HDFC

Why HDFC Finds Homes to Be More Affordable, When They Clearly Aren’t

Summary: HDFC is getting better home loan customers that doesn’t mean homes have become more affordable. HDFC’s conclusion of homes becoming more affordable is an excellent example of survivorship bias.

Before I start writing this, I have a confession to make. I have written about this issue before, around five years back. But given that things haven’t really changed since then, it is a good time to write about it again. Hence, to all my regular readers who have been following me over the years and might have read this earlier, sincere apologies in advance.

Home loans in India are given by two kinds of institutions – banks and housing finance companies (HFCs). Among the HFCs, Housing Development Finance Corporation (HDFC) has been a pioneer in the area of home loans.

The company regularly publishes an investor presentation along with every quarterly result.

I am not sure for how long the company has been doing this, but its website has these presentations going as far back as March 2013, a little over seven years. Since then, the company has had a slide in its investor presentation which talks about the improved affordability of owning a home in India. Usually, it is the eight or the ninth slide in the presentation (sometimes, but very rarely tenth).

This is the slide in the latest presentation for the period April to June 2020.

Improved affordability of homes

Source: HDFC Investor Presentation, June 30, 2020.

Let’s look at the chart between 2000 and 2020, the last two decades. The home loan market in the country before that was too small and evolving and hence, prone to extreme results. So, it makes sense to ignore that data.

What does the chart tell us? It tells us that affordability of homes in the country has gone up over the years. The chart defines affordability as home price divided by the annual income of the individual buying the home.

In 2020, the average home price has stood at around Rs 50 lakh. Against this, the average annual income of the individual buying the home stands at around Rs 15 lakh. Given this, the affordability factor is at 3.3 (Rs 50 lakh divided by Rs 15 lakh).

Hence, the average individual in 2020 is buying a home which is priced at 3.3 times his annual income. (Please keep in mind that the property prices are represented on the left-axis and the annual income is represented on the right axis).

As can be seen from the chart, the affordability factor at 3.3 is the lowest in twenty years. Hence, affordability of homes has gone up. QED.

The trouble is, this goes totally against what we see, hear and feel all around us. Real estate companies have lakhs of unsold homes with absolutely no takers. They have thousands of crore of unpaid loans. The banks and non-banking finance companies (NBFCs) have restructured these loans over the years and not recognized them as bad loans in the process, with more than a little help from the Reserve Bank of India (RBI). Bad loans are loans which haven’t been repaid for a period of 90 days or more.

Further, investors who bought real estate over the years have been finding it difficult to sell it. Indeed, if homes had become more affordable, this wouldn’t have been the case. Real estate companies would have been able to sell homes and repay the loans they have taken from banks and NBFCs. And the RBI wouldn’t have to intervene.

So, what is it that HDFC can see that we can’t? Before I get around to answering this question, let me tell you a little story. During the Second World War, the British Royal Air Force (RAF) had a peculiar problem.

It wanted to attach heavy plating to its airplanes in order to protect them from gunfire from the German anti-aircraft guns as well as fighter planes. The trouble was that these plates were heavy and hence, had to be attached strategically at points where bullets fired by the German guns were most likely to hit. The British couldn’t plate the entire plane or even large parts of it.

The good part was that they had historical data regarding which parts of the plane did the German bullets actually hit. And this is where things got interesting. As Jordan Ellenberg writes in How Not to Be Wrong: The Hidden Maths of Everyday Life: “The damage [of the bullets] wasn’t uniformly distributed across the aircraft. There were more bullet holes in the fuselage, not so many in the engines.”

So, historical data was available and hence, the decision should have turned out to be a very easy one. The plates needed to be attached around the plane’s fuselage. But this logic was missing something very basic. The German bullets should have been hitting the engines of airplanes more regularly than the historical evidence suggested, simply because the engine “is a point of total vulnerability”.

A statistician named Abraham Wald realised where the problem was. As Ellenberg writes: “The armour, said Wald, doesn’t go where bullet holes are. It goes where bullet holes aren’t: on the engines. Wald’s insight was simply to ask: where are the missing holes? The ones that would have been all over the engine casing, if the damage had been spread equally all over the plane. The missing bullet holes were on the missing planes. The reason planes were coming back with fewer hits to the engine is that planes that got hit in the engine weren’t coming back.” They simply crashed.

This is what is called survivorship bias or the data that remains and then we make a decision based on it.

As Gary Smith writes in Standard Deviations: Flawed Assumptions Tortured Data and Other Ways to Lie With Statistics: “Wald…had the insight to recognize that these data suffered from survivor bias…Instead of reinforcing the locations with the most holes, they should reinforce the locations with no holes.”

Wald’s recommendations were implemented and ended up saving many planes which would have otherwise gone down. (On a different note, both the books from which I have quoted above, are excellent books on how not to use data, especially useful if you are in the business of torturing data to make it say what you want ).

If you are still scratching your head and wondering what does this Second World War story have to do with HDFC finding homes more affordable, allow me to explain. Like the British before Wald came in with his explanation, HDFC is also looking at the data it has and not the overall data.

Look at the left-hand of the corner of the chart, it says based on customer data. The analysis is based on HDFC’s own historical customer data. When HDFC talks about an average home price of Rs 50 lakh and an income of Rs 15 lakh, it is basically talking about the set of people who have approached the HFC for a loan and gotten one. Hence, HDFC’s conclusion of better affordability is drawn from the sample it has access to.

But does this really mean that affordability has improved? Or does it mean that the quality of HDFC’s customers has improved over the years? The customers that HDFC is giving a home loan to are ones who can afford to buy homes. The HFC clearly has no idea about people who want to buy homes but simply do not have the financial resources to do so.

They don’t show up as a part of any sample, hence, the evidence on them is at best anecdotal. These people are like planes whose engines were hit and hence, they did not make it back to their base, in the Second World War. And like there was no data on the planes which got hit and didn’t make it back, there is no data on these people as well. Basically, HDFC’s data and conclusion are victims of the survivorship bias

In fact, HDFC’s investor presentation has always carried another interesting slide on low penetration of home loans in India. The following chart is from the latest presentation.


Home loans as a percentage of GDP

Source: HDFC Investor Presentation, June 30, 2020.

Total home loans outstanding given by both banks and HFCs in 2020 stands at 10% of the GDP (On a slightly different note, the ratio of homes loans given by banks to home loans given by HFCs is 64:36). In March 2014, the total outstanding home loans in India had stood at 9% of the GDP. If homes indeed were affordable this ratio would have gone up faster.

To conclude, it’s time that HDFC remove this misleading slide from its investor presentation or at least say that the affordability has improved for its customers and not for the country as a whole.

Mr Mistry, When It Comes to Buying a Home, the Price is More Important Than the Interest Rate

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Keki Mistry, the bossman at HDFC, India’s leading housing finance company, recently told The Economic Times, India’s leading business newspaper: “In my view, it is the best time to buy property. First, by virtue of the fact that interest rates are significantly low. Since 2008, we have not seen rates as low as this. I don’t believe rates will go down any further. Second, property prices haven’t gone up in recent times so one would believe there is time correction of prices.”

Asking Mistry if it’s the right time to buy a home is like asking Nandan Nilekani about the privacy concerns around Aadhaar. Or asking RBI governor Urjit Patel if demonetisation has been a success. Or asking me, if freelance writers should be paid more.

The answers in all the three cases will be a definite yes. Mistry is in the business of giving out home loans. And for him, it is always the right to give out home loans, as long as he takes a margin of safety into account and lends out only a certain portion of the price of the home being financed through a home loan.

Nevertheless, it is important to try and understand what Mistry is really saying here. The first point he makes that interest rates are low, and he doesn’t really see them going down anymore. Mistry might be right about this. Interest rates have been low because of the deluge of money that has come into banks because of demonetisation.

Mistry further says that home prices haven’t gone up in recent times and there has been a time correction of prices. And hence, this is the right time to buy property.

What does Mistry mean by a time correction of prices? Let’s say that a home was selling at Rs 50 lakh in a suburb of a big metropolitan city a few years back. Even today, it is going at the same price. Meanwhile, the price of every other thing has gone up. Once we factor in this inflation, the home has seen a time correction of prices, given that the purchasing power of Rs 50 lakh today is really not the same as the purchasing power of Rs 50 lakh, a few years back.

Given this time correction of prices, buyers should not wait any further and buy homes. This is basically what Mistry is saying.

The trouble is this makes little sense. As always there are several nuances that are involved here. First and foremost, there is the black part of that needs to be paid while buying homes across most parts of the country. It is difficult to generalise the proportion that needs to be paid in black, given that rates vary across the country. But let’s say around 20 per cent of the price of the home is to be paid in black. This works out to Rs 10 lakh (20 per cent of Rs 50 lakh).

Hence, the official price of the home works out to Rs 40 lakh (Rs 50 lakh minus Rs 10 lakh). A housing finance institution like HDFC will not finance the entire thing. HDFC’s average loan to value ratio at the origination of the home loan is 64 per cent. In this case that would mean a loan of Rs 25.6 lakh. (64 per cent of Rs 40 lakh). This is roughly around the average home loan size of HDFC at Rs 25.7 lakh.

Hence, HDFC will finance around Rs 25.6 lakh of the cost of the home of Rs 50 lakh. The buyer has to finance the remaining Rs 24.6 lakh. This basically means that the buyer needs to finance nearly half of the cost of the home. And that is the real equation that the buyer needs to take a look at.

This basically means whether the buyer has Rs 25 lakh of savings which he can use to buy a home of Rs 50 lakh. If he has the money he can buy the home. If he doesn’t, he can’t, irrespective of where the interest rate on the home loan is.

What about the low interest rate that Mistry was talking about? How much difference does it make? The EMI on a loan of Rs 25.6 lakh at 10 per cent per year for a period of 20 years would work out to Rs 24,801. This would have been the case a on a new home loan, a few years back. Now at 8.5 per cent interest, the EMI would work out to Rs 22,303 per month or around 10 per cent lower.

Hence, the lower EMI does help. But the basic question still remains; whether the prospective buyer has a savings of around Rs 25 lakh. Actually, the savings need to be more once we take brokerage, the cost of moving, making the home liveable enough, etc., into account. But for the ease of calculation we will leave all that out and just concentrate on the price of the house.

Now compare this scenario to where the price of the home over the last few years has fallen by 20 per cent and is currently going at Rs 40 lakh. Assuming a 20 per cent black part, the official price of the home works out to Rs 32 lakh. Of this HDFC would lend around Rs 20.5 lakh (64 per cent of Rs 32 lakh). Hence, the buyer would need around Rs 20 lakh to get the deal going.

This meant that anyone with savings of around Rs 20 lakh could carry out the transaction and buy the home. This requires Rs 5 lakh lower savings than the earlier example. In this situation, the prospective buyer is more likely to buy than the earlier one.

The point is similar to the one I have often made in the past, if people need to start buying homes again, the home prices need to come down. Lower interest rates just don’t help enough. And this is something Mistry needs to understand.

To conclude, it is safe to say that if 20 per cent of the price of a home being bought needs to be paid in black, then the buyer needs to have half of the price of the house as savings. Only then can he go ahead with the transaction and buy the home.

The column originally appeared in Equitymaster  on May 9, 2017

How Black Money Helps Indian Banks Finance Real Estate

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Black money or money which has been earned and on which tax has not been paid, is a common phenomenon in India. The fact that only around 3-4% Indians pay income tax explains this. This hurts the government given that it is not able to raise as much tax as it could, if everybody or a substantial portion of Indians paid income tax. It also means that the government has to borrow more in order to meet its expenses, and this pushes up interest rates.

It is also not fair on those Indians, typically the salaried class, who have no option but to pay income tax. What has also happened over the years is that instead of trying to expand the tax base, various governments have tried to milk those who pay tax, for more and more tax.

But not everyone is hurt because of black money. In fact, in case of home loans, banks and housing finance companies benefit because of black money. As Kaushik Basu, current chief economist at World Bank and former chief economic adviser to the ministry of finance, writes in his new book An Economist in the Real World – The Art of Policymaking in India: “A lot of the buying and selling of homes in India occurs with a part of the transaction being made in cash with no record kept of this in order not to leave a trail of evidence.”

Basu then goes on to explain how this benefits banks and housing finance companies issuing home loans. As he writes: “You want to buy a house valued at Rs 100 from the private market. The chances are the seller will tell you that he will not take the full Rs 100 paid in cheque, but will ask for a part, maybe Rs 50 or Rs 60, in cheque with the rest paid in cash with no evidence of this payment. The latter is called a black money payment.”

And how does this help? As Basu writes: “This helps the seller not to have to pay a large capital gains tax. Even many buyers want to pay partly in cash and to show the value of the house to be less than it actually is in order to avoid having to pay too much property tax.”

In fact, what Basu misses out on is the fact that in many cases buyers also have black money and they need to put this to use. And real estate is the best place to put it use given the totally opaque way in which the sector operates.

The black money payment essentially helps banks because the risk they take on in giving out the home loan, essentially comes down. How? “Since mortgage loans [i.e. home loans] can only be taken on the “declared” part of the house price, a house valued at Rs 100 would typically be bought with a mortgage of less than Rs 50. This means that when house prices [fall], unless the price drops [are] extraordinarily large, banks [will] not have a balance sheet problem,” writes Basu. In simple English what this means is that unless home prices fall dramatically, the value of the home (which is a collateral for the bank) will continue to be greater than the home loan outstanding.

He further philosophises that “Economics is not a moral subject”. “Often what is patently corrupt, like the pervasive use of black money can turn out to be a bulwark against a crisis.” In fact, Basu feels that the black money payments ensured that Indian banks did not have their own version of the subprime home loan crisis that hit the United States in 2008-2009.

Let’s understand this phenomenon in a little more detail. The December 2015 investor presentation of HDFC, the largest home finance company in the country, points out that the average home loan that it gives out is Rs 25 lakh. The average loan to value of a home stands at 65%. This means that the average price of a home financed by HDFC stands at around Rs 38.5 lakh (Rs 25 lakh divided by 0.65). The borrower/buyer makes an average down-payment of Rs 13.5 lakh(Rs 38.5 lakh minus Rs 25 lakh).

Over and above this there is a black payment to be made as well. It is very difficult to estimate the average amount of black money that gets paid every time a home loan is taken on to buy a home. Let’s assume that a black money payment of Rs 11.5 lakh is made. This means the real price of the home works out to Rs 50 lakh(Rs 38.5 lakh plus Rs 11.5 lakh).

Against this, HDFC lends Rs 25 lakh. Hence, the real average loan to home market value ratio stands at around 50%. This also when we assume that black money forms around 23% of the total value of the transaction (Rs 11.5 lakh divided by Rs 50 lakh). Black money payments in large parts of the country, especially in the northern part, can be considerably larger than this.

Hence, what this clearly tells us is that banks and housing finance companies end up lending half or less than half of the market value of the homes they are financing through home loans. And this makes it a very safe deal. Home prices need to fall by more than 50% for the value of the home to be lower than the home loan outstanding.

What also helps is the fact that home loans in India are recourse loans. This means that in case a borrower decides to default on the home loan by simply walking away from it, the lender can go beyond seizing the collateral (i.e., the house) to recover what is due to him. He can seize the other assets of the borrower, be it another house, investments, or money lying in a bank account, to recover his loan.

This along with black money payments explains why home loans are such good business for banks and housing finance companies. In case of HDFC, the non-performing loans formed around 0.54% of the individual home-loan portfolio. In fact, even when loans go bad, the institution is able to recover a major part of what is due and this explains why “total loan write-offs since inception [for HDFC]  is less than 4 basis points of cumulative disbursements.” One basis point is one hundredth of a percentage.

In case of State Bank of India, another big home-loan lender, the non-performing loans formed around 1.02% of overall retail loans. The bank does not give a separate non-performing loans number for home loans.

The column originally appeared in the Vivek Kaul Diary on March 2, 2016

One idea that real estate companies want to borrow from Gulzar

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In the film Ek Thi Dayan, lyricist Gulzar wrote a song, which had the following line: “koi khabar aayi na pasand to end badal denge [if we don’t like some bit of news, we will change the end.]”  In the recent past, the real estate companies do not seem to have liked the bad news that has been read out to them. And to tackle that they plan to create their own news. Or at least that is what a recent development suggests.

The Confederation of Real Estate Developers Association of India (CREDAI), a lobby of real estate companies, which has about 10,000 members, now plans to collect its own data on the industry.

As President of CREDAI Geetamber Anand told Business Standard: “The need to come up with its own set of data cropped up after varying figures from real estate consultants including Knight Frank, JLL India, Liases Foras and others, which at times create panic amongst the buyers fraternity.”

A spate of research reports brought out by real estate consultants in the recent past has suggested that real estate developers in large cities are not able to sell homes that they have built. A recent research report by Knight Frank suggested that over 7 lakh homes were unsold in the top eight cities of the country. The report also estimated that it would take more than three years to sell homes that have piled up.

Other real estate consultants have come up with similar reports with similar numbers. This is something which has not gone down well with the real estate lobby, which now wants to put out its own data. How can someone else tell them that all is not well with them?

What has also not gone down well with them is a recent comment by the Reserve Bank of India governor Raghuram Rajan, asking them to bring down prices.

As Rajan said: “It would be a “great help” if realty developers sitting on unsold stock bring down prices…Once the prices stabilise, more people will be keen to buy houses…I think we need the market to clear.”

The CREDAI responded to Rajan with the following statement: “While we respect the RBI governors concern for kick starting the real estate sector, it would be prudent to say that from the developers side a substantial reduction in prices has already happened across the country [italics are mine] and any further decrease in sale prices would be a deterrent for the growth of a sector that contributes so much to the economy and employment at large.”

CREDAI President Anand told PTI that “housing prices have gone down by 15-20 per cent on an average in last two years across India, while input costs have risen by 15-20 per cent.” The good bit here is that here is a top real estate lobbyist admitting that prices have fallen. It is tough to get them to admit even this much. Nevertheless, if the reduction in prices has already happened, why there is an inventory of 7 lakh unsold homes across top 8 cities? Also, the total number of unsold homes all across the country would be much higher than 7 lakh, but no such data is complied.

The real estate companies need to go back and learn some basic economics. One of the most basic laws in economics is the law of demand. The law essentially states that there is an inverse relationship between the price of a product and the quantity demand by consumers. If the price of the product goes up, demand falls and if the price of a product falls, the demand goes up.

In case of the real estate sector in India what the law of demand tells us is that if prices had fallen enough, people would have bought homes to live in and the unsold inventory would have cleared out. Nobody likes to let go of a good deal. But that hasn’t happened.

Why? Some simple Maths should explain this. In the National Capital Territory (Delhi and other smaller cities around it) an average flat costs around Rs 75 lakh (most research reports agree on this number). Assuming 20% of the price has to be paid in black (and I am being extremely conservative here), the official price of the flat is Rs 60 lakh (80% of Rs 75 lakh). A bank or a housing finance company gives a loan against this price.

The housing finance company HDFC has a loan to value ratio of 65%. This means it gives 65% of the value of a home as a loan on an average. This would mean that HDFC would give a loan of Rs 39 lakh. The buyer would have make Rs 21 lakh as a down-payment. He also needs to raise another Rs 15 lakh to be paid in black.

Hence, the buyer would need to raise Rs 36 lakh (Rs 21 lakh down-payment and Rs 15 lakh black) on his own. How many people have that capacity even in a city like Delhi? And I am not even taking into account the cost of furnishing the house, the cost of moving into it, other expenses like stamp duty etc.

The same maths works for all other big cities as well. What this clearly tells us is that home prices are way beyond what most people can afford. They are in a bubble zone. The sooner the real estate companies understand this, the better it will be for all of us.

They may want a different end, but that isn’t going to happen. The longer they hold on to prices, the longer they will have to hold on to all the inventory that has piled up.

The column was originally published on Sep 8, 2015 in The Daily Reckoning

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Why the State Bank of India is in love with home loans

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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