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Ind-Ra Says Real Estate Lenders Could Have A Negative Impact If Homebuyers Are Treated As Financial Creditors

Rajbir Achoriwala

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Real Estate Lenders Could Have A Negative Impact If Homebuyers Are Treated As Financial Creditors

As per a note by India Ratings and Research (Ind-Ra), Under the Insolvency and Bankruptcy Code 2016 (IBC) the order to treat homebuyers as financial creditors instead of operational creditors could be credit negative for the lenders of developers while it may strengthen the end-customers protection and boost the customer sentiment.

The Disadvantages:

Under the ambit of IBC home buyers’ interest as operational creditors did not fully optimize until now, as opposed to the operational creditors in other business. It says that now with the proposed revision home buyers will get equal treatment as financial lenders in the liquidation proceeds of the defaulting builder.

Nonetheless, for the lenders, this is a bad news as now the recovery proceeds will have another layer of distribution. It explained that without changes in the probability of default, loss given default (LGD) could increase for the financiers.

As for the buyers, they can now hope to recover some portion of their dues in case the builder defaults instead of the present scenario where buyers have to depend on the residual value after financial creditors are paid, which entails higher hair-cuts.

Considering the end-user and emotional attachment to the property Ind-Ra believes end-users’ propensity to initiate a case under the IBC would be much lower than investors’.

Repricing of Lending Yield for Financiers:

Ind-Ra believes financiers have to start re-pricing lending yields with the dilution of lenders’ right in liquidation proceeds. Thus the borrowing rates could harden for developers relative to their credit profiles. Ind-Ra suggests through-the-cycle probabilities of default and LGDs are yet to be established for financiers, considering most players are yet to see a full cycle apart from the rampant refinancing prevailing in the developer financing space.

Since institutional lending forms 20%-30% of the total value the increased borrowing cost may not materially increase the end-value of real estate with the balance coming from buyers’ construction-linked receipts. With restricted market readiness to absorb price rise and existing inventory dynamics in most markets, developers would absorb the likely incremental costs. Given the structure of funding, this would also affect private equity financing.

Buyer Advantage:

When it comes to default waterfall with lenders, and bankruptcy-led liquidation buyers will share equal priority. Thus they will have voting rights in line with their advances and they will also be part of the committee of creditors that approves a resolution plan. Thus buyers’ rights and power will strengthen in case of default in payment or planned schedule and bankruptcy of the developer.

Positives for Housing Financiers in the Long Term:

The asset quality of housing financiers will benefit from this ordinance. Even though they don’t stand a direct benefit, they could get some comfort as buyers’ rights over a defaulting builder and cash flows on liquidation will improve. With increased confidence more people will take home loans, thus benefitting the financiers.

Impact on Recovery from Felonious Assets:

In the present financing scenario, most of the delinquent real estate assets either get restructured or taken over by new sponsors and later. Thus it is only in cases where the builder is under extreme financial distress that financial institutes are likely to progress under the IBC.

The increase in LGD shall be contingent on the specific contours of the change in the IBC framework. The financier’s haircut will be very different in case home buyers are treated as unsecured financial creditors and if they are treated equally as secured creditors.

This would not impact the residential mortgage-backed securitisation market. The agency says such transactions are backed by fully disbursed loans. This guarantees completed properties or properties at advanced stages of completion or delivery to buyers.

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