The capital adequacy ratio (Car) is one of the important parameters to determine the solvency of housing finance companies (HFCs). They are required to maintain a minimum capital ratio consisting of Tier-I capital (minimum 6%) and Tier -II capital (not less than 12% of the aggregate risk-weighted assets and of risk-adjusted value of off-balance sheet items).

Keeping in view the requirement of long-term capital, the National Housing Bank (NHB) has proposed to progressively increase in the minimum Car for HFCs to 13% by March 2020, 14% by March 2021 and 15% by March 2022 from the present stipulation of 12%. However, the mix of Tier I and Tier II capital has not been specified.

HFCs have a cap of 16 times their net-owned fund (NOF) including deposits and any loans or other assistance from the NHB. Now it is proposed to implement graded reduction in the limit to 14 times by March 2020, 13 times by March 2021 and 12 times by March 2022.

The ceiling on public deposits for the applicable HFCs is to be capped at 3 times the NOF as against no limit. Infusion of capital (eligible for inclusion under NOF as per the NHB regulations) after such balance sheet can be taken into account for determining the limits. The increase in minimum threshold of Car puts HFCs on par with other NBFCs. It will achieve the integration of HFCs with the broader banking and financial system in the long run.

The loan book of HFCs has more than doubled in the last four years. The sector has maintained healthy asset quality as well as the margins. HFCs' share in lending to housing increased from 41% in the fiscal ended March 2017 (FY 2017) to 43.6% in FY 2018. The loan books of both scheduled commercial banks (SCBs) and HFCs expanded in FY 2018. But the lending of HFCs grew at almost twice the pace of that of SCBs.

There were 91 HFCs end March 2018. Of these, 18 were deposit-taking and the remaining 73 were non-deposit taking. Deposit-taking HFCs are all public limited companies. The only HFC owned by the government had a share of 4.2% in total assets in 2017-18. The asset size of non-government-owned HFCs, the dominant segment, grew at a rate of 27.5% in FY 2018.

The quarter ended December 2018 was a challenging period for NBFCs including HFCs. The tight liquidity conditions after IL&FS payment default increased borrowing cost. HFCs' loan growth moderated a sharp 13% end December 2018 from 22% end September 2018 and 23% end March 2018. Asset quality moderated. The gross non-performing asset (NPA) ratio went up to 1.17% end December 2018 from 1.06% end September 2018 and 0.94% end March 2018. Further, the average net interest margins eased to 3.09% in Q3 of FY2019 from 3.17% in Q2 of FY2019 and 3.32% in Q3 of FY2018.

As most of the top HFCs have comfortable Car and leverage position. They are unlikely to see any meaningful impact of the new NHB norms. Most have Tier I capital ratio of above 10%. They have maintained the overall Car above 15%. However, some HFCs such as LIC Housing Finance and PNB Housing Finance are slightly short of 15% Car. They might raise some Tier II capital to meet the norms.

In contrast to the larger HFCs, many smaller HFCs had taken a conservative stance of maintaining Car in excess of the proposed 15%. They may have little impact from the proposed NHB guidelines. Most HFCs are comfortable on leverage level of 12 times cap. The comfortable leverage is a function not only of regulatory requirements but also of stricter regulatory requirement of credit rating agencies. HDFC and PNB Housing Finance have a meaningful share of borrowings coming from deposits. But their ratio of deposits to NOF of less than 2 times within the proposed regulatory cap of 3 times.

Among the large HFCs, HDFC had the strongest Car of 18.9%, with Tier I ratio of 17.2% end December 2018. It had the lowest leverage ratio of 4.7 times. Its deposit-to-net worth ratio was a comfortable 1.4 times. The loan growth was moderate at 13%. The gross NPA ratio was a low of 1.22%. It is well placed under NHBs new proposed regulations.

LIC Housing Finance's Car is marginally short of the 15% mark at 14.8%. The Tier I ratio was better at 12.6% end December 2018. It needs to raise capital if the pace of growth picks up from the current level of 16% end December 2018. However, due to a huge share of retail loans, at 94%, the risk is low. The leverage level is elevated at 10 times and is likely to put pressure on loan growth and return on equity.

The Car of PNB Housing Finance was also just short of 15%, at 14.5%, with Tier I ratio at 11.4% end December 2018. It will require to raise capital or slowdown its loan growth rate, which was substantially higher, at 28%, to reach the lower leverage level, currently at 10 times and approaching the upper limit of 12 times. The asset quality is healthy, with the gross NPA ratio of 0.51%, along with healthy margins. There is likely to be some pressure to comply with new proposed regulation of higher Car and lower leverage.

Dewan Housing Finance (DHFL) and Indiabulls Housing Finance have comfortable Car and leverage levels. They have exhibited some moderation in loan growth: DHFL's decelerated to 15% and Indiabulls Housing Finance's to 16% end December 2018. Further, the asset quality and the margins are stable.

Among small HFCs, CanFin Homes had a healthy Car of 19.4%, with a comfortable leverage level of 9 times, end December 2018. The loan book consisted mostly of housing loans, with a healthy growth of 17% end December 2018. The asset quality is stable, with the gross NPA ratio at 0.71%. The margins moderated in Q3 of FY2019. The deposits book stood at just 0.1 times of net worth end December 2018.

Gruh Finance had a healthy Car of 19.4%, with a strong Tier I ratio of 18.2% end December 2018. The leverage was comfortable at 9.5 times. The ratio of deposits to net worth stood at 0.9 times, amounting to 10% of the borrowings. The loan growth was a strong 14%, while the gross NPA ratio was lower at 0.9%. Thus, there is no concern to comply with NHBs tighter regulations on Car and leverage. Bandhan Bank received RBI's no-objection approval for acquisition of Gruh Finance on 14 March 2018. It is expected to be operated as a separate business after the merger with Bandhan Bank.

Repco Home Finance had a robust Car of 24.2%, entirely consisting of Tier I ratio, end December 2018. The leverage ratio was substantially lower at 6 times. It is comfortably placed to follow the NHB's new guidelines. The loan growth moderated to 12% end December 2018. The gross NPA ratio was higher 3.9% due to seasonal factors and high share of non-salaried customers.

Conclusion

The HFC sector is highly competitive. Most of the players operate on narrow margins and profitability. Most of them are well below the NHB proposed caps of capital adequacy and NOF. As higher leverage is the key to generating high RoEs, increase in capitalization requirement and constraints on deposit issuance, as proposed by the NHB, will reduce the potential RoE and financial flexibility of HFCs. It will discourage the entry of new players in the sector.

Going forward, availability of capital will play a crucial role. Regulators need to ensure sufficient availability of liquidity for HFCs with strong balance sheet amid tight liquidity conditions to achieve the government's goal of Housing for All by the calendar year 2022.

Top HFCs will see limited impact due to better capitalization and headroom for selling down retail loans to banks. The RBI recently tweaked its guidelines for maintaining risk weights on bank lending to systemically important NBFCs to allow more funds to flow to stronger NBFCs and HFCs. To facilitate flow of credit to quality NBFCs, rated exposures of banks to all NBFCs, excluding core investment companies, will be risk-weighted as per the ratings assigned by accredited rating agencies in a manner similar to that for corporates. The move will benefit established HFCs.