A Real(ty) Risk For India’s Banks

Published: September 28, 2010

India’s real-estate developers are propping up apartment prices. The country’s banks are giving them a hand—at significant risk.

Bank lending to the real-estate sector has grown at a compound annual growth rate of 40% since 2006. That is nearly twice the rate of overall credit growth, amounting to an exposure of $21 billion as of the end of May, according to India’s central bank.

It doesn’t include lending to homeowners. Rather, this is credit being extended to builders, three-quarters of which are small firms that banks can charge high interest rates because they lack access to other sources of capital; many are unlisted or have poor public credit ratings.

Lately, the loans have become a lifeline for the developers, who have seen demand for homes falling but continue to hold off on price cuts. Buyers are balking at prices, which by June were up 157% in Mumbai since late 2005, says research firm Liases Foras.

The buyers’ strike means sales in Mumbai have fallen 38% from a year ago and residential inventories are at all-time highs. Still, the builders refuse to budge, expecting buyers to return soon enough. This has some complaining they are creating an unsustainable situation.

“If the developers don’t lower the prices and clear the existing stock, there could be a problem very soon,” said Deepak Parekh, chairman of Housing Development Finance Corp., India’s largest mortgage lender.

Should the developers lose this standoff with home buyers, India’s banks will suffer along with them. The nine banks tracked by analysts at HDFC Securities would face a 4% drop in profits before taxes next year should 5% of their loans to builders sour. The hit would be worst at Oriental Bank of Commerce and Punjab National Bank, where real-estate sector loans account for 7.4% and 8.2% of total loans: Profits would fall by 9% and 6%, respectively.

Some of the builders have a Plan B. At least seven companies have planned initial public offerings this year.

But this might not go as smoothly as they hope. India’s broad stock market is nearing records, but investors have stayed away from realty stocks. The Bombay Stock Exchange’s realty index is 74% below its peak in January 2008 and down 19% in the past 12 months.

Not all of the capital raised will go to paying back the banks, with the rest likely spent on land acquisition. Land remains the builders’ largest cost, and the Reserve Bank of India prohibits banks from lending specifically for land acquisition.

Both lenders and builders should see this quake coming.

Source: The Wall Street Journal

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