.
Case: Resources of HDFC
HDFC has substantially increased resource mobilization via deposits, term borrowings, and bonds, and is currently developing new methods based on taking a small equity position in housing institutions in undeserved areas.
As at September 30, 2003, HDFC’s deposit base stood at Rs 9,995 crore with over 1.3 million deposit accounts.
For the ninth consecutive year, HDFC’s deposits carry a “AAA” rating from the both, CRISIL and ICRA limited.
During the first half of the current financial year, HDFC raised loans from commercial banks amounting to Rs 3,937 crore. In the line with the lower interest rate regime, HDFC continues to re-price/re-negotiate interest rates on some of its existing loans.
During the six months ended September 30, 2003, non-convertible debentures (NCDs) amounting to Rs 450 crore were privately placed. HDFC raised these funds at rates comparable with the lowest in the market. The NCDs were “AAA” rated by both CRISIL and ICRA.
Reforms needed to mobilize funds
The high cost of borrowing by HFcs from the public deposits, bank funding and also national housing bank refinance has put a constraint on the increased volume of operations of HFCs. What is required for success is to declare housing as infrastructure. This will help HFCs to raise relatively cheaper funds which in turn will help people to borrow to build or buy other shelter.
There is need to innovate need based saving instruments along with identification of fiscal incentives for mobilization of cost efficient sources of saving. The house hold saving which do not adequately flow in to the organized sector and particularly the housing sector (comprising mainly of informal sector households and the rural and urban poor) has to be trapped effectively and efficaciously.
Similarly, the credit for housing is restricted in the informal sector due to legal and institutional impediments. There is need to expand the scope of informal sector in terms of mobilization of untapped households savings and enhancement of credit for housing by devising innovative credit and saving instruments and appropriate institutional linkages.
The major problems confronting the housing sector and hence affecting mobilization of resources for the same are:
Housing attracts high stamp duties varying between 5 to 20% of the purchase value and duties are also levied on the subsequent purchases of the same property
Deduction audible from tax in respect of interest payment for housing is limited only upto Rs 10,000 per year.
Capital gains tax is applicable for housing
No workable foreclosure laws have emerged after a decade of active lobbying
The deposits of housing finance institutions are subject to tax deduction at source from interest on deposit over 10,000 per years which means income on a deposit of around Rs 80,000 only is tax free which is too low in today’s scenario.
There are interest ceilings that housing finance institutions can offer for their resource out of line with market realities.
HFC have to pay interest tax earning on SLR securities, while banks are exempted from such tax
Housing has not been declared as a part of infrastructure unlike power , road , communication.
Investors are not interested to construct rental apartment buildings in India because of provision in Rent Control Act through there is a demand for it
The housing sector in India is vastly undercapitalized. The formal sector accounts for only about 25 percent of the total investment in the sector. The availability of funds for housing is far out stripped by the demand for housing ; the housing shortage is grown at an alarming rate as a result. Both commercial banks and HFIs provide loans for housing. For commercial banks this is only one of their many activities and traditionally has not been preferred activity. Formal housing finance is therefore largely dependant on HFIs. Over the past few years there has been notable increase in the number of HFIs in the private as well as the public sector. These HFIs compete with each other, with the NBFCs, and with the banks for the limited resources in the system. Resource mobilization has consequently become a key issue for market-oriented HFIs. The resource base of HFIs must be substantially enhanced. They must be able to tap the capital market to extend their mortgage operations, but their ability to do so will depend on several factors including the extent to which the housing finance system is integrated into the border financial system. The same economic conditions that influence capital market developments also determine the developments in the financial system of which housing finance is a part.