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Indian Realty Market Is Immune To Sub-Prime Shock
Posted by Pradeep Sadanapalli | September 2, 2007 | 273 views
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Loading ...The mode of functioning of the realty market in India is quite different and it is mature enough to absorb the sub-prime shocks emanating from the US, says Prabhakar Sinha.
The US real estate market is in tizzy because of the high default rate, known as the sub-prime problem. There are apprehensions that it might affect the Indian market as it would slow down the inflow of funds from outside.
However, global fund managers and bankers rule out any such impact on the Indian market. A senior official of ICICI Bank said that first of all there is no subprime market in India.In US,every individual has his credit worthiness rated by an independent agency; expressed by a certain number on the basis of a person’s income, his age and his track record of the repayment of past loans.When credit rating is below the certain number, the person is called sub-prime borrower. In the normal circumstances, banks do not lend to sub-prime borrowers. But as they are large in number, it makes astute business sense to lend loans to them.Even the government encourages banks and other finance companies to lend loans to the sub-prime borrowers, who normally come from relatively weaker sections of the society. At the same time, young borrowers, with lower income are also termed as sub-prime borrower.
To lend money to these borrowers, banks and finance companies in US float subsidiary companies, which expertise in extending loans to the sub-prime borrowers only. Also, as the chances of default by sub-prime borrowers is very high, the interest rates on the loan is higher. Normally, the interest rate on a loan to sub-prime borrower is up to 2 percentage points higher than that to the prime borrower. As the US market is flush with liquidity, many funds and investors have bought the sub-prime loan portfolio.
In the last six months the default cases in the sub-prime borrowers’ category has gone up substantially, leading to an increase in interest rates on sub-prime loan, making the repayment even tougher and increasing the default rate. As the interest rate goes up, the value of sub-prime portfolio has gone down. (As the interest rate goes up, the value of security goes down and vice-versa) Because of this, the buyer of sub-prime portfolio is likely to lose money. To compensate that loss,many felt that real estate fund will sell in the Indian market.
However, a senior global real estate fund manager said that the funds that come to India are long-term resub-prime borrowers who get it at 8.25%. As the interest rate is high, the chances of default further increase. On a loan of $1 lakh, for 30 years, the equated monthly installment (EMI) increases by 22% to $751 (@ 8.25%) from $616 (@ 6.25%).
To enable a borrower to take mortgage loan at high interest rate,the finance companies give loans with a condition to charge only interest portion of the EMI for the first two years. If the borrowers pay the EMIs on time for the first two years,his credit ratings improve and the interest rate on his loan goes down. At the lower interest rates, his EMI including the principal repayment portion remains almost the same.
Interestingly, these finance companies bundle the sub-prime portfolio and sell it to other investors.The fund manager cannot sell the portfolio of an investor, who wants to invest in the Indian real estate market to compensate the loss of other investors in the subprime market in US. Therefore, he argued that the US subprime would not have any impact on the Indian real estate market. At the worst, it might have some effect on stock markets.
A senior banker said that in US the lending is done on different principle. There, the lender can recover the money only by auctioning the property that has been mortgaged to secure the loan.If the property prices crash and go below the mortgage value, banks lose money.
But in India, that is not the case. Here even if the property price falls below the mortgage value and banks cannot recover the entire amount by selling the property given on mortgage, they will create charge on the borrowers’ income to recover the rest of the amount. Therefore, the banks are not perturbed. Besides, as the property prices have already gone up substantially in the last one year, banks can recover their due after selling the property in the market.
The problem, however, can happen where the loan is given in the last one year, when the property prices have declined.The banker said that as the market had started slowing down, banks had already gone slow in extending loan. Even in that category, he said the fall is less than the margin money (which is 20 to 25% of the property value), the borrower had paid. According to a reliable source, bad loan in the real estate sector is less than half a percentage point.
Therefore, the banker argued that apprehensions that the fiasco in subprime market in US would impact the Indian real estate market is unfounded.
SOURCES:
Times Of India
Topics: The Facts, Reports, Real Estate |
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