By Amit Bajpai, Sreya Ray and Bama Balakrishnan, IFMR Capital
This post is a continuation of our earlier post where we had introduced the environment for AHFCs and HFCs in India.
Lending Models of AHFCs
The target clients of AHFCs are mostly people with relatively low funding requirements who either do not have adequate credit history and/or will not be funded by larger HFCs or banks – due to low-ticket size loan requirements, due to earning income from occupations that may be perceived as risky, or due to having non-traditional earning sources that come from self-employment or employment in the unorganized economy with no formal financial documentation. Some segments of the target borrower market may indeed have banking habits and may have borrowings from formal institutions for other needs such as vehicle financing, credit cards, SME loans etc.
The lending model is fairly uniform across various AHFCs, with some variation in naming or sequence. The key features of the lending model are summarized as follows:
- In-house Origination & Collections – Many AHFCs are highly focussed on high quality clients and (with the exception of a few) prefer to have in-house origination. Likewise, the delinquency management process is kept in-house to maintain control, build accountability and implement fair collection practices.
- Separation of Business from credit – AHFCs emphasise the independence of credit from sales and align their incentive structures with high quality origination to achieve maintenance of asset quality and adherence of fair practices.
- Rigorous screening of client information – In the absence of traditionally-accounted cash flows (i.e. in formats such as financial statements, IT returns, payslips etc.), AHFCs rely on triangulation & validation of information through exhaustive personal discussion and verification processes (checking trade records, reference checks, physical visits).
- Emphasis on Cash Flow Analysis – AHFCs base their credit analysis and decision on cash flow analysis, using inputs obtained from clients as explained above. The credit team may also use proxy indicators to evaluate the standard of living.
- Legal, Technical and Internal Audit Functions – Some AHFCs have outsourced these critical functions to pre-approved/empanelled service providers to minimise fixed costs, while others have invested in building these functions in-house as they grow in scale. AHFCs have developed a good working knowledge of property evaluation and security creation given various laws and regulations governing the same. This is incorporated in the origination process through their lending policy. Property eligibility criteria are well defined and closely monitored.
There may be a divergence in process to the above for some AHFC players, as laid out below:
- Some AHFCs choose to rely on outsourced origination i.e. using agents, or by partnering with NGOs and MFIs.
- Some AHFCs prefer to work with salaried customers, where credit analysis is simpler and more standardised; while others may focus on the self-employed business class, who may be more under-served, owing to their inability to access bank funds (due to lack of traditionally-accounted income) and their need for faster, simpler processing and disbursement.
- AHFCs who focus on self-employed customers in the informal sector where fluctuation of income levels is higher, face higher credit and also have stronger processes on credit analysis, data validation and data verification. The information sourced from clients is checked at various levels by sales, independent agencies, Fraud Control Units and Credit, during its movement from application to sanction.
What are the stylized features of the AHFC lending model?
As more and more players enter the housing finance space and existing players scale up, the onus is on optimizing the lending model and capturing higher market share while protecting asset quality. Some processes that are characteristic of AHFCs are:
- Existence of Fraud Control Units (FCUs) to check genuineness of KYCs.
- Some HFCs have taken all household earning members as co-applicants to minimise likelihood of loan default.
- Document Management System – A few HFCs have document truncation system which lets them scan all client documents on their software, thereby reducing their dependence of physical documents.
- High Quality MIS – Some HFCs have inbuilt data validation checks and process controls which leaves little scope for process flow hiccups and data quality issues.
- Double CB for low-income1 customers – As low-income/economically-weaker clients may be borrowers both from banks and MFIs, some HFCs perform Credit Bureau checks both for microfinance institutions and bank lending to these clients.
Road Ahead and Support Required
As has been explained above, AHFCs have designed innovative business models with a lot of attention to origination and credit quality, and who are focused on a customer segment inadequately served by the mainstream financial system. Even as AHFCs seek to scale up operations, capture and consolidate market share and diversify their geographic footprint, they require efficient sources of long term debt financing.
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) Act was enacted in 2002 for regulation of securitization and reconstruction of financial assets and enforcement of security interest by secured creditors. The SARFAESI Act empowers Banks/Financial Institutions to recover their non-performing assets without the intervention of the Court. The SARFAESI Act defines financial institutions (FI) for whom the provisions of the Act are available. In order for an NBFC to qualify as an FI it would have to be a public financial institution as defined under S.4A of the Companies Act or be notified as an FI by the Central Govt. HFCs have from time to time been notified by the Ministry of Finance as FIs for the purpose of SARFAESI. It would be important for AHFCs to be notified as FIs under SARFAESI, as they become eligible for the same.
This apart, National Housing Bank(NHB) refinances lines, helpful as they are in addressing AHFC’s liquidity and ALM needs, are one solution. There is a need for other capital market financing solutions including structured finance products for AHFCs to realize their long-term growth plans.
Structured finance has enabled the microfinance institutions and small business lenders to access capital markets for funding requirements. Similar models could be replicated for the AHF companies. Through securitization transactions, the interests of AHF originators can be aligned to the requirements of investors with different risk-return profiles. Entities with deeper understanding of the underlying asset class and sound risk management capabilities can subscribe to high risk subordinate cash flows. This subordination not only acts as additional credit enhancement but also allows for the bespoke tenures for senior cash flows resulting in attractive options for capital market investors with varied investment mandates. Another way of risk participation is through providing performance guarantees to the AHF loan pools. One such step in this direction had been taken by NHB by setting up the India Mortgage Guarantee Corporation (IMGC) in 2012.
1 – The clients who have equal chances of being either in Microfinance Credit Bureau or Bank credit bureau