NBFC NCDS MAY AGAIN MAKE US SEE A DISASTER SIMILAR TO FD DEFAULTS OF 90S

It was in 1997 when I saw C. R. Bhansali and group taking many lives without violence. They just defaulted on fixed deposits (FDs) that they had raised from public when the instruments matured. The question that troubled me then was, why NBFCs for FDs? Well, the answer was simple. After Harshad Mehta was arrested, the stock market was in a mess and investors were looking for a place to park their money. On the other hand, with RBI cautioning banks against lending to NBFCs (1995), they were hunting for sources to fund their operations. And as it happened, NBFCs started attracting investors with their high interest rate bearing FD schemes (some even promised a return as high as 26%). As the money started flowing in, to serve these high-cost deposits, NBFCs started venturing into all possible sectors, in most cases, without substantial experiences. Result; they not only suffered on asset quality, but ultimately failed to pay back the investors.

Cut to the present scenario, if you observe a little more carefully, retail investors are again slipping into a similar situation and the only difference is that FDs are now replaced by NCDs (Non-convertible debentures). Over the past few months, while few NBFCs like L&T Finance and Shriram Transport Finance have already raised sums in excess of Rs.5 billion, a number of others have lined up retail NCD issues at attractive rates. As per estimations, the next six months will see retail NCD issuance of around Rs.50 billion at an interest offering between 9% and 12%. And considering that the market is already heading south, this is one bait that most investors will get trapped by.

However, NCDs are not the problem, it’s the usage of the money raised. NBFCs are again gung ho on expansion and realty estate is their prime target. While they funded Rs.30 billion to 20 developers last year, it is set to grow high this year (more for the banks’ disinterest in lending to commercial real estate sector, which already owes Rs.1.10 trillion to them). But this funding means a disaster for the NBFCs. As Liases Foras Real Estate Rating & Research Pvt suggests that over the next two years, prices (in Mumbai) will go down by as much as 35%. In that scenario, it will be tough for NBFCs to generate the return desired to redeem the NCDs at the offered interest rates. But the question remains, if there is a bubble in making, why are investors still lurching to jump off the cliff? Well, perhaps the market regulators can answer this better. According to the existing policy framework, there are number of gray areas (allowing the scope for different interpretations), which allow NBFCs to operate at their will without any transparency. For example, there are no guidelines for private placement of NCD. This allows players to issue securities to public at large under the cover of private placement. Also, Listed NBFCs are under no compulsion to disclose their secured and unsecured loans in the quarterly results under clause 41 of SEBI listing agreement. At the same time, NBFCs just need one certificate from a single bank to prove the quality of their assets. If these are not the killer, read this; there are no remedies available to an investor in the Companies Act in the event of default by a company to redeem the debenture on maturity. That means, when the bubble bursts, investors go bankrupt and the bosses of the NBFCs go scot free only to return to action later to suck the life out of a few more investors.

In view of the above facts, this is actually the time when regulators need to act... and act fast. If not anything else, then at least they must come up with a notification that treats all NCD issues for more than a limited amount, say Rs.1 billion, as public issue and forces NBFCs to comply to all disclosure and other norms accordingly. This is the time when regulators must prove that they also learn from past mistakes, else we will soon hear some investor dying of heart attack and CBI chasing the big boss of some NBFC.

TRUST IS THE KEY FOR SUCCESS OF RM MODEL IN INDIA

In a good faith, to help senior citizens, the RBI issued guidelines for Reverse Mortgage (RM) in 2007 and then revised the same in 2008. The then Finance Minister P. Chidambaram also promoted the concept to great an extent in Union Budgets of 2007-08 and 2008-09. The apex body in housing finance, National Housing Board (NHB) came up with a definitive scheme for RM and today as many as 20 banks offer different RM products to Senior Citizens. But till January 2011 (since 2007 when RMs started in India) only 7,000 RMs were sold in the country clearly indicating how big a failure it is.

RMs, as the name suggests, can be considered as reverse EMIs wherein a Senior Citizen (over 60 years of age) can pledge his/her biggest asset, the house, to receive a series of cash flows from the bank for a fixed tenure with the rights to live in the house till the house owner or spouse is alive. For a country like India where insurance is still to go deep into the masses, pension schemes have started drawing attention just recently and pension by Central and State Governments are not enough to sustain the lives of those who are already retired with not much of cash in their pockets, RMs are a boon. But still the senior citizens have not woken up to it. The mute question remains, why?

Well, the answer remains in the basics. In stead of being friendly to the senior citizens, RMs actually aim at minting money for the issuer. For example, one of the main turn offs in these schemes is the loan tenure. While life expectancy is on rise, RMs offer cashflows for 15 years with the clause that the money cannot be used for reinvestment or business purpose. This jeopardizes the person’s future for the fact that if he buys a RM at 60, after 75 he receives nothing from the bank, owing to the terms of RM he could not invest anywhere so no income from other sources, and worse he cannot even rent or sell the property to get funds as it’s already mortgaged with the bank (RM clauses specify so). For that matter, the cash flows that the house owner receives from the mortgage lender is only equivalent to 60% of the value of the property (for example, Rs.3 million for a house valued at Rs.5 million). With such preposterous clauses that almost send senior citizens’ a full-circle from problems at a particular age to even bigger problems and helpless conditions after 15 years, it is certainly not very difficult to understand why the seniors are trying to keep their hands off such schemes.

Nevertheless, there came a ray of hope last year when a new product came out of a bank-insurance tie up and offered annuity with RM allowing the seniors to receive a payment till life. But it is just the beginning, if the RM model needs to be successful; the mortgage lenders need to make the seniors feel that they are their well wishers and not Shylocks from Shakespear’s Merchant of Venice. More so in the Indian context, where the lenders have to go past the biggest hurdle in form of pre-dominant cultural believes whereby most elderly see residential properties as entitlements of bequeaths for their next generation. RM lenders have to prove a point to the seniors before the model can take off in India, and they have to do so by their works, not just words.

The minimum that they must do in this context is to provide a better value for the mortgage (like around 90% of value of the property) and the make cash flows available to the seniors till at least one, mortgagee or spouse, is alive. This becomes all the more crucial in case of the urban middle-class nuclear families, who are the ideal target group for RMs. The government should also show some responsibility towards the senior citizens and play a vital role by subsidising the interest rates associated with these schemes. It’s our moral duty to help the seniors in our society. Thus, instead of creating schemes to mint money, if the financial institutions can act as trustworthy friends to the senior citizens, the RM model can deliver a lot for them in the long-run.