Moody's: Loans against property pose increasing risks in an otherwise stable retail property loans in India

Moody's Investors Service says that the overall asset profile of Indian banks' property retail loan portfolio is stable, although risks are rising in the non-traditional loan against property (LAP) segment.

"Growth in LAP loans has outpaced overall retail credit growth in recent years, but relatively loose underwriting practices and a tightening in credit following India's demonetization would translate into higher asset quality risk," says Srikanth Vadlamani, a Moody's Vice President and Senior Credit Officer.

"Nevertheless, we expect the impact on the banks' overall asset quality will be limited by the relatively small size of the LAP portfolio. On the other hand, non-bank finance companies with a higher exposure to the non-traditional end of the market would get impacted more," adds Vadlamani.

Moody's conclusions are contained in its recently-released report "Indian Banks -- India's Property Retail Loan Segments: Increasing Asset Quality Risks in Loans Against Property".

Moody's estimates the LAP segment -- comprising of loans to small- and medium-sized enterprises (SMEs) for business purposes with a property as collateral -- to have grown at a compound annual growth rate (CAGR) of 25% between 2012 and 2016, compared to 17% for overall retail credit.

However, the unique characteristics of this borrower segment, combined with rapid growth and intensifying competition, are posing risks to this segment of banks' loan portfolios.

In particular, because LAP loans are typically extended to SMEs and self-employed individuals, a borrower's ability to repay is often based on the lender's assessment of the borrower's income (surrogate loans) rather than actual reported income (income-based loans).

At the same time, the ready availability of credit has made it easy for borrowers to refinance their debt, thereby potentially masking any weakening in their ability to repay the debt.

Testifying to these risks, the 90+ days past due rate of LAP loans reached 2.7% as of March 2016 compared to 2.3% as of March 2015.

In this regard, Moody's expects the withdrawal of all INR500 and INR1,000 notes in early November 2016 may further expose the weaknesses in this segment. Disruptions in the borrowers' cash flows may trigger delinquencies, while tightening underwriting practices will make it more difficult for them to take out new debt.

Nevertheless, Moody's expects the stable performance of the much larger home loan segment will mitigate the negative impact, supported also by the country's favorable demographics, growing primary market supplies and an increasingly affordable housing segment.

In addition, the low LTV ratios -- typically around 60%-70% -- of LAP loans and the underlying properties should limit any loss given default.