In yesterday’s edition of The Daily Reckoning, I had discussed why teaser rate home loans are a bad idea. Arundhati Bhattacharya, the chairperson of the State Bank of India (SBI), recently put forward the idea that the country’s largest bank should be allowed to launch teaser rate home loans.
As I had explained yesterday, teaser home loans are essentially home loans in which the interest rate is fixed in the initial years and is lower than the normal floating interest rate on a home loan. The lower interest rate is limited only to the first two-three years after which the loan is priced at the prevailing interest rate on home loans.
The question is, why does Bhattacharya want to launch teaser rate home loans? Let’s look at some numbers of SBI. As on June 30, 2015, the bank had given out home loans worth Rs 1,63,678 crore, having grown by a robust 13.5% since June 30, 2014.This, when the overall domestic lending grew by a much slower 5.38%.
Between June 30, 2014 and June 30, 2015, the bank gave out home loans worth Rs 19,468 crore. Where did the overall lending stand at? The total domestic lending of the bank grew by Rs 54,255 crore during the same period. Hence, home loans formed a massive 35.9% of the total lending that SBI has done within India, between June 2014 and June 2015.
To rephrase the earlier sentence, more than one third of all domestic lending of SBI, over the last one year, has been in the form of home loans. For a diversified bank, which is not just a home loan company, this skew is way too pronounced.
Nevertheless, even after this, why does Bhattacharya want to give out more home loans, by launching teaser rate home loans? In order to answer this question I would need the average home loan size of SBI. I found two newsreports, which gave me two very different numbers. One report published in October 2014, quoted a senior SBI executive said that the average home loan size in case of SBI was at Rs 30-32 lakh. Another report published in April 2015 said that the average home loan size in case of SBI was at Rs 20 lakh.
The second number seems to me more believable given that the average home loan size of HDFC is Rs 23.4 lakh (HDFC shares its average home loan size every quarter). My guess is that the average home loan size of SBI would be a little lower than that of HDFC, given its better reach.
So we will work with an average home loan size of Rs 20 lakh. The next number needed is that home loan to value ratio, at the time the loan is given out. I couldn’t find that number for SBI (dear reader, hope you understand how difficult it is to get numbers on anything in India, despite the improvement over the years).
The number in case of HDFC is 65%. What this means is that on an average HDFC gives 65% of the market value of a home being bought, as a home loan. If we work with this number, the average market price of a home that SBI is giving a loan against is around Rs 31 lakh (Rs 20 lakh divided by 0.65). But this does not take one factor into account.
Almost no real estate deal in India is carried out totally in white money. There is a portion of black money that inevitably needs to be paid. It is very difficult to arrive at an all India number, but my guess is that 75:25 is a good conservative ratio to work with. This means that 75% of the value of the home is paid in white and the remaining in black.
Once this factor is taken into account the market price against which a home loan is given, shoots up to around Rs 41 lakh (Rs 31 lakh divided by 0.75). What does this mean? This means that the loan to value ratio is a little under 50% (Rs 20 lakh expressed as a percentage of Rs 41 lakh).
Hence, giving out home loans is a very safe form of lending. In fact, it is the safest form of lending. For mid-level companies, bad loans were at 10.3%. So for every Rs 100 that SBI gave as loans to mid-level companies, a little over Rs 10 wasn’t repaid.
For, retail loans the bad loans were at 1.17%. The bank does not give a separate number for home loans. Auto loans, education loans and personal loans, are the other forms of retail loans. The default rates in case of these loans is likely to be higher. Hence, the bad loans case of home loans should be lower than 1.17%.
The bad loans in case of HDFC amount to 0.54% of the total loans. What this means clearly is that almost no one who takes on a home loan defaults on it. Given this, it is not surprising that Bhattacharya wants to be allowed to launch teaser rate home loans. It is better for her to do that than be lending to corporates. As Bhattacharya had said: “This is one portfolio where NPAs are the lowest.”
The fundamental problem with teaser rate home loans is that a bank cannot be allowed to give out a loan at a rate of interest lower than its base rate or the minimum interest rate a bank charges its customers. Also, they cannot really be compared to normal home loans, given that the chances of the EMI jumping up in the years to come is significantly higher in case of teaser home loans. And that is a risk that Bhattacharya probably hasn’t taken into account.
The column originally appeared on The Daily Reckoning on August 27, 2015