Crisil Research report on retail assets

Your personal loans, credit cards are under lens

PFW Bureau / Jan 9

There has been some deterioration in the asset quality of retail loans in India in recent times because of increasing exposure to higher risk customers and rising interest rates, a latest study by CRISIL Ratings has revealed this.

The gross non-performing assets (NPAs) in retail loans, which increased to about 2.7 per cent as of March 2007 from about 1.7 per cent as of March 2005, are likely to rise to 4 per cent over the next two years. However, the situation will remain manageable because secured loans such as mortgage and vehicle loans account for 80 per cent of lenders’ retail loan portfolio. 

The increasing exposure to higher risk customers is mainly through personal loans and credit card receivables. These are unsecured and accounted for 17 per cent of total outstanding retail loans in March 2007, up from 6 per cent in 2004, the study stated.

Commenting on this trend, Roopa Kudva, managing director, CRISIL said,  “As competition has increased, players in retail lending, in their quest for growth and improvement in profitability, are reaching out to hitherto untapped clients, such as the self-employed and borrowers from smaller cities. This has increased lenders’ exposure to risk.”

While expecting this trend to continue, CRISIL believes that a reasonable definition of ‘sub-prime’ in the Indian context could include small-ticket personal loans that are given to low-income customers and a portion of credit card receivables.  “Going by this definition, sub-prime assets are still relatively low at 7 per cent of total outstanding retail loans. We estimate the loss levels in this segment to be currently at 7 to 9 per cent and expect them to increase to 10 to 13 per cent over the medium term. However, delinquencies across retail asset categories have gone up and are likely to increase in 2008-09, ” Kudva said.

Housing loans constitute over half of the total retail loans. Gross Non-Performing Assets (NPA)  in home loans increased to 2.2 per cent in March 2007 from 1.8 per cent in 2005; these are expected to increase to 2.7 per cent in financial year 2008-09. Car and commercial vehicle asset segments comprise one-third of retail loans. CRISIL estimates that gross NPAs in these segments have increased to 2.3 per cent and 4 per cent as on March 2007 from 0.9 per cent and 3.2 per cent respectively, in 2005. In 2008-09, these numbers are seen at 3 per cent for car loans and 5.5 per cent for commercial vehicles.

According to Raman Uberoi, senior director, ratings, “September-October 2007 saw a spike in delinquencies because of the slowdown in recovery efforts, following the controversy over the recovery methods of some lenders. Lenders have now taken welcome steps, such as increasing the use of technology in collection and recovery, and training collection agents to overcome the problem.” A possible fallout of the controversy could be that some players exit small-ticket personal loans.  “The exit of players could drive lower income borrowers to seek recourse to money lenders, which will be detrimental to the policy goal of seeking larger financial inclusion,” he said.


Recovery woes plague lenders

The recent controversies reported on the aggressive recovery mechanisms of some lenders significantly impacted the collection operations of almost all players. CRISIL’s analysis reveals that the collection operations in major centres, such as Mumbai, Pune, Kolkata, Chennai, Hyderabad, and Bangalore, had come to a virtual standstill between September-end and mid-October 2007.

The slowdown in collection was a result of lenders not wanting to risk tarnishing their reputations and re-assessing their recovery strategies in view of the challenging operating environment. Law enforcement agencies too have taken strong exception to the recovery mechanisms of some lenders and have asked the industry to ensure that persons employed by recovery agencies have a clean background.
Delinquencies for September and October of 2007 are expected to be high on account of the slowdown in recovery efforts and wilful default by some borrowers.

Lenders have taken steps to overcome the impact on asset quality and improve their collection and recovery mechanisms; these include strengthening underwriting norms, increasing the use of technology in collection and recovery, training employees and collection agents, and ‘in-housing’ collection and recovery activities. Lenders are also increasingly involving law enforcement
authorities in recovery of dues.

The rise in delinquencies and attendant unfavourable reports pertain predominantly to unsecured personal loans (specifically, STPL) and credit cards; segments such as mortgage, vehicle and two wheeler loans have not witnessed significant deterioration in asset quality. Although recovery efforts have steadily improved after the interim slowdown, CRISIL believes that the industry’s asset quality will witness higher delinquencies over the near term.

Increasing delinquencies and the measures adopted by lenders to tackle them could have the following long-term impact on the lenders’ credit profiles:
• Loss of new business owing to weakened reputation
• Deterioration in asset quality, as lenders deliberately go slow on recoveries to avoid damaging
their brand equity, and some borrowers wilfully defaulting on dues
• Increasing operating expenses as a result of investment in technology for recovery operations
such as automated diallers for reminder calls, recording of calls, centralised calling operations,
and ’in-housing’ of collection and recovery activities
• Exit of some players from the personal loans segment
While the first two factors will have a bearing on the business profile of lenders, the third factor will impact profitability and hence their financial profiles. CRISIL believes that profitability may also be impacted on account of material increases in write-offs and provisioning costs.

Players involved predominantly in any single line of business, especially the unsecured asset class, will face higher delinquencies, resulting in increasing pressure on profitability. However, the current capitalisation levels will protect the credit profiles of lenders to some extent. Most lenders have begun pricing the risk of default into their fresh disbursals; this is expected to sustain the credit profiles of the major players.

Sub-prime market in India and US

The sub-prime mortgage crisis in the US was shaped by the fact that borrowers availed of second-and third-lien mortgage loans, on the back of a boom in the real estate market and declining interest rates. Loans were disbursed at floating rates, which were low to start with, but increased sharply after a point. Interest rates in the US began to increase by the end of 2006. A significant portion of the sub-prime loans came up for interest rate resets and a sudden increase in loan repayables resulted in increasing defaults.

Consequently, several mortgage lenders foreclosed their loans. The problems of mortgage lenders were compounded by the fact that property prices began to decline around this time. As a result, mortgage lenders, especially those that had given away second- or third-lien mortgage loans, incurred heavy losses: borrowers could no longer repay, and the value of collateral was insufficient to cover the loans outstanding.

Mortgage lenders in India are unlikely to face a similar crisis. Lenders in India lend only to mortgages with first liens; servicing of loans primarily factors in the income levels of borrowers, not the value of collateral. Also, loans in India are disbursed either at fixed or floating rates from the inception of loans, unlike in the US, where many loans were disbursed at ‘teaser’ rates; thus, the shock of a sudden increase in interest rates and delinquencies are likely to be less sharp in India.