Higher interest rates in India have increased repayment amounts and limited refinancing options for small and medium-size enterprise (SME) borrowers with loans against property/ LAP (loans secured by mortgages over residential or commercial real estate), heightening the risk of delinquencies and defaults, Moody’s Investors Service has warned.

Increase in interest rates by non-banking finance companies (NBFCs) for LAP to SME borrowers is heightening repayment and refinancing risks for these loans.

This situation is credit negative for Indian asset-backed securities (ABS) backed by LAP, the global credit rating agency said.

“While India’s central bank paused its rate rise cycle in April, rate hikes over the past year have increased funding costs for NBFCs. As their funding costs have risen, NBFCs have increased interest rates for LAP to SME borrowers...,” according to the Moody’s report.

The agency said LAP have floating interest rates, so the repayment amounts for these loans have increased as lenders have raised borrowing costs.

Also read: Shift in NBFC sector as a financer to real estate sector

“Even if the RBI were to keep rates on hold from here, the repayment amounts will weigh on SME borrowers’ capacity to repay debt,” Moody’s said.

Furthermore, the rate increases over the past year have reduced the likelihood that LAP borrowers will be able to refinance their debt on more affordable terms if they can no longer meet repayment amounts.

Increase in lending rates

The Reserve Bank of India has increased its policy repo rate by 2.5 percentage points to 6.5 per cent in a series of rate rises since May 2022 to combat inflation.

Moody’s said the higher repo rate, bond yields and the Marginal Cost of Funds-based Lending Rate (MCLR) have pushed up the cost of both market and bank funding for NBFCs, compressing their net interest margins and prompting them to raise rates for LAP.

MCLR is the benchmark rate that banks mostly use to set lending rates for NBFCs,

Also read: Godrej Capital launches SME-focused ‘loan against property’

Slower property price growth

The agency noted that the pace of property price growth has slowed in major Indian cities as a result of rate rises over the past year.

The slower price growth has reduced the recovery prospects for defaulted LAP when NBFCs sell the underlying properties to recoup outstanding debt amounts, which is negative for Indian ABS backed by these loans, it added.

Additionally, slower price growth could erode lenders’ willingness to refinance LAP. Large cities and metropolitan areas are key markets for medium and large LAP.

The agency expects loan delinquency rates for LAP ABS, which have increased over the past year, to continue to rise.

However, LAP ABS are well protected, because of the deals’ structural protections, including non-amortizing cash reserves and excess spread.

Related Topics