The NBFC Real Estate Crisis – What, Why and What Next?

By, Shobhit Agarwal, MD & CEO – ANAROCK Capital

As an alternative to the main banking sector, Non-Banking Finance Companies or NBFCs have had few peers, which makes the perfect storm that has gathered around them now all the more worrisome.

What ARE NBFCs anyway?

NBFCs are financial institutions that are essentially engaged in the business of providing loans and advances primarily to retail customers. Unlike the formal banking sector, they cannot accept deposits from the public; they depend solely on wholesale lending and banks for their operations. Two-wheeler loans, consumer durable loans, gold loans, vehicle finance and loan against property are the segments where NBFCs have a very strong presence across the country and enjoy a much larger share than the public sector banks.

Which sectors do they fund?

After agriculture, the MSME sector is heavily dependent on NBFCs for loans and working capital. Since banks cannot be present in every nook and corner of the country, NBFCs have capitalized on their highly localized presence to grow their business on the back of strong rural demand and the thriving SME and MSME sectors. Their local network and understanding of customer profiles at a local level give them an edge over the banks when it comes to lending at the micro level.

Due to these advantages, NBFCs could rapidly scale their businesses where the formal banking system was slow in lending. Also, the rising Non-Performing Assets (NPA) crisis in the overall banking sector made banks reluctant to lend to the perceived riskier sectors like SME and MSME, thus helping NBFCs to gain market share. Real estate, also considered a high-risk sector, depended heavily on NBFC funding as well.

How did the current crisis play out?

The ongoing liquidity crisis in the NBFC industry is the result of asset-liability mismatch (ALM). Since the NBFCs cannot raise retail deposits from the general public, they depend on wholesale lending for their capital requirements. As a result, the cost of funds for NBFCs is higher than that of banks.

The biggest error that the majority of NBFCs and HFCs committed with regards to the real estate sector is that they ventured into long-term lending to builders and also into underwriting loans with very long-term repayment tenures.

As a result, the NBFCs short-term borrowing was channelized towards financing long-term loans. They were heavily dependent on banks, mutual funds and private placements to meet their capital requirement as well as for refinancing of loans. However, post the IL&FS default, banks and mutual funds have stopped refinancing the loans of NBFCs and also stopped the disbursal of sanctioned loans to them, since there is still no clarity regarding the spill-over impact of the IL&FS default.

How bad is the situation for real estate?

NBFC loans to developers have seen a phenomenal rise since 2014, particularly due to the slowdown in bank loan disbursals. Interestingly, as per the current fiscal, NBFCs alone account for more than 50% of the total developer financing, which is somewhere close to INR 4 trillion in FY2018 as on date.
However, the recent NBFC crisis has clearly spelt intense gloom – if not outright doom – for Indian real estate. Nearly USD 34 billion of mutual funds debt in NBFCs and HFCs is maturing between Oct 2018 and March 2019. Prior to the crisis, the sector was already dealing with a massive cash crunch and subdued demand, due to which more than 75% of the available credit facility was already exhausted.
With the rise in banks’ NPAs to INR 10 lakh crore (as on March ’18), up INR 1.39 lakh crore in a quarter, further funding from banks to NBFCs and HFCs (currently have an exposure to bank lending of more than 40%) seems extremely difficult.
The liquidity crunch has been a major pain-point for Indian real estate over the last two to three years owing to tepid sales, banks’ refusal to disburse loans due to rising NPAs and the widening debt-equity ratio even with the biggest developers. The recent NBFC crisis in September has only exacerbated the pain for the real estate sector and its major stakeholders – the developers.
Post the IL&FS crisis, some NBFCs even halted the disbursal of earlier sanctioned loan amounts to developers for fear of widening the funding crisis even further. The worst phase came when some NBFCs urged developers to return the money that was disbursed to them so that they can repay their dues.
As per the S&P BSE realty index data, the debt-equity ratio of the top 10 listed players (on a stand-alone basis) in FY 2014 ranged anywhere between 0.10 to 0.85 which has increased in the current fiscal to range anywhere between 0.17 to more than 1. This may not seem overly alarming, but the situation is worse in the case of small and mid-size developers whose debt-equity ratio is much higher.
The major bailout option for most of these small developers is to possibly consolidate. It also needs to be highlighted that out of the approximately 10,000 developers in the country today, only 35-36 are listed. Hence, the financial numbers could be even worse.
What next?
The Government’s consistent assurance of ensuring credit to NBFCs is some sort of a relief, particularly for skittish investors who started panic selling in the equity market post the IL&FS default. Sensing trouble, even the RBI came forward to aid NBFCs by relaxing liquidity norms and allowing banks to lend more. Vey recently, the apex bank relaxed asset securitisation norms for the NBFCs in a bid to ease the persistent stress on the sector.
Thus, even while the RBI and the Government have taken steps to ringfence the NBFC crisis and support its financing needs by providing additional liquidity to banks and credit enhancement for refinancing needs, there are speculations over spill-over concerns in the market in the near-term.
Only time will tell whether or not we feel this heat in the near term. However, one major outcome visible in the coming year will be the consolidation of several small NBFCs.