Rajan Offers No Solace as Developers Fight Rut: Corporate India

Apr 03, 2014 7:29 am ET

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April 3 (Bloomberg) -- Indian developers are struggling with the lowest ability to service debt in at least six years and the central bank isn’t offering any solace.

Reserve Bank of India Governor Raghuram Rajan’s focus on curbing the fastest inflation among major economies in Asia- Pacific is weighing on home sales amid the worst slowdown in a decade. Consumers are deferring purchases, while finance companies are seeking possession of properties mortgaged by developers including Unitech Ltd., the nation’s fifth-biggest, against defaults.

The 13-company S&P BSE India Realty index has declined 20 percent in the past year versus a 20 percent gain in the benchmark S&P BSE Sensex as profit margins of developers almost halved from six years ago. Even a quick pick-up in economic growth is unlikely to reverse the slump immediately, said Venkatesh Gopalkrishnan, the chief investment officer at a builder owned by the fourth-richest Indian.

“There will be more short-term pain,” said Gopalkrishnan, who is also the executive vice president at Mumbai-based Shapoorji Pallonji & Co. “The sector has already been experiencing it for a while. Since real estate sales are a lag indicator for the economy, it will take time for benefits to filter down even if gross domestic product takes off.”

Debt Servicing

The ability of developers to service obligations, as measured by debt as a percentage of earnings before interest, taxes, depreciation and amortization, is the lowest since at least March 2008, according to Sreenivasa Prasanna, senior director for corporate ratings at the local unit of Fitch Ratings Ltd. Sales at the nation’s 15 large developers fell 43 percent in the three months to Dec. 31 from a year earlier, Knight Frank LLP said in a March 27 report.

The RBI left the benchmark rate unchanged at 8 percent on April 1, the highest among the biggest Asian emerging economies, even as consumer-price inflation eased to a two-year low and the rupee strengthened. Rajan, who has said inflation poses the “gravest threat” to the $1.8 trillion economy, has raised the repurchase rate three times since September.

A 100 basis point cut in interest rates will improve affordability of residential property by as much as 7 percent, according to Anubhav Gupta, Mumbai-based real estate analyst at Kim Eng Securities Pvt.

Land Parcels

“Interest rate is a key factor affecting realty sales, and there is no respite from RBI,” Gupta said in a telephone interview on April 1. “With no sign of demand revival, the developers are trying to cut down debt by paring land parcels and other non-core assets.”

DLF Ltd., India’s biggest developer by market value, sold Aman Resorts to Peak Hotels & Resorts Group Ltd. and Aman founder Adrian Zecha at an enterprise value of $358 million in February. The company also sold some of its other businesses, including wind farms and insurance, paring its debt to 174 billion rupees ($2.9 billion) from a decade-high of 250 billion rupees as of March 2012, data compiled by Bloomberg show.

Unitech had a debt of 63 billion rupees as of Dec. 31, according to the company.

Life Insurance Corp. of India, the nation’s largest insurer, took ‘’notional possession’’ of Unitech’s mortgaged property after the developer defaulted on a 1.5 billion-rupee loan, according to a March 10 advertisement in the Times of India. LIC Housing Finance Ltd., the country’s second-largest mortgage lender, took possession of Mumbai-based developer Orbit Corp.’s property after the company defaulted on a 950 million rupees loan, a Dec. 4 advertisement showed.

Shares of DLF fell 2.8 percent to 171.75 rupees in Mumbai today, while Unitech gained 1.4 percent to 14.55 rupees, versus a 0.2 percent decline in the Sensex.

Project Log-Jam

Delay in approvals, cost of funds and slowing sales growth made it tougher for cash-starved real estate companies, which in turn “log-jammed construction activity” across India, Knight Frank said in its March 27 report.

Borrowing costs for developers vary from 10 percent to 22 percent depending on their leverage and financial health, said Niranjan Hiranandani, managing director and co-founder of Hiranandani Developers Pvt. Bank loans to realty developers grew by 17.6 percent to 1.47 trillion rupees in the 12 months to Feb. 21, the latest data from the central bank show. Loans to the sector grew by 11 percent in the year before.

A new government after the elections next month may help revive the economy, helping the property sector, Abhishek Kiran Gupta, Mumbai-based analyst at Bank of America Merrill Lynch , wrote in a research note dated March 31.

New Government

The companies are focusing on reducing their debt, and that may make them attractive to investors again, he wrote. “Overall sector valuation looks attractive given the compression over the last two to three years,” he wrote.

Opinion polls show that the leading party will fall short of majority, prompting it to rely on coalition partners to fix the economy. GDP rose 4.9 percent in the fiscal year through March 31, following a 4.5 percent gain in the previous 12 months, the worst since 2003.

“If home sales don’t pick up in another three quarters, we could be looking at more defaults, especially with bank credit rising,” said Prasanna at India Ratings and Research Pvt. “There will be mounting debt servicing pressure and their credit metrics will deteriorate this year if sales are still sluggish.”