Summary

Growing issuer and investor interest has increased attention to the securitization of financial assets in India. As one of the fastest-growing economies in the world, India's favorable demographics, pace of urbanization, growth in disposable income, and government incentives support market growth.

In time, developing offshore investor interest will likely lead to further issuance of residential mortgage-backed securities (RMBS), with the potential for cross-border issuance. In this article, S&P Global Ratings shares an overview of India's housing, mortgage, and RMBS markets; the financial landscape that supports their growth; and highlights key rating considerations.

Residential property market

GDP growth and urbanization underpin housing demand

India is one of the largest countries in the world, and the most populous, with over 1.44 billion people. It has a density of 479 people per square kilometer, and approximately 36% of the populace lives in urban areas. The country's residential property market reflects its economic growth, diversity, geography, and policies.

While housing in urban areas mostly consists of apartments and stand-alone houses, housing in rural areas is of much simpler pucca or kutcha houses. Current conditions in the residential property market suggest a shortage of affordable housing, while there are also reports of unsold inventory across major cities, although the stock of unsold properties has been declining.

We expect continuing improvements in infrastructure and connectivity, growing disposable income, and urbanization to drive growth in the residential property market. Demand for affordable housing remains strong, and with the expansion of upper-middle income households, demand for aspirational residential properties will also grow.

Noting the geographic and economic breath and diversity of India, as a general guide, properties of less than Indian rupee (INR) 4.5 million to INR5 million are considered affordable, those of INR5 million-INR10 million are considered mid-segment, and those costing more than INR10 million are considered premium.

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Approximately 70% of households in India own rather than rent their residences. However, in many cases, the owned housing may be without basic amenities, be of low build quality, or may be insufficient for the size of the household.

To address affordability issues for the lower-income demographic, the government has introduced different housing policies over the years to improve housing supply. These include schemes targeting the urban poor, provision of pucca houses with basic amenities, interest subsidies on housing loans for specific income groups, guarantees for low-income housing loans, and public-private partnerships.

The government has also sought to strengthen consumer confidence in the property market with legislation such as the Real Estate (Regulation and Development) Act (RERA Act) in 2016. The RERA Act has improved transparency and accountability for the completion of new projects and provides some protection to property buyers. We note that although RERA was introduced by the central government, its implementation is by each state, and not all states have fully done so.

Residential mortgage market

The landscape: Growth in lending and variety of participants

While the uptake of deposit accounts has increased since COVID-19 pandemic, India remains an underbanked country, and only a low percentage of the population has home loans. Residential mortgage loans have historically represented 5%-9% of nominal GDP, and loans to the household sector account for about 32% of banking system loans, within which residential mortgages form about half of the total lending to households.

Providing access to and education on banking services, especially in rural areas, as well as the country's low GDP per capita, pose a challenge as well as opportunity for growth. As one of the fastest-growing economies, India's demand for residential mortgages is supported by favorable demographics, the pace of urbanization, growth in disposable income, and government incentives for affordable housing.

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India's residential mortgage market is dominated by commercial banks, followed by nonbank housing finance companies (HFCs). Commercial banks command 70%-80% market share, by our estimate. Reserve Bank of India (RBI) regulates HFCs as well as commercial banks, and the National Housing Bank (NHB) supervises HFCs.

The banking landscape in India is fragmented, with multiple banks and nonbank financial institutions operating. They are categorized based on their ownership or purpose as public-sector banks, private-sector banks, foreign banks, small finance banks, payment banks, local area banks, co-operative banks, and regional rural banks. Together with HFCs, both public- and private-sector banks are active in the residential mortgage market.

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HFCs can be viewed as a subset of nonbank finance companies (NBFCs), registered under the Companies Act, and regulated by RBI. While their activities are akin to banks, NBFCs are generally restricted from accepting deposits, they do not form part of the payment and settlement system, and are not covered for deposit insurance by the Deposit Insurance and Credit Guarantee Corp.

NHB, which is wholly owned by RBI, promotes and supports housing finance institutions. Since August 2019, the regulatory powers of NHB over HFCs, including registration, were transferred to RBI. Since then, HFCs are treated as a category of NBFCs for regulatory purposes. While RBI issues regulations via directions and circulars to HFCs, NHB supervises HFCs, and the grievance and redressal mechanism related to HFCs continues to be part of NHB. Although NHB does not provide direct financing to consumers, it influences this by providing financing to lending institutions or agencies.

Asset reconstruction companies (ARCs) are part of the financial landscape in India. They are regulated by RBI pursuant to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002 (SARFAESI Act). ARCs essentially assist with debt resolution by purchasing non-performing assets (NPAs) from financial institutions. There are approximately 27 ARCs registered with the RBI, which may be private companies, government-related entities, and those formed through consortium of financial institutions.

ARCs may resolve the NPAs acquired by restructuring the business, restructuring the debt, liquidating the business, settlement, or selling the security. ARCs may be involved in all types of NPAs, be it personal loans or loans to businesses of different amounts. Given the economics, ARCs are more active with NPAs of non-personal loans, and personal loans that are of higher value. Whilst ARCs are increasingly active with retail NPAs, granular collections, pricing, and staffing pose challenges.

India has four credit bureaus, namely TransUnion CIBIL, Experian, Equifax, and CRIF High Mark. Since 2015, RBI mandated all scheduled commercial banks, NBFCs, and co-operative banks to be members of all credit bureaus, with standardized information to be provided and updated on a fortnightly or monthly basis. This significantly enhanced the reliability and validity of credit bureau information.

Since October 2024, ARCs have also been required to be members of all credit bureaus. The credit bureaus maintain at least seven years of credit history, and have the details of a borrower's credit facilities. These include details on limits and balances, loan expiry, amounts or limits overdue, arrear buckets, amounts written off or settled, major reasons for restructuring, number of contracts classified as an NPA, suit filed and date. The bureaus also have the details of guarantees and security provided by the borrower, as well as any cheques dishonored.

In addition, credit bureaus hold information on willful defaulters. Credit scores among the credit bureaus are also broadly standardized. While there might be variances, credit scores of more than 730 are typically considered prime.

A feature that influences credit allocation is the priority sector lending requirement set by the RBI, whereby banks are directed to provide credit to certain sectors, including housing, based on stipulated criteria, which may include loan size, location, and or certain socio-economic categories of the population.

Currently, priority sector lending includes housing loans to individuals located in metropolitan centers (with population of 1 million or above), of up to INR3.5 million for purchase or construction of a dwelling unit per family, and where the overall cost of the dwelling unit does not exceed INR4.5 million, among other criteria. For locations other than metro centers, it would be housing loans of up to INR2.5 million where the overall cost of the dwelling unit does not exceed INR3 million.

While the central bank may update the priority sector lending criteria, there can be gaps between policy and market conditions. Strong residential property prices in recent years have seen prices of properties targeting the economically weaker section of the population move beyond the priority sector lending requirement.

Typical product features

The type of residential mortgage products available are fairly standard and broadly consistent with international lending approaches. At a macro level, some common features are:

Key regulatory highlights

RBI, in regulating scheduled commercial banks and HFCs, sets out requirements on various aspects such as capital adequacy, liquidity risk management, provisioning, declaration of dividends, exposure limits, deposits, corporate governance, and fair practice. These regulations shape and influence the residential mortgage market. Some key regulatory highlights and expectations of RBI on lenders include:

• LTV limits:

Housing loan up to INR3 million: not more than 90% LTV (loans not more than 80% LTV attract lower risk weights)

Housing loan of INR3 million-INR7.5 million: not more than 80% LTV

Housing loan above INR7.5 million: not more than 75% LTV

• At origination and underwriting:

Lenders are to inform loan applicants of the "all-in cost" of the loan applied for.

In underwriting floating-rate loans, to consider the repayment capacity of borrowers in the event of an increase in interest rates, by ensuring there is adequate capacity for increase in periodic repayments due and or for lengthening the loan tenure.

Lenders are to incorporate credit bureau information into their underwriting.

• For floating-rate loans, when interest rates are reset, lenders are obliged to:

Provide borrowers the option to switch to fixed rates, if fixed-rate loans are available and in accordance with the lender's policy.

Provide borrowers the option to (1) change the periodic repayment amount payable, or lengthen loan tenure, or a combination of both, and (2) to prepay in full or in part at any point of loan tenure.

• A minimum of two valuation reports to be obtained.

• Upon full repayment of loan, lenders are to release the security subject to any legitimate right or lien for any other claim lenders may have against the borrower. To exercise such right of set-off, notice is to be given to the borrower detailing the claim.

• Penalty interest on late payment or default payment is not permitted. Charging of interest on interest unpaid at the contracted rate of interest is permitted. Penal charges are permitted but not permitted to be capitalized.

• If interest and or instalment of principal remain overdue for more than 90 days, the loan will be classified as an NPA. This will be applicable on a consolidated borrower basis.

• In foreclosing on defaulted loans, lenders should not resort to undue harassment of borrowers.

Credit quality of residential mortgages

We view underwriting standards of banks as moderately conservative. While banks typically focus on prime borrowers, HFCs generally have an appetite for a wider mix of borrowers. However, the mandatory use of credit bureau information has brought in a level of credit discipline across both banks and HFCs.

In assessing affordability, lenders typically consider the cash flow of the borrower and may require a cushion in the income level. The regulatory cap of 75%-90% LTV has also helped overall credit quality. Since the COVID-19 pandemic, the increase in the proportion of electronic repayments has reduced the risk of misappropriation.

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Lenders may source originations from their network of branches or field agents, through third-party direct selling agents, through relationships with property developers or corporates, or simply through cold calling or referrals. Some lenders may have a list of approved property developments that they are willing to take security on.

With documentation, lenders typically require proof of identification, proof of income, and proof of property purchase or ownership. Proof of income may include salary pay slips, tax returns, and bank statements of the last one to twelve months. With self-employed borrowers, this may also include financial statements for the last one to three years.

In underwriting, lenders may use scorecards for screening purposes while others have centralized or partly centralized credit underwriting teams perform verification and credit approval. The extent of income verification may vary by lender, depending on the quality of documentation provided, credit bureau results, or be on a case-by-case basis. To underwrite, lenders often require face-to-face initial discussions with a prospective borrower to confirm identification and the loan's intended use, as well as to determine whether further investigation or verification is required.

Credit bureau information is used in the credit decision-making process to check prior and current credit history and the borrower's repayment track record. The reliability and validity of credit bureau information has significantly improved thanks to requirements for lenders to be members of all four credit bureaus, a standardized information set provided to credit bureaus, and regular updates required on the information.

Fraud checks on the potential borrower and on the subject property are an important part of lenders' underwriting. Some lenders may use external fraud databases to supplement checks performed by their own staff. Fraud checks typically include face-to-face assessments with the prospective borrower, checks on the property title with the sub-registrar office, the registrar of companies if the property owner is a company, and the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI) for any existing mortgage secured by the subject property.

Lenders typically review the cash flow of the borrower, using either gross or net income, and may require a level of buffer in assessing affordability. Such assessment may include any existing debt, other supplemental income, and may also consider an estimated living expense assumption. Apart from assessing affordability, lenders also take into account the age of the borrower. Some lenders may include the borrower's savings history, qualification, stability of occupation, and income source as part of their overall credit assessment.

In India, mortgage payments are tax deductible, which may influence credit behavior of borrowers in higher tax brackets. Mortgage performance also depends on the loan-extension feature of floating-rate loans. For such loans, the RBI has a directive instructing banks and HFCs, such that if there is an increase in interest rates at the time of interest rate resets, borrowers should be given the option to either increase their equated monthly instalments or extend the loan tenure or a combination of both, and to also offer borrowers option to prepay either in part or in full during loan tenure.

The directive also requires lenders to ensure that the elongation of tenure of floating-rate loans does not result in negative amortization. The regulation also expects lenders, as part of the initial underwriting, to consider the repayment capacity of borrowers to ensure that adequate capacity is available for tenure extension and or increase in equated monthly instalments, in case interest rates rise.

The practice of offering tenure extensions when interest rates are rising is common, in our view, and there is no prescribed limit on the frequency of tenure extensions. Such extensions help borrowers manage cash flow and thus mitigate the risk of default.

That said, such loan extensions could pose challenges for securitization if loans are extended beyond the legal maturity of the bonds. However, in offering tenure extensions, lenders generally consider their credit policy as well as the age of the borrower and are bound by regulation not to make changes that result in negative amortization.

Geographic dispersion

India's rising GDP per capita, albeit currently low, will benefit the residential mortgage loan market. We believe demand for residential mortgage loans will rise thanks to improving disposable income, especially with the metropolitan and urban population, and as urbanization increases.

The socio-economic status of home ownership, together with changing consumer preferences and tax deductibility of residential mortgage loans, will also spur demand for aspirational residences. While demand for premium residential properties has increased, broad-based demand remains anchored in the affordable and middle-income housing segments.

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Growth in the mortgage market, however, does not necessarily reflect population distribution. The same economic factors driving mortgage growth could also lead to greater disparities among states and between the urban and rural population. In part, demand dynamics may be swayed by the different policies of each state. Stamp duties of each state and union territory can vary considerably, ranging from 1%-8%, with certain states offering concessions or rebates for women and/or older citizens to encourage ownership.

Nevertheless, there is a strong correlation between the economic growth of a region and demand for housing loans. For example, the state of Maharashtra is a key driver of economic growth for the country, with a gross state product (GSP) that outweighs other states. Its major cities, particularly Mumbai, are key drivers of demand for residential mortgages.

Of India's 36 states and union territories, the top five by GSP collectively contribute over 46% to the country's GDP, and account for close to 60% of total housing loans outstanding by scheduled commercial banks. While continuing urbanization will further fuel such growth, the priority-sector lending policy will influence credit allocation.

Furthermore, against this backdrop and despite the growth in per capita income, the weak housing affordability in major cities compared with semi-urban or rural areas, the strain on existing infrastructure, and time lag for the supply of new infrastructure development may eventually constrain growth of the overall residential mortgage market over the mid-to-long term.

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RMBS market

Long history and diverse issuance

Securitization in India first started in the early 1990s, driven more as a bilateral assignment of financial assets, followed by development of pass-through certificates.

Today, India's securitization market is active across diverse asset classes like auto loans, residential mortgages, microfinance loans, business loans, and personal loans. Uniquely in India, bilateral assignments, also called direct assignments, are considered part of the securitization market, and have historically represented some 40%-60% of the market. In 2024, the total securitization market was estimated to be INR1.9 trillion, of which approximately INR300 billion was RMBS.

Legal and regulatory framework

Present day RMBS are largely shaped by RBI's 2006 securitization guideline (modified in 2012 and 2021), which sets out expectations for securitization by financial institutions of performing financial assets (i.e., financial assets that are not more than 90 days in arrears).

The guidelines cover considerations such as the assets eligible to be securitized, minimum retention requirement (MRR), expected origination standard of securitized assets, expected documentation and disclosures, the exposure limits of originators on their securitizations, conditions on special purpose entity (SPE) and facilities, conditions for simple, transparent, and comparable (STC) securitization treatment, and capital requirements of securitization exposures.

The originator must also submit the details of the transactions undertaken, including the details of the notes issued, to the RBI on a quarterly basis. The guidelines require assets to be held on the balance sheet of the originator for a minimum of three to six months prior to securitization, prohibits securitization of securitization exposures, synthetic securitization, revolving credit facilities, loans with bullet payments of both principal and interest, and loans with less than one year of remaining maturity.

In the case of RMBS, the MRR for the originator must be 5% of the book value of the loans being securitized. The MRR may be in the form of a first-loss facility (for this purpose, overcollateralization is not considered as a first-loss facility), or retention of equity tranche or other tranches. For other asset classes, the MRR is either 5% or 10%, depending on the original loan maturity.

Furthermore, the guidelines stipulate that the total exposure of an originator to a particular securitization structure or scheme should not exceed 20% of the total securitization exposures created by such structure or scheme (for this purpose, interest rate swaps or currency swaps are excluded from this limit). This suggests the credit enhancement that can be provided by the originator is not to exceed 20%.

In order for the originator to apply the capital adequacy rules on securitization exposures, the guideline sets out certain requirements on the SPE, including to:

• Transact on arms-length basis with the originator,
• Not imply any connection with the originator in name or title,
• Not to be owned by the originator (unless specifically permitted),
• Not have more than one originator representative on the board of the SPE (with no veto power and provided there be at least four board members, of which the majority are independent directors),
• Have no requirement for the originator to support the losses of the SPE (except facilities as permitted under the guidelines) or expenses of the SPE, and
• Have clarity for investors that the securitization notes are not insured and do not represent deposit liabilities of the originator.

In addition, if the SPE is a trust, the originator is to exercise no control over the SPE and shall not have any ownership interest in the trustees. The SPE is to be bankruptcy remote and non-discretionary, the trust deed is to detail the functions of the trustee and the rights and obligations of the trustee and investors as well as enable the investors to change the trustee at any time. Furthermore, the trustee is not to undertake any other business with the SPE, and the trust deed and accounts and statement of affairs of the SPE are to be made available to the RBI if so required.

The guidelines permit the reset of external credit enhancement, subject to the consent of the investors in the securitization notes. The consent may either be explicitly obtained during every reset, or the transactions documents may contain general clauses providing implicit consent of the investors for reset of credit enhancement.

For RMBS, at the time of first reset, at least 25% of the total principal amount assigned at the time of initiation of the securitization transaction must have amortized. The subsequent resets may be carried out at every 10% (of the original level) further amortization of the pool principal. A minimum gap of six months should be maintained between successive resets. At the time of reset, all the outstanding tranches of securitization notes should be re-rated (other than equity tranches).

The first reset of credit enhancement will not be permitted if the rating on any of the tranches has deteriorated vis-a-vis the original rating of these securitization positions. The release of credit enhancement for RMBS would be subject to a reserve floor of 20% of the initial credit enhancement provided, at the time of transaction, i.e., at any time, the level of credit enhancement available.

Only securitizations that satisfy all the additional conditions laid out in the guidelines will be deemed STC-compliant. The criteria are based on the prescriptions of the Basel Committee on Banking Supervision. Exposures to STC-compliant securitizations can be subject to the alternative capital treatment.

The originator is to ensure that prospective investors have readily available access to all materially relevant data on the credit quality and performance of the individual underlying exposures, the cash flows and collateral supporting a securitization exposure, as well as such information that is necessary to conduct comprehensive stress tests on the cash flows and collateral values supporting the underlying exposures. The guidelines recommend a particular disclosures format for the originator to follow, which is broadly comparable to investor reports in other regions.

Operational risk

We consider the operational risk of a performance key transaction party (KTP) by assessing severity risk, portability risk, disruption risk, and provision of back-up KTP. This is similar to any global structured finance transaction for which our criteria "Global Framework For Assessing Operational Risk In Structured Finance Transactions," published Oct. 9, 2014, would apply.

Per the criteria, we will not issue or maintain any ratings if, for any reason (including the reputation of any transaction party) we believe that a KTP has insufficient experience; the information on which a rating is based is insufficient, unreliable, or not timely; the transaction parties' roles, responsibilities, and rights are not sufficiently clear; or a KTP's resignation can be effective without a successor in place and the KTP's resignation would materially and adversely affect the securitization's performance.

Highlighting the importance of operational risk assessment is the case of Dewan Housing Finance Corp. Ltd. (DHFL), which entered bankruptcy proceedings in India in 2019.Up to the time of default, DHFL was a prominent HFC, originator, and servicer of a few securitization transactions that were outstanding at the time.

Similar to any structured finance transactions globally, the timely payment to noteholders is dependent on the timely performance of KTPs of their respective roles. The case of DHFL underscores the importance of clarity and independence, not only in documentation, of each KTP's roles, responsibilities, and rights to the timely execution of such roles.

Positively, the subsequent court decision over the securitized assets of DHFL affirmed and upheld the concept of bankruptcy remoteness in India. Of DHFL's outstanding RMBS at the time of bankruptcy, the servicing function continued, with the majority of borrowers maintaining regular repayments. One of the affected RMBS successfully transitioned its servicer function while the servicing function of another RMBS was taken over by the party that acquired DHFL.

Related Criteria

• Global Methodology And Assumptions: Assessing Pools Of Residential Loans--Asia-Pacific Supplement, April 4, 2024
• Global Methodology And Assumptions: Assessing Pools Of Residential Loans, Jan. 26, 2019
• Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014

Related Research

• Banking Industry Country Risk Assessment Update: December 2024, Dec. 19, 2024
• Banking Industry Country Risk Assessment: India, Aug. 19, 2024
• Inflation And Rate Hits Won't Knock Out India Inc., Aug. 23, 2022