India Financial Services Lower Risk Weights: Adding to the Sweet Spot for HDFC:: Morgan Stanley Research,

India Financial Services
Lower Risk Weights: Adding
to the Sweet Spot for HDFC
The RBI has lowered risk weights on certain
categories of individual housing loans: It also carved
out a new segment, ‘CRE – Residential Housing
(CRE-RH)’, within the commercial real estate sector.
Loans to this segment will carry lower risk weights and
standard asset provisioning. This will help release some
capital on existing loans for banks and lower capital
requirements on new loans. The benefit to HFCs,
especially HDFC, is likely to be much higher, if the NHB
follows up with similar regulations (we expect it to follow
the RBI).
Lenders with high exposure to medium / large ticket
home loans will benefit: The RBI has reduced risk
weights on individual housing loans > Rs2 mn and up to
Rs7.5 mn to 50% from 75%. It has also marginally
relaxed the loan to value (LTV) cap on these loans to
80% from 75% previously. Further, loans > Rs7.5 mn will
now attract a risk weight of 75% provided LTV is not
higher than 75% (the previous risk weight was 125%
irrespective of LTV).
This is a positive move given the appreciation in
property prices across the country. Private banks are
likely to benefit more than SOE banks given higher
exposure to medium / higher ticket loans. However,
HFCs, being mono-line lenders, will benefit more (once
the NHB follows up with similar norms).
Lenders to residential housing projects will also
benefit: Because loans to residential housing projects
are less risky and volatile, the RBI has carved out a
separate category, CRE-RH, within the commercial real
estate sector. Loans to this segment will attract a risk
weight of 75% and standard provisioning of 0.75% vs.
100% and 1% respectively for other CRE loans. CRE
exposure in the banking system is relatively limited
(~2.5% of system loans).
The key beneficiary will be HDFC: According to
management ~15% of loans will qualify as CRE-RH.

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HDFC is the key beneficiary (cont’d): On our calculations,
this move will release around 200 bps of Tier 1 (our discussion
with management also suggested that the benefit is likely to be
around 2ppt). Tier I ratio will move up to ~16% from 13.9%
currently. This will structurally take up HDFC’s ROE. There will
be some release of standard asset provisioning on CRE-RH
loans (~1% of F13 PBT on our computations). HDFC may
decide not to release these provisions.
Our view on HDFC is that it is in a sweet spot – loan growth is
strong and spreads are looking up. This makes it amongst the
fastest-growing financial institutions in terms of revenue. The
capital release adds to the positive momentum for HDFC’s
fundamentals, in our view.
Impact on other lenders
According to LICHF management, ~10% of outstanding
individual housing loans are between Rs2 mn to Rs7.5 mn.
Further, ~80% of CRE loans are likely linked to residential
housing and hence might benefit from lower risk weights. On
our computations, this could translate into a capital release of
~40 bps of RWAs.
We do not have details on individual housing loan split by ticket
size and CRE loans that qualify as CRE-RH loans for banks.
Further, we do not have details of loan against property (which
are unlikely to benefit).
In our view, benefits are unlikely to be material for banks
because mortgages form a much smaller part of overall their
portfolios (unlike HFCs). If we assume that ~50% of individual
housing loans are between Rs2 mn to Rs7.5 mn and that ~75%
of CRE loans qualify as CRE-RH, the increase in Tier I ratio
would be around 10-20 bps for SOE banks and around 40 bps
for private banks.
What next – lower rates for residential mortgages & loans
to CRE-RH? On our approximate computations, banks can
afford to lower lending rates by around 25-50 bps for residential
mortgages (>Rs2mn up to Rs7.5mn). However, in the case of
SBI, the yield differential between loans in this bracket and the
lowest bracket (for which there has been no reduction in risk
weights) is only 15 bps. Hence there is unlikely to be any
material change in rates in our view.
Banks with a higher pricing differential across various brackets
may consider narrowing the spread. For residential loans >
Rs7.5mn, the scope to reduce rates is higher, given the
lowering of risk weight to 75% from 125%. However, the
proportion of loans in this bracket for the major players is likely
to be low.
In the case of CRE-RH loans, the scope to lower rates is
around 50-75 bps on our computations. Given the stress in the
developer segment, there is a case to lower rates.
Finally, given that capitalization levels at SOE banks is already
low, they may choose to use the benefit of the new norms to
conserve capital rather than lower rates or expand lending to
the CRE segment.
(Please see table with computations on impact on capital for
the various banks / HFCs in the next page)