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Every housing finance company, and every bank with a large housing finance exposure, will see loss of volumes in this quarter.
The housing finance industry is one of those that has been pretty badly hit by demonetisation. Stocks have been sold down substantially. The long-term prospects may actually be better than the market now believes.
Interest rates are more or less guaranteed to come down. Banks are flush with deposits. The Reserve Bank of India will probably make a big rate cut in December (at least 50 basis points, perhaps 100 bps) to encourage business activity. This means housing finance companies can source funds cheaper and offer lower EMIs.
But, the real estate market, which was already in bad shape, is frozen now. The entire chain of that industry depends on black money built into every transaction.
The ratio of black to white may be different for specific deals and in specific regions. But, there is always some black component. Real estate agents take a large chunk of compensation in cash. The petty officials who do the paperwork and registration, transfer, etc, take cash under the table.
So, no transactions are happening now since there is no cash in the system.
Every housing finance company, and every bank with a large housing finance exposure, will see loss of volumes in this quarter. Until the stock of black money in the system is rebuilt, it will see low volumes and a sharp drop in prices.
Prime Minister Modi's threats to target benami transactions will also have scared that chain of service persons (agents, registrars) who will be reluctant to risk getting caught in the income tax net.
Housing finance companies could be faced with obviously rising chances of defaults. They will also have to rework valuation models since loans-to-value (LTV) ratios and loans-against property-ratios will change for the worse.
Housing finance companies lend a percentage, say 70-80 per cent, of the estimated (white) price of a given property. (Some housing finance players also "informally" arrange personal loans for the black component at much higher interest rates). If real estate prices drop, LTV might hit red-flag territory if for example, the loan exceeds the value of the property.
Again, many mortgages are secured against the value of some real estate unit owned by the person applying for the loan. These "second home loans" would need to be reviewed if the value of the "first home" drops below a critical level.
The pain could well continue for, say, another two quarters. The market is operating on guesswork when it revalues housing finance companies since the dimensions of the impact is unknown.
Even the best analysts will almost certainly misjudge by significant margins. Consensus valuations of the housing finance market could err on either the optimistic or pessimistic side, and there will be big price swings as estimates are re-adjusted through the next six months or so.
Whenever liquidity does return to the system however, housing finance companies will see several long-term factors working in their favour. One is that real estate prices will be down and there will be a large stock of unsold inventory. Realtors will be closer to desperation and more prepared to drop prices. This is good for housing finance in terms of the supply side.
At the same time, middle class persons will be more interested in buying if both real estate prices and EMIs are dropping to more realistic levels. This will be good for housing finance on the demand side. And, as mentioned above, costs will fall for housing finances since they will be able to source cash cheaper.
It could be a wild ride for the industry. The mid-term prognosis is surely bad. That is now being priced into equity valuations. But, at some stage, these companies will see an equally sharp recovery in their business prospects and in their equity valuations.
