Loans to Realtors

Are real estate prices supported by your branch manager?
8th Oct 2009

We live in a strange world.

Millions in India would like to buy homes to live in.
Or offices for setting up a new venture.
Or shops for starting a business
But buying real estate - or renting it - is still way beyond our means.

So we save our money in safe places waiting for that wonderful day when we can buy that home we need.
Or the office for the new venture we wish to start.
Or the shop for the new business we wish to start.

One of the places where we park our money is in bank deposits.

Much of it is parked in the PSU banks - the public sector banks that are owned by the government of India.

According to data from the Reserve Bank of India (RBI), PSU banks account for 74% of the total bank deposits in the country.

Well, what does the PSU bank do with all our money?

They do what all banks are supposed to do: lend it on to someone else at a higher price (the lending rate).
The difference between the lending rate and the borrowing cost (what the banks pays you for your deposits or what it may pay other banks and companies to borrow money) is a margin that needs to cover all the salaries and costs of maintaining a branch.

No harm in that.
None at all: that is the business of all banks whether PSU or private banks.
If there was no profit in the banks, we would not have any banks.
That would be a problem.
So banks which lend money to others and earn a good return on it are a good thing to have around.

Immerse yourself in 2008
But there is something interesting in the RBI data on what banks have done with your deposit money.
But, before we head there - we need to remind ourselves where the world was in December 2008.

Lehman Brothers had gone bust in September 2008.
Merrill Lynch had to be rescued by Bank of America in a shotgun marriage arranged by the US government.
AIG had to be bailed out.
While most Indian banks were healthy, there were concerns that a few banks (which had relied on excessive foreign lines of credit for their excessive growth) may not have money to repay their foreign loans and needs to be "rescued" by the RBI.

Indian companies, in general, had borrowed about USD 20 billion from foreign banks and investors.
This USD 20 billion included what Tata Motors had borrowed for its acquisition of Jaguar, or the working capital borrowing by an Indian company using "cheaper" foreign money to invest in its Indian businesses.
By October 2008, the foreign banks were told to send all their money back to "home country". Their parent banks were in trouble and they needed all the money back in safe US government or UK or Euro government bonds.
Foreign banks were not only refusing to lend any new money to any Indian company, but they wanted all the loans that were falling due returned. They refused to "revolve" or extend the loans.

Too add doom to the gloom, many mutual funds were holding debt issued by Indian real estate companies and these companies were not able to repay this debt.
The Indian companies had parked their surplus cash with these mutual funds. They now wanted it back (to repay their foreign bank loans or for use in their own operations), and the mutual funds could not repay it.
Ouch!

The Indian stock markets were collapsing.
And the general consensus (uh, not from me) was that the Indian stock market could head as low as 4,000 to 6,000 levels from the 8,000 levels of the BSE 30 Index.

And the final knock-out punch: the sale of shares by foreign investors (uh, speculators will be more accurate) to the extent of Rs 70,000 crore and the act of converting this into US Dollars led to a decline of about -30% in the Indian rupee in the year 2008.

Even the sweet and normally confident anchors on TV channels looked like Rakhi Sawant - one day after being with a child.
The financial newspapers stopped publishing photographs of attractive models to add colour to their India fantasy stories.

That, then, was the India we were in.
December 2008.
Please roll back your mind to that period.

And add the spice: there was an election coming up.
Which many believed (eh, not me) could take India into the bullock cart age.

Rescue me!
Let's take a quick peek at what was happening to real estate developers.

People had stopped buying real estate.
Salaries were being held back - the days of the guaranteed 25% annual increase were over.
Jobs were at risk.
Offices were empty.
Businesses were closing down.

Real estate developers were about to go bust.
They were desperate for cash.
There was no money inflow from the sale of real estate.
But there were debts to be repaid.
And the real estate developers also had payment obligations for all the land that they had agreed to buy as they went about building their "land banks".

In this environment, what were the PSU banks doing?
They were pretty busy lending money for real estate.

Between May 23, 2008 and May 29, 2009 the loans given by banks (excluding the loans it makes for agriculture) grew by +18% - from Rs 21,747,670 million to Rs 25,582,500 million.

But the loans given to real estate grew by +52% - from Rs 621,780 million to Rs 944,990 million.

This period is for May 2008 to May 2009 - in a few weeks we will get data for the period October 2009 over October 2008.
That data will probably be more telling.
Global credit markets froze after Lehman's collapse and the "growth" in loans may be more than what this "older" data shows.

But even this "old" data shows the huge rescue of the real estate developers.

It should be noted that "loans to real estate" does not include the loans made to individuals who borrow money to purchase their homes. Those mortgage loans grew by 5% confirming the data from the real estate industry that home-buying has slowed down considerably.

According to industry estimates (and a research report by a foreign stock-broking house), the growth in the number of new homes sold in 5 cities (Bangalore, Bombay, Chennai, Gurgaon, Hyderabad) has declined.

Between April, May, and June of 2008 there were 15,000 units sold in these 5 cities. This works out to an average of 33 units per day per city.

From then on it went into a tailspin and reached the low level of 5,000 units for the period January, February, and March of 2009.
This works out to an average of 11 units per day per city.

It has since picked up - mostly in Bombay - to an estimated 9,000 units for the 3-month period July, August, and September 2009.
This works out to an average of 20 units per day per city.

The point is: there was a small growth in homes purchased - so there was no significant growth in loans given to individuals for purchasing real estate.

But there was a huge (+52%) increase in loans shown to real estate developers - loans given to keep the real estate companies afloat.

Given that foreign banks were asked to send money back home and not to lend in India, much of this increase in "loans to real estate" was probably made by the Indian banks.

And given that ICICI Bank (the largest) and many other Indian private sector banks were being careful and re-assessing the risks they had taken in many previous loans, the chunk of the "loans to real estate" must be from the PSU banks.

Your bank deposit, helps keep real estate prices up!
So, there it is:
You wish to buy real estate but are waiting for it to decline to a price that you can afford to pay.
Stock prices jump around too much so, correctly, you don't wish to put your idle money in stock markets because you may need the money at anytime to buy real estate.
Your bank deposit is with the PSU bank.

The banks have used your money to give it as a loan to real estate developers.
Their act of giving the loan to real estate developers gives them badly needed cash.
The real estate developers no longer need to sell their real estate to get "cash flow" to stay alive.
They got the money from the banks.
Now, the real estate developers can charge you a higher price for real estate.
They can sell it on their terms.
Their terms, of course, are to make a 100% to 300% profit from you.

So, if the calculations in Table 1 above are correct, then the loans to real estate developers were about Rs 323,210 million or Rs 32,321 crore.

These Rs 32,321 crore was - from a cash flow perspective - the equivalent of selling 161,605 homes of 1,000 sq ft each.

So, some 161,605 homes that would otherwise have to be sold by the real estate developers to generate cash flow for the developers (to match the loans they got from the banks) have not come to the market to be sold.

Instead, an estimated 34,000 homes were sold for the 12 months ending May 2009.
And property prices had fallen by -20% to -30%.

What would happen to real estate prices if banks had NOT given these loans (from your deposit money) and if 161,605 homes had to be sold in the 12 months ending May 2009?

The 161,605 homes that did not come to the market are 4.8 times the homes that were sold in the 5 cities in that same time period.

You saw what happened when foreign investors sold Rs 70,000 crore of stocks?
The BSE-30 Index collapsed from 20,500 to a level of 8,000.
A decline of -69%.
But real estate developers have a friendly banker.
That is why property prices have fallen "only" by -20% and are now heading up again!

So, why this sudden friendship?

Well, we had a national election coming up.
Politicians possibly need money to fight elections.
Though this may be a coincidence.

And then many politicians - across political parties - possibly have someone they know from their family in the real estate business.
And they needed to rescue them.

The foreign banks stepped out, the Indian banks stepped in.

The governments control the PSU banks.
A suggestion, a nudge, a wink, or a phone call is all it takes.

And a little bit of your money.
Just a little bit.

Rs 323,310 million of extra money that went to the real estate developers is only 1% of the total bank deposits in the country.
What's a little 1% between friends?

But it is sufficient to ensure that real estate prices may not fall to levels that are affordable for you.
For the aam aadmi that every Finance Minister and every government and every politician is so worried about.

Mahatma Gandhi walked to the sea and made his own salt.
The politicians were all there to pay homage to the great soul on October 2nd.
Dressed in their white khadi and solemn faces.

Like the Mahatma, you can protest, too.

Walk up to your neighbourhood bank branch manager and ask him, "How much of my bank deposit in your bank is going to fund real estate developers who then keep prices so high that I cannot afford to buy real estate?"

Maybe you wish to give your deposit to a bank that only gives real estate loans to individuals who buy homes or offices or shops?
You can deal with banks that refuse to give money to real estate developers.
This small act will force the real estate developers to sell those 161,605 homes that they would need to sell to pay back the loans from your bank deposits.

And then you can buy your real estate at a more "real" price.

Finance remains a very corrupt business, in my humble opinion.
As does real estate.

So, where does that leave the financing of real estate in the ranking tables of corrupt businesses?

I wonder, I really do.....

Which of these according to you is the most corrupt business?

The above is from my Newsletter from Equitymaster, written by Ajit Dayal.
His writings are always thought provoking and point to the deficiencies of the government.
I could not have written better.