Restructuring will lead to increase in loan-to-value and higher EMI to income ratio

In a bid to offer a respite to borrowers who are unable to resume loan repayments post the moratorium period or are otherwise cash-strapped, many banks have announced the contours of the one-time restructuring option. Aside from the mandate of the loan account being standard as on March 1, 2020, banks also need to be satisfied that the borrower has indeed been affected by the pandemic -- fall in income, job loss, closure of business, etc.

The restructuring of retail loans, which involves a moratorium on loan EMIs and extension (if opted) of the loan tenure, implies an increase in loan-to-value (LTV) and higher EMI to income ratio. This will increase the risk for banks, particularly if there is a sharp fall in the value of the underlying asset or the borrower’s income takes a further hit going ahead.

Why?

The concept of LTV applies mostly to home loans. The LTV ratio is the ratio of the loan amount vis-à-vis the value of the property. For instance if the value of the property is Rs 1 crore and the bank offers loan at an LTV ratio of 75 per cent, then a borrower can avail loan up to Rs 75 lakh. According to RBI guidelines, banks can offer LTV of up to 90 per cent in case of home loan amount up to Rs 30 lakh, up to 80 per cent in case of a loan between Rs 30-75 lakh, and up to 75 per cent in case of home loans above Rs 75 lakh.

Banks usually work within the LTV ratio range of 65-75 per cent to mitigate risk of loan default and sharp fall in the price of the asset (property).

But the restructuring of home loans would now lead to increase in the existing LTV ratios for banks.

Under restructuring, a borrower can ask for a moratorium on loan EMIs for a period ranging from 1 to 24 months. Essentially, while the borrower does not pay any EMIs during the moratorium period, interest will be charged during this period. At the end of this moratorium period, the borrower can either retain the original tenure or ask for an extension of the loan tenure by a period equivalent to the moratorium granted. In both cases, the outstanding loan amount would increase (from the amount due before restructuring). Hence the LTV ratio will automatically inch higher.

During SBI’s virtual press conference to launch its online portal for restructuring of retail loans, Managing Director (Retail & Digital Banking), C S Setty, said there could be an increase in the bank’s LTV ratio from 70-75 per cent to about 90 per cent, in some cases owing to restructuring.

In case of other banks, too, it is evident that the LTV ratio would increase substantially from current levels, reducing the margin of safety with banks. A sharp fall in the underlying property price can turn risky for banks. It also needs to be seen how the RBI’s broad LTV rules for home loans and gold loans (which was recently increased to 90 per cent), will apply for restructured loans, where LTV going up is a given.

Shrinking income

The other aspect that can increase the risk for banks is the higher EMI to income ratio. This ratio is critical to gauge the loan eligibility of a person, as it determines his affordability. Usually a bank restricts the EMI to 35-40 per cent of a borrower’s income.

But under restructuring, which sets the pre-condition of a fall in income for borrowers to avail of the option, would result in increase in EMIs, the EMI to income ratio would go up inevitably.

During his media interaction, Setty had also indicated that the EMI to income ratio could go up to 70 per cent (from 50 per cent currently).

A sharp fall in income of borrowers post restructuring can increase the risk for all banks.

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