‘No Home, No EMI’ - Safeguard a Buyer against dubious Builders

The Real Estate Boom in India brought with it a host of unscrupulous builders, who rode on the high waves of bullish investor sentiments and dreams of a growing Indian middle class. Delayed projects and defaulting loan payments have been the legacy of their unchecked advance. Complicit in this act have been Banks and NBFCs, who have knowingly turned a blind eye to this nefarious activity. In the aftermath of crushed dreams and financial losses, what recourse are the buyers left with?

THE BACKGROUND

Imagine a company Balance Sheet that reads:

• Service Tax Defaults = 10+ Crores
• ESI/PF Defaults = 2+ Crores
• Term Loan Defaults = 15+ Crores

No bank would be willing to extend credit/loan to such an entity, which would be trading as a penny stock on the share market.

The example stated above is that of builder “MVL Limited”, a habitual defaulter with all its projects under development and significantly delayed. Such examples are rampant in India. Unfortunately, banks and financial institutions have repeatedly extended loans for such uncreditworthy builders and their projects, putting not just ‘public money’ in jeopardy but also causing untold misery for families that have invested in such projects.

THE STORY OF GROWING NPAs

A large chunk of the ever-increasing Non-Performing Assets (NPAs) with Banks and financial institutions comprise of loans extended to unscrupulous business houses (and dubious real estate projects). Such loans – with respect to the Real Estate sector – are extended either to gain larger share of the loan-market or to increase income from loans extended to individual buyers. These exposures, whether to uncreditworthy builders or to individuals investing in dubious projects, are equally at risk of turning into defaults. They are partially saved because of honest individual investors who are left with no choice but to pay their loan EMIs irrespective of the project getting delivered to them on time (if at all).

And it is not just Public Sector Banks that are guilty of such irresponsible behavior. Private Banks and Home loan NBFCs are an equal party to this callousness prompted by their greed to bolster earnings.

HOME LOANS - A SAFE BET FOR BANKS AND NBFCs

They consider Home Loans to individual buyers a safe bet largely due to the following reasons:

• Individuals can be pressurized to pay EMIs as they would want to safeguard their credit rating
• An individual pays atleast 20% money upfront while a bank takes exposure after the fact
• Rate of return on Home Loans is considerably better for Banks compared to corporate loans
• Less hassles / distributed risk. Since buyers are scattered, the play is more about distribution and not about one big risk valuation
• By the time all the scattered exposures are consolidated across projects and markets, the assessment year changes, making it difficult to detect the systemic risk infecting the system.

WHERE IS THE DUE-DILIGENCE?

Having said that, it is equally surprising that Banks and NBFCs discounted the following indicators staring them in the face:

• Lot of these builders were otherwise unfit candidates for term loans from the same banks.
• Loans were being extended not against completed homes but against under-construction properties, which are nothing more than promises on paper.
• In an event of builder default, under-construction properties would be dead-weight and a grave credit risk.
• Construction-linked plans are usually aggressively loaded in favor of a builder and as such a lot of advance credit without a competent collateral was extended.
• Banks and NBFCs did not take any corrective measure or collateral when the exposure became visibly high for a particular project. Builders therefore were free to divert this cheap money from the project it was meant for, into buying more land.

All this, when Banks and NBFCs have enormous resources, access to historical data of real estate project construction, builder’s track record across past projects and experts to study and dissect all this information. Instead they were convinced that a Residential development of 10 acres could be completed within a span of 3 years while all the data available indicated to the contrary. They infact facilitated investor buy-ins into the project and offered no counsel to buyers. Lastly, these Financial Institutions did not share this data with their share-holders, despite having seen the sub-prime melt-down in USA not so long ago.

PLENTY OF QUESTIONS BUT FEW ANSWERS

• Is this not willful negligence on the part of Banks and NBFCs?
• Shouldn’t buyers have the right to legally try them for criminal negligence?
• Wouldn’t buyers be within their rights to not pay EMIs during the period such projects are delayed?
• Why must buyers not be compensated by these banks and NBFCs for misleading them into believing the ‘worthiness’ of otherwise uncreditworthy builders and for trapping buyers into loss-making borrowings?

Shouldn’t buyers – where builders have delayed/defaulted – have the right to say “No Home, No EMI”