Documet of The World Bank IFO OMCL USE ONLY Reot No. 12021 PERFORMANCE ALDIT REPORT INDIA HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT (LOAN 2929-IN) JUNE 17, 1993 MICROGRAPHICS Report No: 12021 operations Evaluation Department This document has a restricted distribution an# may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
Transcript
Documet of
The World Bank
IFO OMCL USE ONLY
Reot No. 12021
PERFORMANCE ALDIT REPORT
INDIA
HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT(LOAN 2929-IN)
JUNE 17, 1993
MICROGRAPHICS
Report No: 12021
operations Evaluation Department
This document has a restricted distribution an# may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.
Average 1989 * 16.226Average 1990 = 17.504Average 1991 = 22.742
ACRONYMS AND ABBREVIATIONS
ALL - Average Loan LifeGOI - Government of IndiaHFIs - Housing Finance InstitutionsHFS - Housing Finance SystemIFC - International Finance CorporationLIC - Life Insurance CompanyNHB - National Housing BankMF - Ministry of FinancePAR - Performance Audit ReportPCR - Project Completion ReportRBI - Resezve Bank of IndiaSAR - Staff Appraisal ReportSOE - Statements of Expenditures
FISCAL YEAR
April 1 to March 31
FOR OFFICIAL USE ONLY
THE WORLD BANKWashington, D.C 20433
U.S.A.
Office of Director-GeneralOperations Evaluation
June 17, 1993
=MHRAMDUM TO THE EXE9UTIVE DIRECTOR6 MD THE PRESIDET
SUBJECT: Performance Audit Report on IndiaHousing Development Finance Corporation Proiect (Loan 2929-IN)
Attached .. the report entitled "Performance Audit Report on India -Housing Development Finance Corporation Project (Loan 2929-IN)" prepared by theOperations Evaluation Department.
The Audit covers the only loan for US$250.00 million equivalent madedirectly to the Housing Development Finance Corporation (HDFC), 4 private companylaunched with IFC's assistance in 1978.
The audited project helped HDFC to expand its mortgage lending andto pursue its lower-income targeting by earmarking half the loan to borrowersbelow the median urban income. The demonstration effect looked for by theproject was achieved: mortgage len6ing by private specialized housing financeinstitutions is viable and sustainable. The improvements to the legal andregulatory framework for housing finance were elusive. The central-governmentapex institution created on the eve of the project had no success pushing severallaw changes, but it introduced a contractual savings scheme and provided allhousing finance institutions with refinancing facilities. Overall, the choiceof the Borrower made difficult the implementation of sector-level reforms.
The Audit concludes that the project was successful and that housingfinance is a good transfer avenue when the intermediary is well managed.
This document has a restricted distribution and may be used by recipients only in the p, rmance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.
FOR OFFICIAL USE ONLY
PERFORMANCE AUDIT REPORT
INDIA
HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT(LOAN 2929-IN)
TABLE OF CONTENTS
Page No.
Preface.................................................................. iBasic Data Sheet......................................................... iiEvaluation............................................................... iv
I. BACKGROUND......................................................
II. A. Objectives................................................. IB. Disbursements............................................... 2C. Beneficiary Targeting....................................... 4
III. HOUSING DEVELOPMENT FINANCE CORPORATION............................ 5
A. Financial Policy.............................................. 5B. Financial Covenants........................................... 7C. Portfolio Quality............................................. 8D. Bank Loan's Maturity, Grace Period and Exchange Risk.. ........ 9E. Organization .................................................. 10F. Accounting and External Audit................................. 10G. Sustainabillty................................................. 11
IV. SECTOR POLICY CHANGES................................ ............. 11
A. Role of NHB ................................................... 11B. Secondary Mortgage Market..................................... 12
V. CONCLUSIONS AND LESSONS ........................................... 13
A. HDFC Performance.............................................. 13B. Bank Performance.............................................. 14C. Project Rating................................................ 15
ANNEX
Comments from the Borrower........................................ 16
This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.
PERFORMANCE AUDIT REPORT
INDIA
HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT(LOAN 2929-IN)
PREFACE
1. This is a Performance Audit Report (PAR) on the First Housing FinanceProject in India. involving a World Bank loan amounting to US$250.0 millionequivalent, to the Housing Divelopment Finance Corporation (HDFC) with theguarantee of the Government of India (GOI) to finance mortgage loans for thepurchase or construction of houses or apartments generally in the urban areas ofthe country. The loan was approved on March 31, 1988; it was entirely disbursedbefore the closing date.
2. The PAR is based on the Project Completion Report (PCF) prepared by theSouth Asia Regional Office and issued on June 29, 1992, (Report No. 11453) theStaff Appraisal Report (SAR), the loan documents, and a study of the projectfiles. An OED mission visited India in October 1992. The excellont cooperationand valuable assistance provided by HDFC in the preparation of this report isgratefully acknowledged.
3. The PCR provides a comprehensive account of the project experience, isinformative on the achievements and allows checking on the compliance withcovenants. The PAR elaborates on selected aspects of proj ct implementation, inparticular the financial performance of HDFC, the affordability of its mortgageloans to households, and the relative progress made to put in place a regulatoryframework favorable to the growth of housing finance institutions. The PARconcurs with the PCR satisfactory rating of the Project.
4. Following standard OED procedures, copies of the draft PAR were sent to theBorrower and to the Executing Agency for comments. Couments received from theHousing Development Finance Corporation have been reproduced as an Annex to thePAR.
PERFORMANCE AUDIT REPORT
INDIA
HOUSING DEVELOPHENT FINANCE CORPORATION PROJECT
(LOAN 2929-IN)
BASIC DATA SHEET
KEY PROJECT DATA
Appraisal Actual Actual as %ungg Expectations Estimates of AVRr. st.
First Mention in Files 01/9/86Appraisal 08/87 10/87Negotiations 02/88 02/88Board Approval 04/88 3/31/88Loan Agreement Date 05/88 4/21/88Effectiveness Date 05/88 5/18/88Loan Completion 09/91 2/13/91Closing Date 09/30/91 2/13/91
Stage of Month No. of Days in PerformanceProiect Cycle Yea Persons Field Rating'
Identification 12/86 2 1.6 NAPreparation 03/87 3 4.8 NAPre-appraisal 06/87 3 9.6 NaAppraisal 10/87 3 9.6 NASupervision I 09/88 1 3.0 1Supervision II 03/89 1 0.8 1Supervision III 08/89 4 5.6 1Supervision IV 03/90 4 6.4 1Supervision V 12/90 2 3.6 1Completion 10/91 2 6.0 1
OTHER PROJECT DATA
Borrower: Housing Development Finance Corporation (HDFC)
Executing Agency: Housing Development Finance Corporation
Fiscal Year of Borrower: April 1 - March 31
Follow-up Project: none
1. Problem Free; 2. Minor P-oblems; 3. Major Problems.
iv
PERFORMANCE AUDIT REPORT
INDIA
HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT(LOAN 2929-IN)
EVALUATION SUMMARY
Introductinto improve sector incentives. The
1. At the time of appraisal in first two objectives we,z to be1988. the organized -apital market of controlled through the loan madeIndia vas largely ignori-g the directly to HDFC and the third onefunding needs of housing investments. through trenching (PAR, para. 4).At present, the housing finance The main component of the project wassystem (HPS) is still not an conceived as a time-slice of HDFC'sintegrated part of the financial lending over the period October 1987system. Furthermore, the informal (appraisal date) to March 1991 (endhousing sector continues to be the of FY91). US$248 million of the loanmain source of supply. The Housing were to refinance 30% of allDevelopment Finance Corporation disbursements made by HDFC, with at(HDFC) established in 1978, for least half earmarked to sub-borrowersseveral years was the only financial with incomes below the median urbaninstitution, yet private, dedicated income and the other half without anyto providing mortgages (PAR, para. conditionality (PAR, para. 5).1). The 7th Plan, which gavepriority to meeting the housing Project Implementationdemand, called for changes in theaector, among which a much greater 3. The loan to HDFC was fullyemphasis on private finance for disbursed 32 months before the end ofhousing. To control the expected the grace period, and over 3 yearsmultiplication of housing finance before a traditional urban project.institutions (HFIs), GOI proposed the This illustrates the resourcescreation of an apex institution, the transfer advantage of housing financeNational Housing Bank (NHB) (PAR, projects over the traditional sites-para. 2). For the Bank, this and-services projects (PAR, para. 6).operation was a major departure from The concept of trenching wasthe tested strategy of financing introduced prior to appraisal co givespecific investment projects, mostly the Bank the means to enact theof the sites-and-services type (PAR, institutional changes in the sectorpara. 3). which were under GOI's control (PAR,
para. 7). Prior to negotiations, theProject Objectives and Components first two conditions were met and the
Bank kept only the last tranche, yet,2. The project's main objective revised to require NHB to implementwas to endorse the private sector specific proposals tc regulate HFIsapproach to housing finance as and to promote resource mobilizationcarried out by HDFC. to encourage for the sector. Yet, the firstdissemination of its experience, and mission following loan signing stated
V
that only "the minimum requirements offering training and consultingfor the second tranche release were assistance (PAR. para. 12).satisfied". This Audit concurs withthe PCR vhich states that: "Inretrospect, ne.ther the timing of thetranche conditions not the actions 6. HDFC has succeeded in remainingspecified ptovei to be effective in in control of a very rapidensuring consistency of NEB's actions development. Its financial situationwith the project'e aims." during the period FY87-92 has beenRetroactive financing (US$25 million characteriztd by solid results due inor 10% of the loaa amount) back to large part to a prudent financialOctober 1987 (appraisal) although it policy. Growth by any measure haswas not really necessary with been rapid. Revenues (made up forfinancial intermediaries such as HDFC about 95Z of irterest payments)which are permanently refinancing increased by 36.9% compounded p.a.past loans to offset the usual betwern YY86 and FY92 (PAR. para.mismat3h of maturities. Retroac4ive 15). To tap domestic savings, HDFCfinancing allowed to stretch the had to diversify its products. HDFCtime-slice eligible for reimbursement launched a successful deposit,.y six months and thus to increase mobilization drive. Trust bonds andthe loan amount at negotiations (PAR, corporate bonds were issued. Thepara. 8). contractual savings scheme introduced
in 1985 proved to be premature. In4. It was required of HDFC that at 1989 NHB introduced a better schemeleast 50% of the loan finance (PAR, para. 17). HDFC has been anborrowers below the median urban innovator in zany ways. It hasincome estimated at Rsl,700 (US$131) offered variants of mortgage loans toin 198. Since HDFC's borrowers with make the debt-servicing moreincome lower than the median affordable. The "Step-up Repaymentaccounted for 34.7% of loans in FY87, Facility" is a graduated paymentthe Bank zriterion (being equivalent loan; the "Telescopic Loan Plan" isto 15% of lending) did not put an initial 30-year loan where thepressure on HDFC to lend more to debt-servicing capacity of thelower-income groups. Ninety-two borrower is reviewed after 5 years.percent of the Bank disbursements in these products are, however, notFY91 went to loans granted to popular (less than 4% of outstandingborrowers below the median income loans). HDFC's most rewarding(PAR, para. 10). However, the PCR innovation has been the "Lines ofoverstates the number of housing Credit" which essentially useunits financed with the Bank loan selected corporations to distribute(300,000). This Audit estimates loans to their employees and tothat, in the best scenario (no more collect payments from them (about 13%than 50% allocated to lower income of loans are made this way) (PAR,borrowers), 164.500 units were para. 18).financed directly. This would stillbe more than twice the SAR target 7. The Bank projent retained the(PAR, para. 11). financial covenants which had been
set by IFC since 1978 when it war,5. Te:hnical ussistance was not an associated with HDFC: debt-equityimportant component of the project. ratio, interest coverage ratio,Actually HDFC has become a resource administrative costs, and provisionsinstitution for HFIs in Asia, for bad loans. HDFC has been able to
vi
net these covenants without 1986). It cannot be emphasizeddifficulty (PAR, para. 19). EDFC is enough that HDFC's record on this keyusing additional ratios to monitor issue of housing finance isits performances capital adequacy, impressive by any standard (PAR.return on equity, average cost of pats. 24).debt, and average yield on loans.HDFC has been succesaful in avotding 9. Loan 2929-IN had an expectedthese two pitfalls of specialized average loan life of 10.23 years atfinancial intermediaries. Ensuring a the time of appraisal. The close topositive margin between the average expected disbursements kept it atportfolio yield and the average cost 10.16 years, which is a very goodof funds has been a steady item of match with the averaZe duration ofEDFC's strategy, even during the loans. Since the exchange risk wasrecent run of interest rates toward hedged, the 10-year figure will20%. Ensuring a positive match remain iegardless of the evolution ofbetween the average portfolio the .. e. Ia other words, the loanmaturity and the average debt to Ok is a rare case where the Bankmaturity is more difficult given that loan has indeed contributed to afew lenders offer the 20-year loan positive match of maturities (PAR,maturity needed to match of mortgage para. 25). The technique used t-loans as the Bunk loan does. The elim-nate the exchange risk was aspread between cost of funds and series of swaps. This removed theyield has, however, decreased below r..sk element in exchange for a flattwo points (1.3 in FY92), which is a fee. set such, however, as not tomi-imum for an autonomous financial bring the -ffective intereSL rateintermediary (PAR, para. 21). above HDFC's overall rate on long-
term borrowing (12.5%). The fact8. HDFC takes third-party that HDFC has made a policy ofguarantees on 80% of the loans to hedging the exchange risk on its
supplement the cumbersome legal foreign borrowings has cont:ibuted inhurdles of registering mortgage a substantial way to its viability ascollaterals (it takes up to 5 years a financial intermediary (PAR, para.to complete deed recording in some 26).states and the foreclosure laws aredifficult to enforce). When payments 10. As HDFC was already anare lat., HDFC threatens to collect efficient organization, the projectfrom the guarantors. The quality of did not address any organizationcollaterals is also maintained by issue beyond the decentraiizationHDFC's policy of not generally effort to set up additional branchesfinancing more than 802 of the where there is a concentration ofappraised value of the dwelling demand for housing loans. HDFC has(actual average around 55%). Yet, been operating at a high level ofthere is a tendency for HDFC's staff efficiency as can be expectedborrowers to over-extend themselves, from a private company. Low staffespecially in high-price metropolis mobility is also a noted feature ofsuch as Bombay (PAR, para. 23). The HDFC's performance (PAR. paras. 27-
most important demonstration effect 28).expected of HDFC vas that high loanrecovery can be achieved in the 11. HDFC's accounts have never beenhousing mortgage lending sector. qualified (PAR, para. 30).This was the first pi ority laid outin the initials Project Brief (June
vii
12. The nature of the project is FIs, while good for the sector, hadsuch that sustainability hinges on an adverse effect on HDFC becausethe collection of principal and several vere promoted by c-tercialinterest payments. HDFC has a very banks which diverted fundinggood record on loan recovery. As a previously earmarked for HDFC toresult, the project benefits are their nw subsidiaries (PMR par.likely to be sustainable (PAR. pa,a. 39). HDFC has been able to keep all32). the financial perame:srs, which are
often the cause of financial distressSetor_Polinr Change& mong financial intermediaries. under
control. The interest spread is13. The Bank questioned early on positive. The duration of funds isthe advantage of creating another well matched. The exchange risk iscentral government financial not an issue. Arrears areinstitution. NHB is claiming that it insignificant. All these translatedis not doing more regulations or. the into good profitability as reflectedNFIl than the Resevve Bank of india by the increasing valuation given to(REI) is imposing on non-bank HDFC share by the stock exchangecompanies. Yet, NHB has strengthen-ad (PAR, para. 40).restrictive regulations and notremoved recognized constraints. 15. This project confirmed,Several laws have beea for some time however, the Bank's inability to tiein process of being updated to meet macro reforms with microthe requirements of a growing improvements. By project completion,mortgage portfolio. No legislation the housing finance system was stillhad been passed at the time of the not integrated into the bankingfield Audit (PAR, paras. 33-34). The e7stem or so haphazardly (e.g., newidea of developing the housing Uls set up by selected commercialfinance sector to a size justifying banks) as to underscore the progressthe adjunction of a secondary still needed (PAR. para. 41). Themortgage market has been touted by Bank loan was additional instead ofHDFC for several years. This will displacing domestic resources. Withnot be feasible as long as several hindsight. the Bank's insistence onprerequisites (alleviation of atamp having the exchange risk covered exduties, simplification of ante proved correct, and explains inforeclosures, etc) are met (PAR, large part why HDFC has been able topara. 36). maintain sound financial ratios (PAR,
pare. 44). Given the suc:ess of thisConclusions and Lessons pilot project, the absence of a
follow-up loan was regretted by HDFC.14. The Bank helped increase thescale of HDFC's intervantion. It is 16. froject Rating. This projectto the credit of HDFC to have geared was successful in all respects and isthe organization to handle the rated, both by the PCR and thisadditional resour-es. The expectation Audit, as highly satisfactory (PAR,of continued Bank assistance to HDFC para. 46).did not, however, materialize (PAR,para. 38). HDFC has shown a greatadaptability tc the changing marketconditions, which helped it focus ondomestic retail resourcemobilization. The multiplication of
PERFORMANCE AUDIT REPORT
INDIA
HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT
(LOAN 2929-IN)
I. BACKGROUND
1. At the time of appraisal in 1988, the formal capital market of India waslargely ignoring the funding needs of housing investments.' Central Bankregulation obliged commercial banks under the directed credit approach toallocate funds to the sector, but the level of transfers was too low to have animpact (0.5% of their total credit advances in 1987). Over 90% of housinginvestment was financed by household savings and borrowing from the informalsector. The Housing Development Finance Corporation (HDFC) established since1978 was for several years the only financial institution (furthermo:e private)dedicated to provi1ding mortgages. Despite being very successful in opening amarket for formal housing mortgage finance, it still had a limited impact. Theperception that the potential market corresponded to the low-income populationwas a major constraint to the development of an unsubsidized housing financesystem. Another factor was GOI policy to limit the availability of formal sectorhousing finance (SAR, para. 1.01).
2. Past GOI housing strategies depended on direct investments by the publicsector with funds mobilized under the directed credit system and recovery beinga low priority. The 7th Plan, which gave priority to meeting the housing demand,called for two changes in the sector: (a) a refocusing of public resources onfinancing land development and shelter for the lowest-income groups, and (b) amuch greater emphasis on private finance for housing. The latter involved amajor effort to improve institutional finance for housing and a proposal for thecreation of an apex institution, the National Housing Bank (NHB).
3. After twelve projects supporting public sector development of urban land,infrastructure and municipal services, this was the first housing financeproject. While the shift had been made much earlier in smaller countries, forBank operations in India, this project was a major departure from the testedstrategy of financing specific investment projects, For all its novelty, the Bankchose an established intermediary which had been launched with IFC equity fundsten years earlier.
2/ At present, the housing finance system (HFS) is still not integrated intothe financial system. Furthermore, the informal housing sector continuesto be the main source of supply.
2
II. PROJECT OBJECTIVES. DESCRIPTION AND IMPLEMENTATION
A. Obi*ctives
4. The project's main objective was to support the private sector approach tohousing finance as carried out by HDFC. to encourage dissemination of itsexperience, and to improve sector incentives. As stated in the SAR. the specificobjectives wores
(a) support of HDFC's lending in a period of transition in the capitalmarkets in order to extend the benefits of market-oriented housingfinance to a wider geographical area and to a broader group ofmiddle- and lower- income beneficiaries;
(b) further institutional development ot HDFC's roles as an innovatorand advocate of market-oriented housing finance, and as sectorleader assisting the entry and development of similar institutions;and
(c) development of a supportive regulatory framework to ensure thefinancial integrity of housing finance institutions and theircapacity to mobilize resources at mprket rates (SAR, para. 4.01).The first two objectives were to be controlled through the loan madedirectly to HDFC and the thi rd one through trenching (PAR. para. 7).
5. The main component of the project was conceived as a time-slice of HDFC'slending over the period October 1987 (appraisal date) to March 1991 (end ofFY91). US$248 million of the loan were to refinance 30% of all disbursementsmade by HDFC. with at least half earmarled to sub-borrowers with incomes belowthe median urban income and the other half without any conditionality. A smalltechnical assistance component (US$2 million) was allocated to assist HDFC infurthering its decentralization, its computerization and its pursuit ofinnovation.
B. Disbursements
6. Th6 Bank loan was disbursed slightly faster than projected in the SAR.Retroactive financing in the amount of US$25 million equivalent had been approved(PAR. para. 8). Table 1 shows a close parallelism between projected and actualdisbursements, and the trenching of the Bank loan did not affect the actuals(PAR, para. 7). The comparison with the standard disbursement profile for theurban sector in India illustrates the resources transfer advantage of housingfinance projects over the traditional sites-and-services projects: the loan wasfully disbursed 32 months before the end of the grace period, and over 3 yearsearlier than a traditional urban project. This increased considerably theeffective availability of Bank funds for HDFC (PAR, para. 25). It alsodemonstrated the absorptive capacy of the housing finance intermediary sincethe loan amount was increased from US$100 million prior to appraisal to US$250million at negotiations. Net transfer to HDFC remained positive during theproject implementation period, which is another advantage of housing financeloans.
3
7. Trenchint The concept of trerching was introduced prior to appraisalto give the Bank the means to enact the institutional changes in the sector whichwere under GOI's control. Initially, three trenches were designed: (first)initiation of an enabling regulatory environment fostering a financially-soundmarket-oriented approach: to be met by creating NEB; (second) legislation on NHBpassed by Parliamentl (third) Bank review of NRB's specific proposals foraction.' Within three months, the first two conditions were met and the Bankkept only the last tranche; yet, it revised the conditions to require from NHBthe implementation of specific proposals to regulate RFIs and to promote resourcemobilization for the eec.or. Bank management noted that Bank review of NHBproposal was not required anymore as a condition and objected. Bank staffresponded that th4 appraisal mission had informally assessed - preliminary draftas satisfactory. Yet, the first mission following loan signing stated that only"the minimum requirements for the second tranche release were satisfied" and that"further steps are necessary if the intentions of the conditions are to beeffectively carried out".' The distinction between conditions fulfilled inspirit vs in letter was thus made in the record. The following month, the secondtranche was nonetheless released because the conditions had been "substantiallyfulfilled". As a result, the trenching did not affect disbursements to HDFC.This Audit concurs with the PCR which states that: "In retrospect, neither thetiming of the tranche conditions no the actions specified proved to be effectivein ensuring consistency of NHB's actions with the project's aims." (PCR, para.17) .s
Projected in SAR 64.0 76.5 86.4 23.1Actual 54.0 88.8 93.9 13.3'Urban profile7 2.0 18.0 35.0 40.0 50.0 40.0 40.0 20.0
8. Retroactive Financi ta The Bank agreed to allow retroactive financing(US$25 million or 10% of the loan amount) from October 1987. It was not reallynecessary. The rationale for choosing the appraisal rather than the more usualnegotiation date is that a substantial share of past eligible expenditures wouldbe left unfunded if the Bank did not include them in the project. This rationale
3/ Project Brief (September 2, 1987).
4/ Aide-Memoire (March 1990).
5/ The original english of this sentence is confusing.
'/ In terms of HDFC's fiscal year. loan disbursements were Rs. million 1,250,1,113 and 1,770 in FY8, 1990 and 1991, respectively.
7/ "Standard Disbursement Profiles", June 1992.
4
is solid in investment projects with shortage of counterpart funds or badlyneeded foreign exchange, it is less so with financial intermediaries which arepermanently refinancing past loans to offset the usual mismatch of maturities.HDFC's good resource mobilization performance did not justify retroactivefinancing, except to acknowledge the fact that subprojects were readily eligible(PAR, para. 10). Retroactive financing allowed to stretch the time-sliceeligible for reimbursement by six months and thus to increase the loan amount atnegotiations.
9. SOecial Account Although HDFC was the Borrower of the Bank loan, it wasdecided that "it would not be in its best interest to operate the specialaccount".' Fungible retroactive financing eventually served the same purpose.
C. Beneficiary Targetin
10. Given the Bank focus on poverty alleviation, it was required from HDFC thatat least 50Z of the loan finance bo.rowers below the median urban incomeestimated at Rsl,700 (US$131) in 1987. Since HDFC's borrowers with inc me lowerthan the median accounted for 34.7% of loans in FY87, the Bank criterion (beingequivalent to 15% of HDFC's lending) did not motivate IDFC to lend more to lower-income groups. Requests for reimbursements by the Bank were supposed to confirmthe meeting of the criterion and the corresponding documentation was supposed tobe audited (PAR, para. 29). The PCR stated that the target was met at over 30%(PCR, para. 9). Table 2 shows that to be correct every year with respect to thenumbers of borrowers, but only two years out of three in terms of loan volumes.Still, it could be considered that 92% of the Bank disbursements in FY91 went toloans granted to borrowers below the median income.
Table 2: Targetini of Bank Loan
FY 1987 1988 1989 1990 1991
Urban median income (Rs/month) 1700 1860 2000 2110 2450Z of borrowers below median inc. 34.7 41.6 34.8 37.1 42.4% of loans to same borrowers 22.6 25.8 26.7 24.3 29.5Bank target (Re million) - - 625 556 885Actual approvals by HDFC 424 465 578 969 1623
11. The PCR overstates the number of housing units financed with the Bank loan.From 70,000 in the SAR (p. iii), it is claimed to have reached 300,000 unitsdirectly financed (PCR, para. 19).' During the three fiscal years concerned bythe above disbursements (1989-1991), total approvals reached 256,075 (PCR, p.18). Given the need to disburse half of the loan to borrowers below the medianincome, this Audit estimates that, in the best scenario (no more than 50%allocated to lower income borrowers), 164,500 units were financeu. directly. This
6/ Internal memorandum (February 12, 1988).
No verifiable computation is provided.
5
would still be more than twice the SAR target. The median household income ofHDFC's borrowers increased from Rs2,300 in FY87 to Rs2,800 in FY91, which is aslower slippage (21.7%) than all India's median urban income (35.3% from Rs1,700to Rs2,300). Yet, the distribution of loan amounts grew more in favor of higher-income borrowers because the loan ceiling was increased fivefold to RsO.5 million(Table 3). Well after project completion, HDFC is still meeting with a widemargin the allocation criterion set in the Bank project.
12. Technical Assistance. Training and Studies Training abroad and foreigntechnical assistance was not an important component of the project given thestage of development of HDFC. It did not use foreign consultants as allowed inthe component. Instead of purchasing off-the-shelf softwares. HDFC staffdeveloped its own custom software thus gaining in-house capability to keep ittailored to HDFC's operational needs. HDFC has established its own trainingfacility wherr all staff re sent on a rotating basis. Recently it started tooffer courses to staff of foreign housing finance institutions with success. Itis another indication of HDFC's maturity that it has reached a stage where it canprovide training and consultancy abroad.
Table 3: Income Distribution of HDFC Loans
Rs/month <1000 1000-2000 2000-3000 >3000in units terms (in % of units approved)September 1988 10.2 32.4 25.5 31.9March 1992 1.0 6.0 20.0 38.8in loans terms (in % of "individual loans" approved)September 1988 5.4 22.4 23.8 48.5March 1992 1.0 3.0 15.0 57.0
13. Procurement Being a first loan to the housing finance sector,procurement followed the pattern established for Bank loans to HFIs made sincethe early 1980s which essentially adopt the intermediary's procedures. Directproject procurement was used only for the purchase of computers. No problemswere reported.
14. Economic Rate of Return The SAR estimated the ERR at 20-30% based onimputed rental values and sales data. Given the pent-up demand for mortgageloans, these rates were expected to remain high for a long period (SAR, para.5.03). The PCR did not provide a recomputed ERR. This Audit did not attempteither. Given that HDFC borrowers have been able to afford the debt-servicing,the ERR is, however, estimated to be a multiple of the average yield on the loanportfolio (about 14% for the last several years).
6
III. HOUSING DEVELOPMENT FINANCE CORPORATION PERFORMANCE
A. Financial Policy
15. HDFC has succeeded in remaining in control of a very rapid development.Its financial situation during the period FY87-9210 has been characterized bysolid results due in large part to a prudent financia. policy. Growth by anymeasure has been rapid. Revenues (made up for about 95% of interest payments)increased by 36.9% compounded p.a. between FY86 and FY92. Profits followed atthe same pace (36.8% p.s.), thus showing that growth was not obtained at theexpense of margins. The equity base grew mostly out of retained earnings (43.8%p.a.) while the share capital was increased from RS 100 million to 200 in FY87and again to Re 450 million in FY90. Total debt increased at the same pace ashousing loans (33.4% and 34.5%, respectively) which is sound intermediationpractice. The Bank ias been the largest single lender (17% of total at the endof FY92) despite granting one loan. Term deposits have been growing at a muchslower pace than other borrowed funds (20.6% p.a.) but they still account for thelargest share (36%) of total debt. Given the shorter maturity of deposits(actually offset by good stability), this trend is not adverse to the soundnessof HDFC's financing plan. It is no coincidence that deposits have financed adecreasing share of housing loans until FY92 when HDFC was forced to launch adeposit collection drive to offset changing market conditions (Table 4): loansfrom domestic commercial banks, US-AID and the World Bank have levelled off sinceFY91. IFC (HDFC's initial shareholder) and the National Housing Bank havestepped in, but in limited ways. It is, therefore, significant of HDFC's abilityto capitalize on its reputation in a crowded domestic financial market to haveraised new debt in FY92 mainly through bond issues (20.6%) and new deposits(47.7%).
16. HDFC re.;ource mobilization strategy changed in 1991 due to the downgradingof India's credit rating. No foreign borrowing could be mobilized (the US$60million syndicated tranche of the last IFC loan was postponed). To tap domesticsavings, HDFC had to diversify its funding instruments. HDFC launched asuccessful deposit mobilization drive with the assistance of a network of brokerspaid on commissions. This network is currently bringing Rs600 million per month.The marginal cost has increased for deposits to remain attractive. Although nodeposit is remunerated above 15%, the final cost is 17% after brokerage fees.
'o/ While the period covered by loan disbursement is FY89-91, this Auditassesses HDFC's performance over the last six audited years.
7
advertising, and servicing costs. Trust bonds were launched three years ago whenHDFC became eligible to receive trusts' investments. They can be subscr!bed for1-48 months at 13-14.5% interest rate. Corporate bonds have been issued for 10to 30-year maturities with a buy-back at-par facility to create a resale marketfor them. Refinancing from NHB has been tapped since made available in FY91 giventhat its costs of 12.8% is substantially lower than HDFC average cost of funds.
17. HDFC established a contractual savings scheme in 1985 after m"rket surveysconcluded that there were savings to be tapped in this form, especially among themiddle-income groups. The German model was adopted with some relaxation sinceHDFC did not insist on regular savings which proved to be a costly loopholebecause some depositors could claim eligibility for a loan by transferring fundLonly at the end of the saving period. Savings were remunerated at one pointabove deposits with commercial banks (then 5%), and the lending rate was set at2.5 percentage points above or 8.5% whizh represented a steep discount over thenormal mortgage loans at 12.5%. The scheme did not succeed as expected despitean improvement of the loan-to-savings ratio from 1.5 initially to 2.37. As oneof the concept's premises (i.e., new savers finance the loans taken by theoriginal savers) did not materialize, HDFC was left with funding the loancommitments with other funds. The scheme was terminated early 1992. Theexperience proved to be only premature, not wrong for India. In 1989, NHB nadintroduced a better scheme called "Home Loan Accounts" which took savings at 10%for 5 years, and granted loans up 4 times the accumulated savings at 10.5-14.5%.Like the other HFIs, HDFC is authorized to keep in its balance sheet the depositscollected under this new contractual savings scheme in exchange for funding outof the same funds the future requests for loans. Only when the original depositswould be exhausted, HDFC could then request NHB to provide complementaryfinancing.
18. HDFC has been an innovator in many ways. It has offered variants ofmortgage loans to make the debt-servicing more affordab3. The "Step-upRepayment Facility" is a graduated payment loan; the "Telescopic Loan Plan" Isan initial 30-year loan where the debt-servicing capacity of the borrower isreviewed after 5 years to reduce maturity without change in the interest rate.Although advantageous, these products are not popular (less than 4% ofoutstanding loans in the Madras branch). It is due in part to the newness andthe perceived complexity of the products, which active promotion by HDFC couldovercome. It is also that HDFC borrowers have a high propensity to prepay theirloans. A study based on HDFC loans granted in the initial years showed a 37%-prepayment level. The reasons are: the Indian dislike for debt, the taxincentive, and the use of refunds given every 5 years on life insurance policies.HDFC's most effective innovation has been the "Lines of Credit" which essentiallyuse selected corporations to distribute loans to their employees and to collectpayments from them. From FY87-91 48,200 corporate loans were extended (13.4% oftotal).
8
Table 5: Financial Covenant.
Fiscal year Covenant 1987 1988 1989 1990 1991 1992
19. The Bank project retained the financial covenants which had been set by IFCsince 1978 when it was associated with HDFC. They are: (1) the debt-equity ratiodesigned to limit the leverage derived from a relatively small capital base, (2)the interest coverage to ensure a positive spread between average yield and costof funds, (3) the administrative cost in percentage of the loan portfolio tomaximize the productivity of the institution, and (4) the provisions for badloa.s also in percentage of outstanding loans to self-insure againstirrecoverable loans. HDFC has been able to met these covenants withoutdifficulty or creative acccunting as it is often the case (Table 5). One of thecovenants is redundant because the local practice imposes a more stringentceiling. The debt-equity ratio, while allowed to go up to 17.5:1 with the BankGroup, is limited to 15:1.
20. HDFC is using additional ratios to monitor its performance. In its bid tobe considered a full-fledged financial institution, HDFC is also monitoring itscapital adequacy (7.3% by mid-1992 on the basis of 100% risk'weighted assets)against the international "Cook Ratio" of 8%, which implies lowering the leveragefurther.12 The doubling of the share capital carried out at the end of 1992 hasbrought HDFC above 8%. Additional ratios are: (1) the return on equity (rangingfrom 25-33% since 1986) because HDFC is a private corporation whose shares aretraded on the Bombay stock exchange, (2) the average cost of debt outstanding,and (3) the average yield generated by the loan portfolio.
21. Although SAR projection assumed that the spread between cost of funds andyield would remain above 2.2 percentage points, it has decreased below twopoints, which is a minimum for an autonomous financial intermediary (Table 6).Only because its administrative costs are kept low, is HDFC able to remainprofitable with a reduced margin. It is the increased cost of funds which forcedHDFC for the first time in 1992 to pause in its rapid lending growth because ofthe affordability issue. HDFC made a conscious decision to reduce lending tomaintain portfolio quality since there is a correlation between higher interestrates and greater arrears. The same trend also explains why HDFC has been
1/ HDFC disclosed only arrears older than six months iin its FY92 Annual Report.
n/ The capital adequacy or Cook ratio requires from financial institutions anequity base equal to at least 8% of their liabilities.
9
reducing its leverage. Beyond these, measures to restore the spread are limitedbecanse the leneing rates are imposed by NHB if its refinancing is used.
Table 6: Yield, Cost of Funds and Spread
Fiscal year 1987 1988 1989 1990 1991 1992
Average cost of debt (%) 11.6 12.0 12.5 12 7 12.7 13.3Average yield of loans (Z)14.1 14.0 14.1 14.1 14.1 14.6Spread (1 points) 2.5 2.0 1.6 1.4 1.4 1.3
22. The interest risk and the mismatch of tuaturities are two perils which haveundone many financial institutions; a notable example in the housing sector isthe US savings-and-loans system. The interest risk was flagged during projectpreparation, but deemed "limited" at a time when inflation rates were single-digit.1 HDFC has been successful in avoiding these two pitfalls of specializedfinancial intermediaries. Ensuring a positive margin between the averageportfolio yield and the average cost of funds has been a stady item of HDFC'sstrategy, even during the recent run of interest rates toward 20%. Ensuring apositive match between the average portfolio maturity and the average debtmaturity is more difficult given that few lenders offer the 20-year loan maturityneeded to match mortgage loans as the Bank does. The stability of deposits hasbeen a positive factor as well as the long availability of the Bank loan (PAR,para. 25).
C. Portfolio Quality
23. HDFC takes third-party guarantees on 80% of the loans to bypass thecumbersome legal hurdles of registering mortgage collaterals (it takes up to 5years to complete deed recording in some states and the foreclosure laws aredifficult to enforce). When payments are late, HDFC threatens to collect fromthe guarantors. The pressure is generally sufficient as the impressive recoveryrecord attests. While these guarantees seem superfluous given the overall gooddebt-servicing record, the practice has contributed to educate mortgage borrowersthat loans need to be repaid. The quality of collaterals is also maintained byHDFC's policy of not generally financing more than 80% of the appraised value ofthe dwelling." This Audit found in a sample of 60 recently-approved loans inBombay that this ceiling is respected (3 cases over 80% and an average of 55%).Yet, there is a tendency for HDFC's borrowers to over-extend themselves,especially in high-price areas such as Bombay. The already-mentioned sampleshowed that borrowers purchased housing equal to 4.76 years of income on average,but that many were well above this already-high figure (25% were above 6 years,10% above 8 years and 2% above 10 years). Even if the current recovery recordis good, these figures represent potentially greater risks. This Audit confirmed
/3 Issues Paper (January 9. 1986).
/I Letter from HDFC (January 14, 1988).
10
that in Madra. for example, the average price-to-income ratio has crept up fromaround 5 times to 6-7 in about ten years.
24. Loan Recover The most important demonstration effect expected of HDFCwas that high loan recovery can be achieved in the housing mortgage lendingsector. This was the first priority laid out in the Initial Project Brief (June1986). It cannot be emphasized enough that HDFC's record on this key issue ofhousing finance is impressive by any standard. It compares very well with thedelinquency ratio observed in the U.S.. for example, where arrears of over threemonths reached 0.88Z in September 1992. To facilitate payments. HDFC has openedaccounts in 200 commercial banks spread in the country. Thirty five percent ofpayments are received in this fashion. Every borrower over two months in arrearsis visited to ascertain the situation and work out affordable debt reductionarrangements. As a result, HDFC has had no need to change its policy ofmaintaining a loan-loss reserve equal to about 1% of outstanding loans, which istwo and a-half time the level required by covenant.
D. Bank Loan's Maturity, Grace Period and Exchange Risk
25. Average Loan Life The Bank Loan was granted directly to HDFC for 20 yearsof maturity, including 5 years and 6 months of grace, in order to help match thelong maturities of mortgage loans. From HDFC's viewpoint, the availability overtime of borrowed funds can be measured by an indicator called the Average LoanLife (ALL). It is defined as: the ratio of (a) the sum, until maturity, of theloan balances (in US dollars) outstanding at the end of each year over (b) theloan amount not of cancellations. This indicator measures the number of yearsduring which the entire loan proceeds stay effectively at the borrower's disposalassuming up-front disbursement. The faster the disbursements and the slower therepayments, the longer the availability of loan funds. In the case of Loan 2929-IN, it had an expected average loan life of 10.23 years at the time of appraisal.The close to expected disbursements kept it at 10.16 years, which is a very goodmatch with the average duration of loans. Since the exchange risk was hedged(PAR, para. 26). the 10-year figure will remain regardless of the evolution ofthe Rupee. In other words, the loan to HDFC is a rare case where the Bank loanhas indeed contributed to a positive match of maturities.
26. Exchanie Risk Bank staff have been pro-active on the issue of theexchange risk since project yreparation, requesting "appropriate allowance" forthat risk as early as 1986. Yet the Bank estimated later that "HDFC can bearthe risk" on the proposed Bank loan while recommending its coverage with GOIassistance."' This meant removing the risk element in exchange for a flat fee,set such, however, as not to bring the effective interest rate above HDFC'soverall rate on long-term borrowing. The technique used to eliminate theexchange risk was a series of swaps. While it was originally aimed to swap withother Indian corporations, the magnitude (US$75 million for the first tranche)obliged HDFC to deal exclusively with GOI. This explains why the accountingpresentation is confusing. Schedule 14, Note 10 to the FY92 Annual Report
/! Letter to the Minister of Finance (July 8, 1986).
/, Internal memorandum (January 21, 1988).
11
discloses the interest payments to IBRD and IFC under the label "expenditure inforeign currency". Although HDFC does buy the foreign currencies needed toinsure the debt-servicing, it is done on behalf of the swappers (GOI for the Bankloa, the Industrial Finance Corporation of India for the IFC loan). Theresulting cost of Bank funds for HDFC was a fixed 12.5%, which was higher thanthe then-cost of funds, but proved to be a favorable deal since the devaluationof the Rupee since 1991. The fact that HDFC has made a policy of hedging theexchange risk on its foreign borrowings has contributed in a substanteal way toits viability as a financial intermediary (PAR., para. 29).
E. Organisation
27. Staffina HDFC has been operating at a hieh level of staff efficiency ascan be expected from a private company. Low staff turnover is also a notedfeature of EDFC's performance.
28. Organization Chanaes As HDFC was already an efficient organization, theproject did not address any organization issue beyond the decentralization of fortto set up additional branches where there is a concentration of demand forhousing loans. Ten branches were opened during the project period, bringing thetotal to 26. They are given large autonomy: they approve all loans toindividuals and up to a set amount loans to corporations (for on-lending to theiremployees). With the check of internal auditing decentralization is considereda good experience. The organization chart has not changed substantially sinceappraisal, except for the addition of a deputy managing director and theregrouping of the ten additional branches under regions each overseen by afunctional director. The introduction of computers and customized software underthe technical assistance component of the project contributed to productivitygains and institution efficiency.
F. Accounting and External Audit
29. HDFC is being audited by independent auditors acceptable to the Bank. Theyissued at Bank request separate reports on Statements of Expenses (SOE), andthere was no problems with this disbursement procedure. The audit ofbeneficiaries is part of the normal audit process (through random samples takenat each branch), but only as far as their loan balances vis-A-vis HDFC, not forthe affordability of the debt burden. To that extent, the intent stated in theSAR (para. 4.04) of having the external auditors review the documentation keptby HDFC to ensure that at least half of the Loan finance lower-income groups wasnot fulfilled. However. HDFC met the target (PAR, para. 10).
30. HDFC is operating under the Company Act which says what financial dataought to be disclosed and the Accounting Board set the specific guidelines. Someimprovements are possible although HDFC's accounts have never been qualified.For example, the lending comitments accumulated outside balance sheet such a.those linked to the new contractual savings scheme promoto-d NHB are notdisclosed because it is not atatutory. They need to be known by the maincreditors of HDFC. Similarly the funding requirements of the approved but yetundisbursed loans weighs heavily onto the medium-term financial policy of HDFCand thus ought to be also readily available in the published accounts. Anotherexample deals with the exchange risk. Although HDFC does not bear any, an item
12
in the income statement labelled "Expenditure in foreign currency" might beconfusing. Actually HDFC buys the foreign currencies needed to service the Bankloan, for example, and then debits the Central Government's Stabilization Fundof the difference between the nominal interest rate (about 7.7%) and 12.5% (theswap interest rate). The somewhat misleading label should be either changed orclarified in a footnote to the audited accounts. The cost of swapping theforeign-currency resources to avoid the exchange risk is substantial (althoughless than the annualized exchange losses thus Fsr); it should be shown on aseparate line in the income statement.
31. Environment was not a prominent issue in this project. Over 90% of HDFClending vent to urban areas and 75% to finance apartments. These are moderndwellings, all linked to electricity, water and sewerage networks.
G. Sustainability
32. The nature of the project is such that suatainability hinges on thecollection if principal and interest payments. HDFC has a very good record onloan recovery. As a result, the project benqiits are likely to be sustainable.
IV. SECTOR POLICY CHANGES
A. Role of NHB
33. The Bank questioned early on the advantage of creating another central-government financial institution.1
34. NHB is claiming that it is not imposing more regulations on the HFIs thanthe Reserve Bank of India (RBI) is imposing on non-bank companies. Indeed itpromoted the establishment of additional HFIs by providing "refinancing" ofselected mortgage loans initiated by them. NHB has become de facto the onlylarge-scale financier of mortgages to low-incoce groups because HFIs withoutaccess to low-interest deposits (such as the subsidiaries of coumercial banks)cannot afford lending below the current market cost-of-funds. This refinancingfacility is a form of subsidy because, while limited to loan- that finance housesof a certain price or size, it can reach large multiples (up to 5 times the HFI'snetworth and up to 3 times deposits). NHB relaxed its refinancing criteria inMarch 1990 by allowing loans for housing larger than 40m2 provided the cost wasbelow Rsl50,000. This easing was partly offset by halving the spread left afterrefinancing on loans above Rs50,000 (to 1% instead of 2%). In FY90 and FY91,HDFC's borrowing from NHB went from 0 to Rs2,781 million, or exactly 37% HDFC'sadditions to debt these two years.
35. Several laws have been for some time in the process of being updated tomeet the requirements of a growing mortgage portfolio. The industry has been
"/ First Issues Paper (January 9, 1986).
13
lobbying since its beginning for a relaxation of the stamp duty and of theForeclosure Law. Both make the transfer or repossession of mortgages andproperties more costly. There is a proposal -o MOF to allow more rapidforeclosure (which is said to take up to ten years) through an amendment to theNHB Act rather than a revision of the original law. The stamp duty is adding somuch (up to 131 in one state) that HFIs are not recording the deeds, but insteadholding them in safe deposit boxes. They are hindering HDFC's intent to launcha secondary mortgage market based on a free-flow of mortgage-backed securities(PAR, para. 36). The Bank noted in December 1991 that NHB had prepared draftlegislation to simplify mortgage registration and foreclosure, but one year later(field Audit mission) it was still not passed despite the need created by theincreased number of HFIs whose lending is growing rapidly. A committee set upby RBI to look at the non-banking sector recommended recently several measuresto ease other widely acknowledged constraints, inter alia by reducing the minimumdeposit period from two years to one year and offering tax parity with commercialbanks on deposits. NHB pointed to some advantages enjoyed by HFIs such as the101 liquidity requirement compared to 15% for other financial institutions. Yet,the Bank noted in January 1991 that NHB had strengthened restrictive regulations,including imposing a new structure of interest rates.
36. NHB is an agency of GOI. Its financing plan calls for substantial supportfrom the Government. The central bank provided equity (16%) and soft loans(11%); GOI provided guarantee on debt (16%) and channeled the tax-deferring ofcapital gains in the business community through NHB-issued bonds (10%), thusbringing total GOI support to 53% of total resources mobilized. The insurancemonopoly (Life Insurance Company) contributed 25%, foreign aid agencies (6%), andvarious schemes and retained earnings the remainder. The average duration of NHBborrowings is 12 years, their average cost is 12.5%. With the average return onloans at 13.7%, NHB has a small but positive spread. NHB does not compete withthe HFIs for deposits. The Home Loan Account scheme (PAR, para. 17) is only acontra account (i.e., outside NHB's balance sheet) because funds mobilized underthis contractual savings scheme launched by NHB in 1990 are left with the HFIs.The multiplication of HFIs on the HDFC model will, however, create additional,mand for refinancing which would stretch NHB's capability.
B. Secondary Mortgage Market
37. The idea of developing the housing finance sector to a size justifying theadjunction of a secondary mortgage market has been touted by HDFC fir severalyears. It is the corner stone of every fully-matured mortgage markets such asin the U.S.A. or France. While understanding that it can be a goal for HDFC'sfounders, it remains that securitizing housing portfolios in India would requireseveral prerequisites to be met for the market to serve its purpose and which areyet to be met (PAR, para. 34). The practice of limiting the loan-to-value ratioat 80% and actually recording a 55% average (PAR, para. 23) is a positive steptoward the necessary standardization of mortgages for suitable refinancing.
14
IV. COVCLUSIONS AND LESSONS
38. A distinction must be made between the tasks which were to be carr-.ed outby the borrover (HDFC) And those by the guarantor (GOI). Given the legal set-up(e.g.. loan made directiy to a private corporation), the Bank did not have thesame leverage to achieve the sector-wide objectives as under traditional urban
projects. This only confirms what ought to be an hypothesis in any risk analysisat appraisal time, that is, sector changes are best achieved if the Bank lcan isgranted to the government, hence, if the dialogue is with the agencies concerned.
A. DEC Performance
39. The project met its main objective of demonstrating that housing financeis a viable alternative in India. While it can be argued that HDFC had alreadyproven the point in the early 1980s, it was more of a pilot phase given the lowvolume of loans involved. The Bark helped increase the scale of HDFC'sintervention. In the process, however, a "bubble effect" was created becauseHDFC h 4 to absorb much larger resources in a short time while the lack of afollow-up loan left HDFC with the challenging task of finding alternativeresources of same magnitude. It is significant that the issue of HDFC'sabsorption capacity was raised when a loan of US$100 million was considered.'8
When the amount was eventually increased .o US$250 million, the issue did notappear in the risk assessment in the SAR. Ihere was indeed no problem for HDFCto onlend what represented then 64% of its outstanding portfolio. It is to thecredit of RDFC to have geared the organization to handle the additionalresources. The expectation of continued Bank assistance to HDFC did not,however, materialize.
40. HDFC has shown a great adaptability to the changing market conditions.Following the downgrading of India's credit rating. HDFC changed its funding
licy and focused on domestic retail resource mobilization. The Bank alwaysialt that it was HDFC's biggest challenge to sustain future growth.""Deteriorating prospects for resource mobilization" casted doubts on thesustainability of growth.2 The multiplication of HFIe, while good for thesector, had an adverse effect on HDFC because several were promoted by commercialbanks which diverted to their new subsidiaries funding previously earmarked forHDFC. As a result, term loans from banks and insurance companies, whichaccounted for over 50% of resources in 1987, contribute now an insignificantsharb of HDFC's sources of funds.
41. HDFC has been able to keep all the financial parameters, which often thecause of financial distress among financial intermediaries, under control. Theinterest spread is positive. The duration of funds is well matched. The
1/ Initial Project Brief (June 24, 1986).
19/ Aide-memoire (March 1990).
20/ Supervision report (January 23, 1991).
15
exchange risk is not an issue. Arrears are insignificant. All these translatedinto good profitability as reflected by the increasing valuation given to HDFCshares by the stock exchange.
B. Bank Performance
42. This project confirmed, however, the Bank's inability to tie macro reformswith micro improvements. By project completion, the housing finance system wasstill not integrated into the banking system or so haphazardly (e.g., new HFIsset up by selected commercial banks) as to underscore the progress still needed.Although the project's achievements should not be discounted, the sector impactwas disappointing. The Bank believed that the project offered an opportunity forinfluencing the direction of NHB policies. This did not materialize in asignifican* way. To this extent, the Bank performance is rated mixed.
43. During project preparation, it was stressed that the Bank loan should notdisplace domestic resource mobilization." This objective, although ambitiousgiven the loan amount, was met overall. While the Bank disbursed Rs 4,133million, HDFC raised Ra 6,372 million from deposits, bonds and NHB. Yet the PCRacknowledges that the loan increase at negotiations and the retroactive financing"allowed HDFC to choose to replace deposit mobilization by the foreign funds toa substantial extent" (PCR, para. 14).
44. A premise of the Bank assistance was that high interest rates "especiallydiscourage long-term borreing for durable goods such as housing"" The recentyears have demonstrated this to be incorrect in the case of India. While HDFChas slowed down its psce of growth, the new HFIs have stepped in. The Bankproject, which rewarded HDFC with visibility, in turn encouraged the entry ofother financial institutions (commercial banks and insurance companies) into thesector.
45. The dank's insistence on having the exchange risk covered ex ante wascorrect, and explains in large part why HDFC has been able to maintain soundfinancial ratios. The Bank position was not based on hindsight only given thereasonable expectation of depreciation of the Rupee vis-a-vis the hard currenciesmade available by the foreign lenders. When the foreign funds are beingrecovered only in local currency, the exchange risk associated with them shouldbe hedged through financial techniques (when available and mastered) or insuredwith the Guarantor's assistance (against preset flat fees to be passed on).
46. Given the success of this pilot project, the absence of a follow-up ioanto HDFC and to the new HFIs is an anomaly in view of the Bank's tenets ofcountry's assistance. All the required ingredients for effective developmentlending are met: quick disbursing loan, acceptable funds targeting below themedian urban income, above average cost recovery, viability and sustainabilityof the financial intermediary. The inability of achieving needed regulatorychanges highlighted the limitation of the direct loan format.
21/ Letter to the Ministry of Finance (July 8, 1986).
47. This project was successful in all respects. It confirms the viability ofa private specialized housing finance institution to help address the permanentissue of providing housing to the rapidly increasing urban population. The Loanwas disbursed on schedule. By its nature, the project had no cost overrun. Theinstitution-building targets were met and the loan recovery ratio was very high.This Audit, therefore, concurs with the PCR-based assessment of a highlysatisfactory project with substantial institutional achievements and a highlikelihood for sustained benefits.
48. Main Leesone To pick a private comparv as the Borrower increases thechance of success given the many other market-oriented reasons company managementhas to survive and to succeed. The drawback of this choice is likely a lowleverage on the Guarantor to enact far reaching reforms of the legal andregulatory framework. Specialized financial intermediation is a worthwhileobjective for a government to encourage and for the Bank to support ifprerequisites (such as sector size and appropriate financial approach) are met.Positive spread, positive match of maturities and highest possible loan recoveryare the ingredients of success in fInancial i.termediation such as housingfinance.
17
Page I of 5
CObMNTS FROM THE BORROWER
Coqqnts to the draft Performance Audit Reportconcerning the Housint Finance Proiect 2929-IN
ANNEXURE I
THE WORLD BANK'S FUTURE HOUSING STRATEGY FOR THE 1990S ISBEING RECAST IN TERMS OF PROGRAMMES NOT PROJECTS? MACRO NOTMICRO? ENABLING NOT INTERVENTIONIST IN THE HOUSING SECTORWITH FOCUS OF ATTENTION ON THE EFFICIENCY OF HOUSING MARKETS(BOTH DEMAND AND SUPPLY), CAREFUL SELECTION OF INSTITUTIONSAND INNOVATIVE INSTRUMENTS FOR RESOURCE MOBIL-SATION AS WELLAS MORTGAGE LENDING. THE EVOLUTION OF THE INDIAN HOUSINGFINANCE SYSTEM IS AT A STAGE WHERE CRITICAL CONCEPTUAL ASWELL AS STRTEGIC INPUOPIY REQUIRED PRECISELY IN THISDIRECTION AT THE PRESENT TIME.
THE INSTITUTIONAL BASE IS IN PLACE AND THE FINANCIAL SYSTEMIS PRESENTLY IN TRANSITION FROM CONTROLS TO MARKET PRICING?THE LEGAL ISSUES NEED TO BE URGENTLY ADDRESSED. 8
NPLUDINGTHOSE RELATING TO FORECLOSURE AND DEBT SECURITISATION. ITWOULD BE A PITY IF THE FIRST HOUSING FINANCE LOAN TO INDIAWERE NOT TO BE PURSUED VIGOROUSLY, BUILDING ON THE STRENGTHSOF ITS PERFORMANCE AND CORRECTING ITS WEAKNESSES IN THE NEARFUTURE.
MOST OF THE HOUSING FINANCE INSTITUlTIONS BESIDES HDFC HAVEBEEN PROMOTED BY MAJOR COMMERCIAL BANKS OR INSURANCECOMPANIES. THESE INSTITUTIONS HAVE LARGE PUBLIC INSTITUTIONSBACKING THE ACTIVITIES OF THEIR PROMOTEE COMPANIES, TO THEEXCLUSION OF THE INDEPENDENT HOUSING FINANCE INSTITUTIONS.
AS COMMERCIAL BANKS AND THE LIFE INSURANCE CORPORATIONPROMOTED THEIR OWN INSTITUTIONS. THEIR LENDING TO OTHER HFISESPECIALLY HDFC TENDED TO STOP IN FAVOUR OF GREATER SUPPORTTO THEIR OWN INSTITUTIONS. WITH THE EMERGENCE OF NHB,ATTENTION FOCUSSED ON REFINANCE AND THE CREATION OF DETAILEDGUIDELINES FOR THE EMERGING HOUSING FINANCE INDUSTRY. AS ARESULT, NHB PLAYED AN INT-ERVENTIONIST ROLE IN THE SYSTEMRATHER THAN AN ENABLING ONE. REFINANCE HAS CREATEDDEPENDENCE THUS FORCING THE SMALLER HFIS TO RELY TO ANUNHEALTHY EXTENT ON NHB FUNDING. AS THE DEMAND FOR REFINANCEIS GROWING, NHB HAS TO LOOK FOR ALTERNATIVE FUNDING SOURCES,SPECIALLY AS DIRECTED CREDIT IS EXPECTED TO REDUCESUBSTANTIALLY IF NOT ALTOGETHER.
ANNEX18 Page 2 of 5
THE KEY REQUIREMENT OF THE GROWING HOUSING FINANCE SYSTEMHAD NOT BEEN MET: ITS RESOURCE BASE. TODAY HOUSING FINANCEINSTITUTIONS ARE REQUIRED TO COMPETE WITH THE BANKS ANDMUTUAL FUNDS FOR RETAIL RESOURCE MOBILISATION. ALTHOUGHTHERE HAVE BEEN INDICATIONS OF A MOVEMENT TOWARDS A LEVELPLAYING FIELD, IN REALITY THE SITUATION IS VERY DIFFERENT.FOR EXAMPLE HOUSING FINANCE COMPANIES ARE REQUIRED TO DEDUCTTAX AT SOURCE FROM INTEREST PAYMENTS IN EXCESS OF RS 2500PER ANNUM. THIS PROVISION DOES NOT APPLY TO BANKS AND MUTUALFUNDS. FURTHER HOUSING FINANCE INSTITUTIONS CANNOT ACCEPTDEPOSITS FOR PERIODS BELOW 24 MONTHS. IF HOUSING FINANCE ISTO INTEGRATE WITH THE FINANCIAL SECTOR SUCH ANOMALIES SHOULDBE REMOVED.
HDFC CONTINUES TO DIVERSIFY ITS RESOURCE BASE. IN EFFECTBUILDING A MULTIFACETED RESOURCE MOBILISATION STRATEGY. NHBIS NOW IN THE PROCESS OF DETERMINING ITS OWN STRATEGY FORLINKING ITS RESOURCE RAISING TO THE FINANCIAL SYSTEM. HUDCORELIES ON GUARANTEED DEBT FOR RESOURCE MOBILISATION AS WELLAS FOR CREDIT DISSEMINATION. WHILE THIS IS A SIMPLISTICANALYSIS IT DOES HIGHLIGHT THE ESSENTIAL FEATURES OF THESYSTEM. THE POTENTIAL DANGER OF A FUTURE STRATEGY COULD BECUTTING OFF DIRECT ACCESS OF HFI'S TO THE FINANCIAL SYSTEMAND THE HOUSEHOLDS AND CREATING ANOTHER APEX SYSTEM OFDIRECTED CREDIT. POSITIONING INSTITUTIONS, LOOKING AT THEIRMAIN OBJECTIVES AND THEN DETERMINING MARKET ORIENTEDRESOURCE MOBILISATION STRATEGIES (WHICH WOULD AUTOMATICALLYENCOURAGE MARKET PRICING) WOULD SEEM TO BE THE DIRECTION INWHICH THE SYSTEM SHOULD MOVE.
A POTENTIAL FUTURE STRATEGY OF HOUSING FINANCE IN INDIA
ONE OF HDFC'S MOST IMPORTANT CONTRIBUTIONS TO THE SECTOR HASBEEN ITS DEMONSTRATION EFFECT, THAT GIVEN SOUND MANAGEMENTAND ORGANISATIONAL STRUCTURING, EVEN MAJOR ENVIRONMENTALCONSTRAINTS CANNOT HINDER THE DEVELOPMENT OF A SOUND HOUSINGFINANCE SYSTEM. IN FACT IT TENDS TO OBVIATE THEM. IT HASENCOURAGED OTHERS TO ENTER THE MARKET WHICH HAS GRADUALLYDEVELOPED AN EXTENDED INSTITUTIONAL PRESENCE IN THE SECTOR.THE KEY ISSUE SEEMS TO BE: WHERE DOES ONE GO FROM HERE? ACLEAR METHODOLOGY IS REQUIRED TO ACHIEVE CAREFULLYESTABLISHED OBJECTIVES WORKING THROUGH THE INSTITUTIONALSTRUCTURE AS IT EXISTS TODAY.
HOUSING DEVELOPMENT FINANCE CORPORATION LIMITED
.HRFC CONTN_UFS TO BE THE MST TYNAMT- ANr,D iNNOVATIVE RHFI ANDA STANDARD BEARER FOR THE INDUSTRY. IT CONTINUES TO BELOOKED UPTO FOR ITS LEADERSHIP QUALITIES.
HDFC COULD BE !LNCOURAGED AND SUPPORTED IN ITS ENDEAVOUR TO
1. PUT IN PLACE AN APPROPRIATELY STRUCTURED INSTRUMENT TODEVELOP A SECONDARY MARKET IN MORTGAGES.
2. ASSIST IN STANDARDIZING DOCUMENTATION ACROSS THEINDUSTRY TO AID THE DEVELOPMENT OF A SECONDARY MORTGAGEMARKET.
ANNEX19 Paae 3 of 5
3. DEVELOP APPROPRIATE MORTGAGE PRODUCTS SUITABLE TO THECURRENT ECONOMIC ENVIRONMENT, SUCH AS ADJUSTABLE RATEMORTGAGES.
4. DEVELOP INNOVATIVE RESOURCE MOBILIZATION INSTRUMENTSWHICH WOULD HELP REDUCE TERM TRANSFORMATION RISKS FORLENDERS.
5. TRANSFORM ITS RESOURCE BASE TO INCLUDE HOUSEHOLDSDIRECTLY.
6. TRY AND DEVELOP AN EFFECTIVE METHODOLOGY FOR LINKINGFORMAL AND INFORMAL FINANCE MECHANISMS THROUGHINSTITUTIONAL DEVELOPMENTS AT THE GRASS ROOTS LEVEL.
7. DEVELOP A MENU OF COURSES/PROGRAMS OF INTERNATIONALSTANDARDS THROUGH ITS TRAINING CENTRE -- THE CENTRE FORHOUSING FINANCE TO BE MADE AVAILABLE TO THE EMERGINGHFIS.
AS THE ECONOMY OPENS UP HDFC WILL EXPAND ITS FINANCIALSERVICES TO INCLUDE NEW SERVICES LINKED TO HOUSINGINVESTMENTS SUCH AS INSURANCE AND RETIREMENT FUNDS. WHILETHE WORLD BANK'S COMPLETION REPORT ON THE HDFC PROJECT FINDSHDFC'S PERFORMANCE PARTICULARLY ACTIVE AND EFFICIENT. WITHOPERATIONS EXPANDING MUCH FASTER THAN EXPECTED AND BEINGUTILISED TO ACHIEVE RESULTS BEYOND EXPECTATIONS. IT IS NOTAS SANGUINE ON THE POLICY RESULTS OF THE PROJECT.
WHILE THE AUDIT REPORT BEMOANS POLICY INEFFECTIVENESS, THENUMBER OF UNITS FINANCED BY THIS LOAN EXCEEDED THE NUMBER OFUNITS AND PLOTS FINANCED BY 10 EARLIER BANK FINANCEDPROJECTS IN INDIA. THIS WAS ACHIEVED THROUGH EFFICIENTCREDIT CREATION (MAJOR EXPANSION IN LENDING WITHOUTSACRIFICING PORTFOLIO QUALITY). INNOVATIVE LENDINGINSTRUMENTS AND GEJGRAPHICAL SPREAD. WHILE THE PROJECT WAS ASUCCESS FOR HDFC AND THROUGH A DEMONSTRATION EFFECT ON THEDEVELOPMENT OF MARKET ORIENTED HOUSING FINANCE. THE PROJECTDID NOT SUCCEED IN THE DEVELOPMENT OF THE HOUSING SECTORFRAMEWORK.
STRUCTURING A LOAN PROGRAM
IT SEEMS THAT THE OPPORTUNITY THAT PRESENTS ITSELF AT THEPRESENT TIME IS ONE WHERE THE SHORTCOMINCS OF THE EARLIERPROJECT CAN BE CORRECTED THROUGH A PROJECT THAT ENCOMPASSESTHE ENTIRE SECTOR. IDENTIFIES THE LINKS BETWEEN VARIOUSSEGMENTS AND PUTS IN PLACE A FUNDING MECHANISM THAT ISLINKED TO A RESOURCE BASE ON THE BASIS OF COMMERCIALPRICING.
WHILE THE POLICY AGENDA MAY NOT HAVE BEEN AS SUCCESSFULLYIMPLEMENTED. AS HOPED FOR. IN THE FIRST HOUSING FINANCELOAN. THERE IS NO DOUBT THAT THE ?DEDNSTRATION EFFECT? THAT.----HDFC'S SUCCESS HAS HAD IN THE WIDENING AND DEEPENING OF THEHOUSING FINANCE SYSTEM HAS BEEN A MAJOR CONTRIBUTION TO THEDEVELOPMENT OF THIS NASCENT SECTOR.
20 AN"XPgga 4 of 5
LEADING FROM THE FRONT, SO TO SPEAK. HAS IMMEASURABLE VALUEIN PERSUADING NEWER ENTRANTS TO EMULATE SIMILAR PRACTICES,ESPECIALLY DURING TURBULENT TIMES. THE FINANCIAL SECTOR ININDIA IS CURRENTLY IN THE MIDST OF MAJOR UPHEAVALS ,BROUGHTABOUT BY (I) THE TRANSITION FROM A REGULATED ECONOMY TO AMARKET DRIVEN ONE AND (II) THE IRREGULARITIES IN SECURITIESTRADING BROUGHT TO LIGHT RECENTLY.
THE NEED TO DEVELOP ADEQUATE REGULATORY AND SUPERVISORYCAPABILITY OF THE APEX INSTITUTIONS CANNOT BEOVEREMPHASIZED. AT THE SAME TIME THERE IS URGENT NEED TODEVELOP PROPER CREDIT CONTROLS AND INFORMATION FLOWS IN THEINTERMEDIARY INSTITUTIONS.
ONE WAY OF TACKLING THIS ISSUE COULD BE TO BRING ABOUT AWRENCHING. ONCE FOR ALL, CHANGE IN THE ENTIRE FINANCIALSECTOR WITH THE ATTENDANT RISKS AND UPHEAVALS. ALTERNATELYTHESE CHANGES COULD BE BROUGHT ABOUT IN A SUB-SECTOR - SAY,HOUSING FINANCE - TO BEGIN WITH, INCLUDING THE ENFORCEMENTOF CAPITAL ADEQUACY NORMS AND A SHIFT AWAY FROM THE DIRECTEDCREDIT SYSTEM SO PREVALENT IN INDIA. THE DEMONSTRATIONEFFECT OF THESE CHANGES AND THE CONSEQUENTIAL BENEFITS,COULD FACILITATE INITIATING SIMILAR CHANGES IN THE REST OFTHE FINANCIAL SECTOR.
PREFACE
PARA 1 LINE 4
SUGGEST SHOULD READ AS
?...FINANCE MORTGAGE LOANS FOR THE PURCHASE/CONSTRUCTION OFHOUSES OR APARTMENTS GENERALLY IN THE URBAN AREAS OF THECOUNTRY.?
PAGE III ?OTHER PROJSCT DATA
FISCAL YEAR OF BORROWER : APRIL 1 - DECEMBER 31
EVALUATION SUMMARYPARA 6 LINE 3
?CORPORATE LOANS? SHOULD BE REPLACED WITH ?LINES OF CREDIT?
UNDER THE LINE OF CREDIT FACILITY HDFC LENDS EITHER TO ORTHROUGH A CORPORATION FOR 'EMPLOYEE OWNED HOUSING'. UNDERTHE CORPORATE LOAN FACILITY HDFC PROVIDES ASSISTANCE TOCORPORATIONS FOR 'EMPLOYER OWNED HOUSING'
PARA 8 LINE 3
REPLACE THE WORD 'BYPASS' WITH 'SUPPLEMENTS'
PERFQRMANCE AUDIT REPORT
PARA 15 LINE 8
HDFC'S SHARE CAPITAL WAS INCREASED FROM RS 100 MILLION TO RS200 MILLION IN FY 1987 AND WAS FURTHER ENHANCED TO RS 450MILLION IN FY 1991.
PARA 18 LINE 13 21
?CORPORATE LOANS? SHOULD BE REPLACED WITH ?LINES OF CREDIT? Page 5 of 5
UNDER THE LINE OF CREDIT FACILITY HDFC LENDS EITHER TO ORTHROUGH A CORPORATION FOR 'EMPLOYEE OWNED HOUSING'. UNDERTHE CORPORATE LOAN FACILITY HDFC PROVIDES ASSISTANCE TOCORPORATIONS FOR 'EMPLOYER OWNED HOUSING'
PARA 20 LINE 3
CAPITAL ADEQUACY OF 7.3 INDICATED IN THE PARA IS ON THEBASIS OF 100 RISK WEIGHTED ASSETS.
PARA 22 LINE 4
?AT A TIME WHEN INTEREST RATES? SHOULD READ 'S ?AT A TIMEWHEN INFLATION RATES?
PARA 23 LAST LINE
AFTER 5 DROP THE WORD 'YEARS'
PARA 24 LINE 8
SHOULD READ AS ?THIRTY FIVE PERCENT?
PARA 26
THE LABEL ?EXPENDITURES IN FOREIGN CURRENCY? INCLUDES THELOAN OF US DOLLAR 4 MILLION FROM IFC WHICH WAS REPAID IN FY91.THE SECOND IZC LOAN OF US DOLLAR 40 MILLION WHICH WAS SWAPPEDWITH INDUSTRIAL FINANCE CORPORATION OF INDIA IS REFERRED TOIN SCHEDULE 14 NOTE 3 TO THE FY92 ANNUAL REPORT.
PARA 30 )8,3 5
REPLACE 'NBH' WITH 'NHB'
PARA 34 LINE 13
SHOULD READ AS ? HDFC'S BORROWING FROM NHB AMOUNTED TO RS2,781 MILLTON IN FY92...'
NHB FORMULATED ITS REFINANCE SCHEME IN 1989 AND HDFC MADEITS FIRST DRAWAL OF REFINANCE IN JUNE 1990. THEREFORE THEREFINANCE LEVEL OF RS 2.781 MIILION WAS REACHED OVER A TWOYEAR PERIOD AND NOT ONE YEAR AS INDICATED IN THE REPORT.1184829 HDFC IN248423 WORLDBANK
