Document of

The World Bank

FOR OFFICIAL USE ONLY

Reprt No. 7081-IN

STAFF APPRAISAL REPORT

INDIA

HOUSING DEVELOPMENT FINANCE CORFORATION PROJECT

February 12, 1988

Country Department IVAsia Region

This document has a restricted distribution and may be used by redpients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Currency unit - Rupees (Rs)

US$1.00 - Rs 13.25Rs 1.00 - US$0.0755

FISCAL YEAR

July 1 - June 30

MEASURES AND EQUIVALENTS

Rs 1 lac - Rs 100,000Rs 1 crore - Rs 10,000,000

ABBREVIATIONS AND ACRONYMS

AID = Agency for International DevelopmentCHFS = Cooperative Housing Finance SocietiesEROR = Economic Rate of ReturnGDP = Gross Domestic ProductGIC = General Insurance Corporation of IndiaGOI = Government of IndiaHDFC = Housing Development Finance CorporationHSP = Home Savings PlanHUDCO = Housing and Urban Development CorporationIFC = International Finance CorporationICICI = Investment Credit and Investment Corporation of IndiaLLD = Loan-Linked DepositsLIC = Life Insurance Corporation of IndiaLOC = Line of CreditMUD = Ministry of Urban DevelopmentNIHB = National Housing BankRBI = Reserve Bank of IndiaUTI = Unit Trust of India

FOR OFFICIAL USE ONLYINDIA

STAFF APPRAISAL REPORT

HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

Tabl, of Contents

Page No.

LOAN AND PROJECT SUMHARY .............................................. iii

I. SECTOR BACKGROUND ......................................... 1

A Introduction ........................................... 1B. Urban Housing Supply and Demand ........................ 2C. Housing Finance and Broader Financial Policy ........... 3D. Structure of Financial Intermediation for Housing ...... 4E. Regulatory Environment and the National Housing Bank ... 6

II. TEE HOUSING DEVELOPMENT FINANCE CORPORATION (HDFC) 7

A. Overviewof Operations and Finance ..................... 7B. Lending Program ........................................ 10C. Resource Mobilization .................................. 12D. Institutional Development .............................. 13E. Other Activities .. 14

III. BANK SECTOR EXPERIENCE AND RATIONALE FOR BANK INVOLVEMENT. 15

A. Bank Sector Experience .15B. Rationale for Bank Involvement in the Project 17

IV. THE PROJECT .. 18

A. Project Objectives .. 18B. Project Description .18C. Project Costs and Financing ............................ 21D. Procurement and Technical Assistance .23E. Disbursement of the World Bank Loan .23F. Audits and Project Monitoring ............. ............ 25

V. PROJECT BENEFITS AND RISKS ................................ 26

A. Project Benefits ....................................... 26B. Project Risks .......................................... 26

VI. AGREEMENTS AND RECOMENDATIONS .. 27

This report is based on the findings of a mission which visited Bombay duringOctober 1987. The mission included Nina Shapiro (MissJon Leader), RobertBuckley and Songsu Choi.

This document has a restricted distribution and may be used by recipients only in the performanceof their offcial duties. Its contents may not otherwise be disclosed without World Bank authoriztion.

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Table of Contents (Cont'd) Page No.

TABLES

2.1 HDFC Operational and Financial Profile .. 94.1 Summary of HDFC Project Costs by Year ..................... 224.2 Procurement Method for the HDFC Project .. 24

ANNEXES

1. HDFCUs Projected Financial Statements .292. Summary of Technical Assistance Component and Costs 343. Estimated Schedule of Disbursements.. 394. Diagrams of HDFC's Organizational Structure .405. Profile of HDFC Borrower Income Distribution 1986-1987 416. Profile of HDFC Housing Loans .427. Details of HDFC Resource Mobilization for FY 1987 448. Summary of Comparative Terms for Deposit Rates at

HDFC, Commercial Banks and Non-Financial Corporations 459. Summary of Comparative Terms for Housing Loans in the

Indian Formal Sector ................... 4610. Diagram of Formal Intermediation in Indian Housing

Finance Sector ............................................ 4711. GOIPs Sector Policy Statement to the World Bank ........... 4812. List of Documents in the Project File ..................... 51

MAP

IBRD No. 19996-R: Location of HDFC Branch Offices

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INDIA

HOUSING DEVELOPMENT FINANCE CORPORATION

LOAN AND PROJECT SUMMARY

Borrower: Housing Development Finance Corporation, Ltd.

Guarantor: India, acting by its President.

Executing Housing Development Finance Corporation, Ltd.Agency:

Amount: US$250 million equivalent.

Terms: Repayment in 20 years, including five years grace, withinterest at the Bank's standard variable rate.

Beneficiariest The project loan benefits directly about 70,000 householdsreceiving mortgage loans from HDFC; the borrowers comemainly from the middie and lower-middle income groups.

Proiect The objectives of the project are to support:Obiectives: I

(i) HDFC's lending to extend the benefits of market-oriented housing finance to a wider geographical areaand to a broader group of middle and lower-incomebeneficiaries;

(ii) further institutional development of HDFC roles as aninnovator and advocate of market-oriented finance,and as a sector leader assisting the entry anddevelopment of similar institutions; and

(iii) development of a regulatory framework to help ensurethe financial integrity of housing financeinstitutions and their ability to mobilize resourcesat market-rates, during a difficult period of change,increased competition and refirm in the capitalmarkets.

Proiect The proposed project helps finance housing through a lineDescription: of credit to HDFC, equal to a maximum 30Z of HDFC's mort-

gage lending program over a 3-1/2 year period. RDFC'saverage loan for Rs 40,000 (about US$3,000) finances about45' of the total housing cost. In the context of sectordevelopment, the loan is eligible for disbursement in twotranches tied to conditions relating to: (1) the initiationof a regulatory environment for housing finance; and (2)thE promotion of competitive resource mobilization, and the

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formulation of measures to reduce mortgage credit risk.Technical assistance supports HDFC's institutional develop-ment, branching to new geographic areas and development ofnew mortgage instruments, especially for lower-incomegroups. The project also supports HDFC's own technicalassistance to other emerging housing finance corporationsfor their establishment of operating procedures and controlsystems.

Proiect The project supports the development of market-orientedBenefits: finance in India. It comes at a critical time in the

Government debate whether to encourage housing financemainly through directed credit or competitive resourcemobilization. HDFC demonstrates the viability of thelatter approach, and the project helps stabilize its short-term lending program during a transition period in thecapital markets. As the lead agency in the sector, HDFC isexpected to extend the benefits of market-oriented housingfinance through its own expansion and the promotion ofsimilar institutions. The development of sector policy isexpected to allow more competition in the financial mar-kets, with households gaining greater opportunity to bidfor resources, and to promote a greater variety of housingfinance services with lower risks and lower costs. Theeconomic rate of return for urban housing investments fa-cilitated by HDFC is estimated to be between 20-30Z. Atleast 50Z of the bank loan would benefit households withincome below the urban median.

Proiect Given HDFC's record, there is little institutional riskRisks: associated with its ability to disburse the loan or meet

the project covenants. Although there is some risk thatthe implementation of the conditions relating to sectordevelopment could be delayed by political or economic con-siderations, the project design is consistent with policydevelopments underway by GOI. Since the loan disbursementis tied to HDFC's ability to mobilize at least 70? of itsresource requirements, the loan cannot be drawn down asprojected unless the sector enjoys an enabling environmentwhere funds can be raised competitively at market rates.The project supports the emergence of such an environment.

v

Zstimated Costs:'Local Foreimn Total

--------- USS Million --------

HDFC Mortgage Program 839.0 - 839.0Technical Assistance 0.7 1.1 1.8

Total Project Costs 839.7 1.1 840.8

Financing Plan:

Bank 248.9 1.1 250.0HDFC 5S0.8 - 590.8

Total 839.7 1.1 840.8

Estimated Disbursements:

Bank FY: 1988 1989 1990 1991

---------------- US$ Million ----------------

Annual 25.0 2 76.0 81.5 67.5

Cumulative 25.0 101.0 182.5 250.0

Estimated Proiect Completion Date: March 31. 1991

Economic Rates of Return: 20-30Z (based on imputed rental and salesvalues of housing financed by HDFC mortgages).

Map: IBRD No. 19996-R

1/ Project costs are given in current terms. The Technical Assistancecomponent excludes duties and taxes (of US$118,000), and includes physicalcontingencies (of US$146,000) and price contingencies (of US$160,000).

2/ Includes retroactive financing of US$ 25.0 million.

INDIA

HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

I. SECTOR BACKGROUND

A. Introduction

1.01 This project supports policy developments in the housing andfinance sectors in India. To help meet the vast housing demand, it fa-cilitates construction of housing which has been constrained by lack ofhousing finance. At the same time, by assisting the innovative effortsof the Housing Development Finance Corporation (HDFC) to make mortgagefinancing available at market rates, the project is consistent withorderly liberalization of the capital markets.

1.02 The Government of India (GOI) has recognized the deep-rootedproblems in its highly regulated and centralized financial system, whichhas effectively controlled interest rates and directed credit. Recently,GOI has taken a number of corrective measures to allow market forces toplay a greater role in resource allocationl . However, the transition toa more competitive, efficient financial system is likely to be a diffi-cult one. Increasing the competition for funds when many of the coun-try's major financial intermediaries are in poor financial conditioncreates pressures on regulators. On the one hand, there is pressure toreduce the competition for funds and ration out households and otherborrowers perceived to be of low priority. On the other hand, there ispressure to permit financial intermediation to expand without estab-lishing a sufficient regulatory framework.

1.03 HDFC is the only significant source of market-oriented housingfinance in India and it has been the chief promoter of a competitivesector and a fiduciarily-sound regulatory system. Providing Bank supportto a well-functioning intermediary like HDFC contributes to the develop-ment of the sector in two ways:

(a) During a period of piecemeal change and increased competitionin the capital markets, the project helps stabilize HDFC'sshort-term program and its ability to both expand the availa-bility of market-rate mortgages and assist the entry ofsimilar institutions.

(b) Coming at a critical point in the Government's debate onwhether to encourage housing finance mainly through directedcredit or through competitive resource mobilization, the proj-ect helps HDFC demonstrate the viability of the latterapproach.

1/ India: Credit and Capital Markets Study, The World Bank, South AsiaProjects, Report No. 6661-IN, February 1987.

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B. Urban Housing Supply and Demand

1.04 India's cities and towns are growing rapidly in response toindustrialization and economic expatnsion. The high urban populationgrowth rate of 3-42 over the past two decades is expected to continue,with more than half of all Indian population growth taking place in urbanareas. By the year 2000, the urban population is projected to reach atleast 325 million. The resulting implications for housing demand aredramatic: about 1.7 million new urban housing units would be required ineach year for the rest of the century. This supply would just meet newdemand and not start to cope with present overcrowding, or a depreciatinghousing stock. The formal sector, through government programs and finan-cial intermediaries, currently provides funding for onl) about 275,000urban units a year.

1.05 There is a growing realization that urban development is animportant part of economic development and that past efforts to limiturban growth have not only had limited impact but may have been counter-productive. Due to the scale of the housing requirement, more attentionis being given in India to the development of appropriate sector policiesand institutions which can help meet the demand.

1.06 Four broad issues characterize India's emerging housingpolicy, which will take some time to realize fully: (a) increased effi-ciency and effectiveness of resource utilization, including affordabledesign standards and low-cost technologies; (b) market-oriented pricingand improved cost recovery and resource mobilization; (c) strengtheningof public sector management in terms of planning, budgeting and opera-tions; and (d) a more rational allocation of responsibility between thepublic and private sectors.

1.07 The project represents a particularly good oppertunity tofoster objectives (b) and (d) above by encouraging the role of theprivate sector in market-oriented housing finance. Past GOI housingstrategies have depended heavily on direct investment by the publicsector with funds mobilized under the directed credit system and usuallynot fully recovered (paras 1.15-1.17). These programs have been subsi-dized and limited in effect and replicability. A large amount ofpublicly subsidized housing has gone to middle and upper-income groups,which could have paid market rates.

1.08 In the Seventh Plan, GOI gives priority to meeting the housingdemand. The Government now maintains that: (a) greater emphasis shouldbe given to facilitating market-oriented housing finance by the privatesector, since the vast demand for housing can only be satisfied withunsubsidized lending; (b) public resources should focus on efficient landdevelopment, and selective', on delivery of serviced sites for lower-income groups; and (c) the legal framework should be adjusted to reducethe non-financial disincentives to housing investment such as rentcontrol, costly building regulations and restrictive land-managementpolicies.

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C. Housing Finance and Broader Financial Policy

1.09 In spite of rising incomes, the share of housing investment inIndian Gross Domestic Product (GDP) fell from about 5Z in the late 1960stc about 3Z in the 1980s. An important factor in this trend was the GOIpolicy to limit the availability of formal sector housing finance.Because G01 directed so much heavily subsidized credit to 'priority'sectors like industry and agriculture and to public enterprises, onlymarginal amounts have been allocated to housing. Potential mortgageborrowers were effectively rationed out of the financial sector andunable to bid for funds. As countries develop, housing finance typicallybecomes a major factor in the capital markets.

1.10 Through the nationalized financial intermediaries, GOI hascontrolled not only the flow of credit but, with an extensive system oftax incentives and administered borrowing terms, has influenced wheresavers place their financial assets. Banks have compensated for theiriubsidized lending, and low level of loan recoveries, with low interestrates on deposits and high rates on lending to non-priority sectors. Asa result of government policies, the banking system suffers from rela-tively low profitability and inefficiency. The growth of the non-bankdeposit market was a direct response to the inability of the financialsystem to respond to market demand for services and resources.

1.11 At the same time that credit policies have caused housing'sshare of investment to decrease, they also resulted in a stagnating shareof savings held i4 financial assets. Moreover, this stagnation occurreddespite the fact that the savings rate increased2 and there was an extra-ordinary amount of wealth held in precious metals. In effect, thestrictured financial system, with its low or sometimes negative realreturns, has helped dissipate the benefit of India's high savings rate irtinefficient savings patterns.

1.12 GOI has recognized the basic structural problems in the finan-cial system, and has begun a series of reforms to improve the system'scompetitiveness. HMrket-oriented housing finance can play a supportiverole in this new system by contributing to more dynamic competition inthe credit and capital markets. If unconstrained by financial policies,the demand for housing finance would increase. Allowing households toborrow for a *safe* rsset like housing could reasonably be expected toboth: (a) lower the transaction costs associated with the growing shareof housing investments; and (b) increase the utility of the formalfinance sector for households, and thereby mobilize greater financialresources.

2/ Report of the Committee to Review the Working of the Monetary System(Chakravarty Report), Reserve Bank of India, Bombay, 1985.

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1.13 Changes undervay in the capital markets could provide theopportunity to integrate housing finance demand into the financialsystem, and allow households to bid for credit at competitive rates.However, the current system is so centralized, multi-tiered and with suchan extensive array of fiscal incentives and controls, that it will takemany years to fully deregulate, and for the cost of services and asso-ciated risks to be more appropriately priced. Furthermore, the effectsof the implemented changes are difficult to predict and coordinate, andcan create disequilibrium in the system.

1.14 The combination of this gradual movement towards financialliberalization, the rising GOI deficit, and the low profitability of thebanking system, all create pressures to again limit access to credit by*lower priority' bidders, such as households. A possible result could beanother centralized system with an apex lender that channels below-marketrate funds to a restricted number of borrowers. This type of limitationcould create problems for market-oriented housing finance institutions,at just the time GOI is evaluating how these institutions should bestructured and regulated.

D. Structure of Financial Intermediation for Housing

1.15 India's housing finance sector is still in its infancy.Merely 22 of formal financing is lent for housing and, as a result, theformal sector is providing only about 20X of the total housing invest-ment. Like the financial sector in general (paras 1.09-1.10), thestructure of housing finance has been centralized, dominated by thepublic sector, and characterized by the restricted allocation of directedcredit instead of market-oriented intermediation. (A chart showing thestructure of formal intermediation in the housing finance sector is givenin Annex 10.) The major public housing finance intermediaries, theHousing and Urban Development Corporation (HUDCO) and state apex socie-ties generate few resources directly. They depend almost exclusively onallocations from the central aad state governments and nationalizedfinancial intermediaries: the Life Insurance Corporation of India (LIC),which supplies the dominant share; the General Insurance Corporation ofIndia (GIC) group; and the nationalized banks to a small extent. Thefunds are placed among various retail agencies mainly according togovernment planning objectives. In sum, these ho!ising finance institu-tions do not perform meaningful financial intermediation by makingmarkets for mortgage investment, but merely act as segmented administra-tive channels for subsidized funds.

1.16 HUDCO: Established in 1970, under the Ministry of UrbanDevelopment (MUD), HUDCO is the main instrument for implementation of theGovernment's housing policy. It is the largest formal housing financeinstitution and disbursed about Rs 220 crores in FY 1986. A part of itsfunds is raised through the issuance of below-market rate debentures,which are government guaranteed. These are subscribed by insurance

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companies and scheduled banks in order to meet the minimum governmentlending targets for the housing sector. GOI also budgets subsidizedfunds directly to MUDCO for special social programs. HUDCO then on-lendsits funds to state housing boards and development authorities for middleas well as lower-income housing projects, also at below-market interestrates. Repayment of loans to HUDCO is high because loans are guaranteedby state governments and agencies. However, default rates by final bene-ficiaries to the implement] ng agencies are as much as 402. Overall,implicit subsidies from the low interest rates and low cost recovery areestimated to equal almost half of HUDCO's spending. The subsidies them-selves have acted as a disincentive for efficient use of real resources.

1.17 Cooperative Housing Finance Societies (CHFS): Numberingapproximately 25,000, the CHFS's are located in most urbanized areas, andreceive, as a group, the largest share of housing credits. Most of thesocieties are organized by builders and middle to upper-income groups totake advantage of preferential access to land and finance from commercialbanks and state apex CHFS. Generally, these societies have also not beenwell managed and have been subject to delinquency rates on repaymentsaveraging about 25Z. State apex societies raise nearly all their funds(about Rs 150 crores in FY 1986) through term loans from LIC and GIC.Significant growth in their lending has been restricted by the amountsGOI allocates toj housing through the insurar.ce companies, and the highdefault rates from primary societies.

1.18 Private Sector Housing Finance Institutions: Since the late1970's, several private sector institutions have begun to make housingloans. Most are affiliated with particular developers to finance theirown inventories, and only HDFC has attained any significant scale ofoperations. Its operations are free from the critical weaknesses oftraditional formal housing finance, notably the high rates of default,unsustainable subsidies and strict dependence on directed credit. Byestablishing a direct relationship between the supply and demand formortgage funds, HDFC has helped to generate additional resources for thesector (see Section II). Although in the longer term, the increasingliberalization of India's financial sector is expected to favor thegrowth of market-oriented operations, in the short term, there are uncer-tainties facing intermediaries competing for housing finance resources(paras 1.13-1.14).

1.19 Other Forms of Formal Housing Finance: Ccmmercial banks andinsurance companies do a small amount of lending for private sectorhousing mainly to the higher-income groups and corporations. Additionalformal housing finance is provided by larger corporations for employeehousing, and by trusts and provident funds for their members, with orwithout explicit intermediation by financial institutions.

1.20 Informal Housing Finance: By far, the dominant share ofhousing investment is provided by the informal sector. While it is dif-ficult to quantify various modes of informal financing, it is believedthat self-financing through liquidation of tangible as well as financialassets is the most important. Borrowing from informal money lenders is

expensive (6-8Z above formal market rates) and short-term, and essen-tially provides only bridge financing. This pattern makes home-ownershipunaffordable to most Indian urban families, and forces even the middleand upper-middle-income group to delay investments.

E. Regulatory Environment and the National Hoising Bank

1.21 For housing finance to profit from a more liberal financialsystem, there is a need for an enabling regulatory ervironn. --t that wouldprovide confidence in the way housing finance institutions operate and intheir capacity to mobilize adequate resources. To expand sufficiently,yields on investments in mortgage credit must be competitive with alter-native investments. The recent creation of a National Housing Bank (NHB)3

and its placement under the Reserve Bank of India (RBI) gives the Govern-ment a vehicle to develop the financial integrity of the housing financesector, to manage elements of the regulatory framework and to supervisehousing finance institutions in the public interest. The NHB Billdefines broad functions for the new institution as a regulator and pos-sible lender for housing finance, and its specific orientation and tasksare still to be worked out.

1.22 In a policy note to the Bank, GOI stated that, as part of itsoperations, the NHB would have a regulatory confirmed function to helpcreate an "enabling environment to encourage housing finance institutionsto raise funds and ernage in market-oriented financing" (see Annex 11).However, there is still some concern that the NHB could become anothercentralized mechanism for allocating credit on subsidized terms. Thedetails of a system for fostering and regulating private sector housingfinance, with perhaps separate windows catering to the credit needs ofpublic sector agencies, has yet to be fully developed. It is clear that,for the regulatory environment to be able to affect the large-scaledemand for housing funds, it must facilitate the expansion offinancially-sound housing financa institutions and the creation of newones. HDFC provides the model for a workable system (see Section II).From a small capital base, it has been able to exploit the advantages ofmarket competition and well-managed risk and cost recovery to become themajor player in urban housing finance.

1.23 There are three major sector issues which require attention byNHB, and which are being addressed by the project tranche conditions(paras 4.09-4.12):

(a) The Regulatory Framework (para 4.10): Existing regulationsare insufficient to ensure the fiduciary responsibility orviability of private housing finance institutions. Considera-tion should be given to setting criteria for the capitalstructure (i.e. debt to equity ratio, net worth, contingencyreserves); asset management (i.e. portfolio structure, typesand security of loans to be made); liability management (i.e.

3/ Bill No. 91 of 1987, Lokh Sabha, Government of India

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norms for retail deposits and marketable securities); andfinancial management (i.e. guidelines for operational controlsand financial audit).

(b) Resource Mobilization (para 4.11): In competing for funds,housing finance needs diversified linkages to the creditmarkets and access to household savings. Currently, market-oriented housing finance is at a disadvantage with respect toall major competitors: the Unit Trust of India (UTI) canoffer larger tax advantages for savers; banks can offer theconvenience of an extensive and heavily subsidized branchingsystem, a wider range of financial services, and greaterliquidity of deposits; corporations can offer better returnson deposits; and the Government still controls the forcedinvestments of the financial system. A more competitive posi-tion would require housing to receive similar tax and regula-tory treatment as other investments with similar risks.Access could also include the reduction of constraints forhousing finance to compete for funds with banks and corpora-tions, particularly for short-term savings and for investmentsfrom provident funds. Although these funds, which hold about25Z of household savings, would be a good match for long-termmortgage investments, they are now allowed to invest only inbelow-market government securities. Until the capital marketsare less tightly controlled, NHB must assure that the newhousing finance sector has adequate instruments to attractmarket finance.

(c) Reduction of Credit Risk (para 4.12): Current mortgage lawmakes foreclosures extremely difficult, time-consuming andexpensive. The potentially high cost of default forceslenders to exact high downpayments, which is a major deterrentto the expansion of mortgage finance for lower-income groups.Mortgage insurance, if supported by changes in foreclosurelaws, may be the best instrument to bear and spread the creditrisk. However, it would only be effective if it were market-priced according to the actual risk of default for each insti-tution and not coercive at a uniform rate.

II. THE HOUSING DEVELOPMENT FINANCE CORPORATION (HDFC)

A. Overview of Operations and Finances

2.01 Incorporated in 1977, HDFC had majcr equity participationfrom the IFC, Industrial Credit and Investment Corporation of India(ICICI), and Aga Khan Fund for Economic Development. Nearly 55Z of thestock is held by large Indian corporations and 25Z is widely distributedamong small companies and the public. Host of its operations aregoverned by regulations of the Reserve Bank of India. However, as aprivate sector corporation, HDFC is free to set it3 own borrowing andlending rates within the context of the Indian financial environment.

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2.02 HDFC's primary objective is to provide long-term housingfinance to middle-income urban households which are mostly unserved bythe formal housing finance system (paras 1.15-1.20). HDFC has managed toexpand rapidly around the rigidly directed credit system. It has becomea viable alternative both to public sector mortgage lenders, and a saferinvestment than the competitive unregulated corporate deposit market.Since 1980, loan disbursements have grown at over 35Z a year, to Rs 176crores (about US$135 million) in FY 1987, financing about 46,000 units inthat year. By 1991, HDFC expects to disburse about Rs 400 crores (aboutUS$300 million), financing 77,000 units or about 4? of projected newhousing demand (para 1.04 and Table 2.1). HDFC now ranks as the secondlargest housing finance institution after HUDCO and as the largest inurban housing finance. The on-going liberalization of the financialsector is expected to further strengthen HDFC's position relative to themajor public sector institutions, which rely heavily on subsidized anddirected credits for funds and on intermediary guaranties for recovery.

2.03 Carefully positiored lending and borrowing rates have enabledHDFC to compete effectively and profitably (paras 2.08, 2.14, 2.15). InFY 1987, the average cost of funds was 11.6Z nn all outstanding debt and12.5Z on long-term borrowings, and the aver..&e interest income was 14.1Zon outstanding loans. HDFC's overall spread, after expenses, was 1.8Z.HDFC has conservatively managed its loan appraisal and recovery processesto contain arrears and defaults to a negligible proportion of itsoutstanding portfolio (para 2.10). Combined with low administration costof less than 12 of outstanding loan volume, the interest spread has beensufficient to enable HDFC to earn after-tax profits of over 20? of networth in each of the last five years. (HDFC's current and projectedfinancial statements are given in Annex 1.)

2.04 HDFC's second equity issue in 1.987, which was highly over-subscribed, doubled the shareholder equity to Rs 20 crores; another shareissue of Rs 10 crores is planned for FY 1991. Despite recent declines inthe Indian stock market, HDFC's share price has maintained a steady levelof about Rs 130-135 per share (a third increase over the par value ofRs 100 per share) and currently pays a dividend of 16Z on par. The divi-dend policy, the relative stability of domestic interest rates, andHDFC's consistently good financial performance have led stockholders toview HDFC as a stabLe investment with almost bond-like features.

2.05 Without a compatible regulatory environment, HDFC has safe-guarded its fiduciary integrity as would a well-regulated institution.It has a variety of protections from liquidity problems: average loanmaturities of about nine years are satisfactorily matched with averageliability life of about seven years; its liquidity position, in cash andliquid securities, has been consistently maintained between 20? to 252 oftotal assets or half of its deposit liability; and its debt-to-equityratio currently stands at about 14. Through accumulation of reserves andmoderate capital increases, this ratio is expected to stay below 17.5over the next few years.

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Table 2.1: Housing Development Finance Corporationoperational and Financial Profile

(in Rs cro-es)

ProjectedFiscal Year 1978-79 1982-83 1986-87 1990-91

Housing Loans Disbursed 1.3 47.8 175.5 397.3

Cuzulative 109.0 598.4 1,870.6

Housing Loans Sanctioned 7.1 76.1 237.5 437.5

(Number of Units) 6,645 19,472 46,023 77,300

Number of Staff 76 222 575 1,072

Net Worth 9.9 14.2 43.1 111.9

Total Assets 10.2 121.2 614.8 1,669.2

Debt/Equity Ratio 0.1 7.5 13.3 13.9

Profit after Tax 0.06 2.89 9.25 22.6

(Z of net worth) 0.6Z 20.3X 21.52 23.2?

Source: HDFC annual reports and financial projections.

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2.06 As the only significant market-oriented housing financeinstitution, HDFC has played an important role as the sector leader tofacilitate development of housing finance in India. It is promotingvarious new institutions in the sector through equity participation andtechnical assistance (para 2.23). Since its inception, HDFC has identi-fied and advocated policy reforms to enable itself and other similarinstitutions to mobilize resources competitively. Although the extraor-dinary growth in its portfolio is expected to slow to about 25Z a yearover the project period, HDFC's continued expansion and innovative per-formance will have a significant impact on efforts to increase availablehousing finance. While expanding rapidly to 16 branches, located in allmajor metropolitan areas, HDFC has experienced some pressure on itsoperating systems, and training and computerization of controls have beenan on-going effort.

B. Lending Operations

2.07 HDFC make3 three major types of housing loans, almost all fornew construction. Conventional 15-year mortgage loans to individualsaccount for approximately 70Z of total loan disbursements. Under theLine of Credit (LOC) facility, loans are made available to corporationsacting either as guarantor for employee mortgages or as the borrower foron-lending to individual employees. Corporate loans are also extendedfor employe6 housing. These types of bulk lending to or through corpora-tions equal about 27Z of current lending. Marketing efforts are beingfocused on these in order to take advantage of the efficiency of volumelending, lower risk, and better reach to lower income groups who are themajority beneficiaries of such loans. The remaining 3Z of total lendinggoes to cooperatives for home-building by members and to builders forshort-term construction loans.

2.08 Terms for individual mortgage loans include repayment inequal monthly installments over a period between 7 to 20 years, normally15 years, at an annual interest rate between 12.5Z to 14.52; this rate islower for smaller loans to the lower-income borrowers. Corporate loansare repaid over 3 to 7 years at an annual interest rate of 14.5Z to15.5Z. HDFC retains the right to adjust interest charges as a partialprotection against possible escalation of borrowing costs. Annex 9 indi-cates HDFC's lending terms compared with those for other institutions.The maximum amount of an individual loan is 702 of housing cost includingland up to Rs 1.5 lacs; 80Z of housing cost or Rs 1.5 lacs for LOC loans;and 50Z of construction cost or Rs 1 lac per housing unit for corpora-tions. However, other loan eligibility criteria, related to householdcash flow, have limited the average loan to around 45Z of total housevalue, or Rs 40,000 as of June 1987.

2.09 All HDFC housing loans are secured by an equitable mortgageon the property fi nced. Due to serious difficulties in enforcingmortgage rights (para 1.23), conservative appraisal and disbursement

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procedures are adopted to ensure the market values of the land andproposed structure, and to minimize defaults. Loans are normally limitedsuch that the monthly payment would not exceed 302 of family income.Loan approvals can also be contingent upon large downpayments, net worthrequirements, credit history, third-party references and guaranties, andhypothetication of life dnsurance proceeds. Loan disbursements are madein stages according to the progress of construction; they start aftercompletion of the land purchase and the preliminary phase ofconstruction. Viability of the project and repayment capacity ofborrowers are further confirmed during the disbursement.

2.10 Repayment: HDFC strictly monitors repayment of loansstarting right after the first disbursement. The Accounts Section ofeach branch follows up on arrears of a month or more by mail notificationand personal interviews; status of arrears accounts is reported to head-quarters every week. Due to its rigorous procedures of appraisal, dis-bursenent, and follow-up, HDFC's arrears over twelve months are very lowby any standard for similar institutions; they comprise less than 0.2? oftotal loans outstanding or about 3.3? of repayments due for FY 1987.

I2.11 Beneficiaries' Income Distribution: Although there is noupper income limit for eligible borrowers, the maximum loan per unit iseffectively of little interest for high-income groups. Most HDFC loansgo to middle-income households, with about 35Z of the beneficiariesearning less than the urban median income, which is conservatively esti-mated to be at least Rs 1,700 per month (see Annex 5). While 28? ofindividual borrowers in FY 1987 had incomes below the urban median, 88?of the beneficiaries of the corporate loan programs fell below themedian.

2.12 The loan distribution, with the concentration on middlerather than lower-income households, can be attributed to a combinationof factors: the high cost of home-ownership in Indian cities relative tohousehold incomes; the concentration of HDFC operations in large metro-politan areas such as Bombay, where average income levels as well ashousing costs are much higher than in smaller cities; and HDFC's conser-vative loan appraisal criteria required due to the lack of mortgage secu-rity. Continuing efforts to enlarge lending to lower-income groupsinclude: increased marketing of LOC and corporate loans, and contractualsavings schemes; expansion of branches and out-reach programs into smal-ler, less expensive urban areas; and participation in experimental low-income housing finance programs.

2.13 With access to longer-term loan funds, HDFC plans to offer acorrespondingly more mortgages with 20-year repayment term for lower-income borrowers. HDFC has recently introduced loans with more flexiblelending terms; for example, the graduated repayment schedule (Step-UPRepayment Facility), with five-yearly increases averaging 5? per year ininstallments, is presently being test-marketed to younger families.

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Through two new saving and loan schemes--the Home Savings Plan (HSP) andLoan-Linked Deposits (LLD)--HDFC hopes to assist borrowers to qualify formortgages by establishing the necessary equity base and credit records.The HSP is a contractual savings scheme making the subscriber eligiblefor a housing loan one and a half times the savings accumulated over 2 to7 years. The savings are paid interest of 62 per annum, lower thannormal HDFC deposits of similar maturity, but competitive to commercialbank rates; the loan is repayable in 12 years at the low interest of8.5Z. In LLD, although the linkage between savings and loans is looser,the loan amount can equal up to four times the accumulated savings.Savings of 2 to 5 yea4s are paid interest of 92 per annum; the loancarries the regular interest rate but a longer maturity than usual. Forboth HSP and LLD, the actual loan amount Is limited by the normalappraisal criteria.

C. Resource Mobilization

2.14 HDFC mobilizes resources through a diversified combination ofsavings deposits, term loans, bonds, and equity (see Annex 7 for detailsof resource mobilization in FY 1987). As HDFC matures, repayment ofprincipal on housing loans is becoming an important and self-perpetuatingsource of funds; it is expected to increase to about a third of all dis-bursements by FY 1989. Borrowings are nearly evenly divided between HDFCdeposits from individuals, trtsts and corporations; and HDFC bonds andterm loans from other financial intermediaries. HDFC's rates are uni-formly about 2Z above bank rates, but about 1.52 below corporate and UTIrates (see Annex 8). To compensate for the higher rates of corporateinstruments, HDFC deposits carry lower risk, certain institutional taxadvantages, and explicit or implicit preferences for obtaining mortgageloans. Also, since HDFC has proven itself a relatively safe investment,HDFC deposits have been deemed eligible for trust savings and fulfillmentof liquidity requirements by corporate deposit takers. Although HDFCdoes offer higher rates than banks, it does not offer checking facil-ities, and is less attractive for the significant portion of bankdeposits which are held in very short-term accounts. Households appa-rently place a premium on liquidity and are willing to accept very lowinterest on accounts of less than 30 days. HDFC is requesting governmentpermission to offer shorter-term accounts, and to advertise more openlythe yield advantages 6f its deposits for households.

2.15 Bonds and term loans from other financial intermediaries haveincreased steadily in importance for HDFC since the early 1980's.Although HDFC bonds mature in ten years, they are more freely transfer-able and therefore more flexible than other bonds on the market. HDFC isalso exploring the marketing advantages of developing alternative typesof mortgage-backed securities. Term loans include some 18-year loansfrom the Life Insurance Corporation (LIC), and shorter-term loans fromcommercial banks, and trust funds. Earlier, HDFC raised foreign loans(para 4.15) from the IFC (US$4.0 million) and through the USAID HousingGuaranty Program (US$90.0 million). The importance of the foreign bor-rowings has declined sharply in recent years as domestic resource mobili-zation has increased at a rate approaching 502 per year.

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2.16 HDFC has been able to compete effectively against largerfinancial institutions for domestic resources and achieve rapid growthowing to three related factors: an effective product mix and marketingto take full advantage of the limited set of opportunities; its growingstature as a fiduciarily sound institution; and until now, its relativelysmall size compared with the domestic financial market. While seekingrelaxation of the restrictions on its borrowing instruments and abilityto advertise commercially, HDFC is branching and attempting to diversifyits resource base in borrowings and deposits from households and corpora-tions.

D. Institutional Development

2.17 HDFC is governed by the Board of Directors which currentlyhas sixteen members, including the Chairman of the Board who is one ofthe leaders of the Indian financial community and led the effort to foundHDFC. The Managing Director, who is the chief executive of the company,and five outside Directors constitute the Executive Committee which makesimportant operational and policy decisions, including approval of largerloans.

2.18 HDFC's operations are organized into four functional Depart-ments headed by General Managers (the organizational chart is shown inAnnex 4):

(a) OPERATIONS--all lending activities;

(b) RESOURCES--mobilization of funds and short-term fund manage-ment;

(c) FINANCE and PLANNING--corporate planning, accounts, loanrecoveries, and administration; and

(d) HUMAN RESOURCES--personnel administration, training, researchand publicity.

2.19 Headquartered in Bombay, HDFC has 16 branches located in allmajor metropolitan areas of India (see Map). A few branches have as manyas 50 employees and organizations similar to the headquarters; the orga-nizational structure of a more typical branch with 20 to 30 staff isshown in Annex 4. Five sub-branches have only five or six employees andreceive accounting and administrative support from larger branchesnearby. Even smaller markets are reached by "outreach camps" set up atregular intervals by visiting HDFC staff to accept deposits and loanapplications; a network of local representative offices is planned toexpand the outreach program. The hierarchy of regional offices allowsHDFC to concentrate on marketing in new areas without committing fulloverhead resources until a location warrants them.

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2.20 Reflecting Bombay's status as the locale of the nationalcapital market and large corporate headquarters, approximately half ofdeposits and 752 of all funds are mobilized at the head office, where 75Zof the loans are made at branches. Loans are concentrated in the *festernand southern regions (see Annex 6). As HDFC tries to increase lower-income clientele in terms of both savings and loans, it will expand andstrengthen the branch network in smaller cities where income levels arelower. It must be noted, however, that the timing of expansion alsodepends on the extent to which the local housing industry is well orga-nized and can respond to the availability of finance. Between FY 1988and FY 1991, HDFC plans to open five full branches, four suL-branches,and twelve representative offices. So far, operations have been stronglycentralized, but more control and support functions are being devolved tothe branches under a new regional management structure.

2.21 HDFC has attracted a well-qualified and highly motivatedstaff. The number of staff is expected to grow from the current 575 toabout 1,000 by the end of FY 1991, and about half of the increase will berequired by the branches opening from FY 1988. HDFC is engaged in threerelated developmental efforts to accommodate decentralization and growthin its size and complexity of operations (see Annex 2): (i) review ofoperations and management controls to assure an appropriate organizatio-nal structure and the consistent application of operational proceduresand controls; (ii) expansion of computerized automation to all branchesand areas of operations; and (iii) strengthening of formal training pro-grams for technical and human relations skills needed for branch expan-sion, system development and computerization.

E. Other Activities

2.22 HDFC provides a variety of technical assistance to borrowersin conjunction with its lending. For individuals, HDFC maintains aninformation base of planned and on-going housing developments for publicuse, and offers real estate services. Track records of developers andcontractors are kept on file as a market information resource, and alsoas reference for loan appraisals. Corporate buyers are often givenassistance in technical and financial planning of employee housingprojects and in implementation supervision.

2.23 In an effort to promote new housing finance institutionssimilar to itself, HDFC is contributing equity capital and technicalassistance to three new institutions (see Annex 2):

(a) HOUSING PROMOTION FINANCE CORPORATION--providing housingfinance and developing demonstration housing complexes ineastern and north-eastern India where income, savings, andhousing consumption are low;

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(b) GUJARAT RURAL HOUSING FINANCE CORPORATION--providing homeconstruction and improvement loans in rural areas of Gujaratstate; and

(c) CANFIN HOMES--establishing a mortgage finance company,promoted by Canara Bank, for lending mostly in southernIndia.

HDFC will coordinate its operations with these companies to the extentthat they will not set up direct competition in any one area. Since themarket demand is so large, HDFC does not view the new entrants as threat-ening competition but as an opportunity to create a brcader institutionalbase for the sector.

2.24 Since HDFC. is also recognized as a technical leader inhousing finance for the South Asia region, its personnel have beeninvited frequently to provide consultancy services in Nepal, Bhutan, SriLanka, Bangladesh, The Philippines and Indonesia.

2.25 HDFC's secondary activities include HDFC Developers Ltd,which was established in 1980 as a wholly-owned subsidiary with a sepa-rate financial structure. It has developed two medium-scale residential-cum-commercial complexes in Maharashtra State at the cost of about Rs12.5 crores. In 1986, HDFC also started a modest leasing operation andhas disbursed about Rs 3.4 crores for equipment related to urban infra-structure services and construction. In addition, HDFC will be a thirdpartner with the Central Bank of India, and the Unit Trust of India(UTI), in a joint venture to establish Infrastructure Leasing and Finan-cial Services Ltd., which will serve municipalities and companies in needof infrastructure facilities.

III. BANK SECTOR EXPERIENCE AND RATIONALE FOR BANK INVOLVEMENT

A. Bank Sector Experience

3.01 The Bank has supported public sector development of urbanland, infrastructure and shelter, and a range of municipal services espe-cially for the lower-income groups. Projects have also included majorefforts to improve sector management and resource mobilization. To date,the Bank has committed a total of about US$765 million to support 12urban projects in India. Six proj;ects have been completed4 and sixprojects are under implementation.5

4/ Bombay Transport (Ln. 1335-IN); Calcutta I (Cr. 427-IN) and II (Cr.726-IN); Calcutta Transport (Cr. 1033-IN); Kanpur (Cr. 1155-IN); andMadras I (Cr. 687-IN).

5/ Bombay (Cr. 1544-IN); Calcutta III (Cr. 1369-IN); Gujarat (Cr.1643-IN); Madhya Pradesh (Ln. 2329-IN); Madras II (Cr. 1082-IN); andUttar Pradesh (Cr. 1780-IN).

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3.02 Physical investments are largely being implemented satisfac-torily, and progress is being made in achieving better cost recoverythrough market pricing and interest rates, although less so in raisingproperty tax revenues. Improvements in sector management of operationsand maintenance have proven more difficult to achieve. The Bank'slending program will continue to iuiclude investment projects, particu-larly in states where little Bank assistance has been provided pre-viously. Bank sector work and lending will increasingly support thecentral and state governments in formulating sector policy and improvingsector management.

3.03 In its urban projects, the Bank has been effective in establi-shing a policy dialogue on housing with GOI. The Government's recentlyprepared draft paper on National Housing Policy as well as the SeventhPlan (para 1.08), have stressed much of the same strategy advanced inWorld Bank sector work and urban projects.

3.04 With appropriate design standards and construction techniques,and efforts to reduce constraints in the land market, Bank-assisted proj-ects have demonstrated the feasibility of more efficient land develop-ment, the extension of infrastructure to slum neighborhoods and the pro-vision of a large supply of affordable housing to lower and lower-middle-income groups at market rates of interest. The Bank intends to pursuethis housing strategy through the development of state housing boards andHUDCO as potential intermediaries for the design and supervision of spe-cific projects. The separation of the financial and development func-tions has been recommended by the Bank as a way to improve discipline ofcost recovery and efficiency of operations. While the Bank has increa-singly included the private sector in its projects for housing con-struction and finance, the lack of an adequate housing finance system haslimited implementation of the Bank's approach. As part of its sectorwork in India, the Bank completed a Housing Finance Review6 which led tothe preparation of this project.

3.05 Through the International Finance Corporation (IFC), the BankGroup has already been involved directly with HDFC. IFC supported theoriginal capitalization of HDFC in 1978 by investing (Investment No. 404-IN) about US$600,000 in equity, and providing US$4.0 million as a line ofcredit for operations. IFC's wseedw loan was critical in starting opera-tions before HDFC was able to attract long-te.-m lending from local insti-tutions. Also, IFC helped provide access to housing finance expertise,which allowed HDFC staff to adapt a workable system of mortgage lending.In 1987, IFC exercised its rights under HDFC's subsequent equityoffering, and invested an additional US$400,000 to retain its 5Z share-holding interest in HDFC.

6/ World Bank Report No. 6453-IN, February 1987.

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B. Rationale for Bank Involvement in the Project

3.06 The project comea at a particularly important moment, whenhousing finance issues are being broadly discussed in India and priorityhas been given to development of the sector. It also comes at a time oftransition in the capital markets. In addition, decisions will soon betaken on the emphasis to be given by NHB to its roles as a possible apexsource of directed credit or as a regulator of a diversified and market-oriented housing finance sector.

3.07 The project supports an effective alternative to housingfinance through directed credit. HDFC has already demonstrated the via-bility of market-oriented housing finance and, with a greater regionalpresence, should become a more forceful advocate in the NHB and sectorpolicy debates. Conversely, by encouraging policy ch nges that wouldfacilitate the environment for housing finance, the project also helpsHDFC and similar institutions to flourish, and to expand resourcemobilization for housing.

3.08 HDFC is viewed as the innovative and principal institution inthe sector and can serve not only as a promoter of regulatory change, butas a model and provider of technical assistance for the entry of newinstitutions. Given the size of HDFC's current program and financingneeds, and HDFC's role in developing housing and finance sector policies,it is appropriate that the Bank become involved.

3.09 The project helps stabilize HDFC's short-term program in aperiod of increasing competition and deregulation in the credit markets.This loan is not viewed as the first of a series; clearly, over the longterm, large-scale borrowings for mortgage lending should be mobilizedfrom domestic rather than foreign sources. Specifically, the projectgives HDFC an opportunity to accelerate its branching, and to attempt newtypes of savings and borrowing instruments such as graduated mortgagesand new savings schemes that it might not otherwise attempt in thepresent uncertain environment. It also assures HDFC of market-rate fundsduring a period of adjustment when certain of its current *niches" forresource mobilization may be eroded by the deregulation of the financialsystem.

3.10 In terms of the Bank's financial sector goals for India, theproject is consistent with supporting more efficient and equitable finan-cing patterns. Through branching and competitive resource mobilization,HDFC would help develop a broader and more flexible network for housingfinance. This would give households a better opportunity to shiftsavings into financial assets at market rates, and allow effective inter-mediatlon for long-term investment in housing.

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IV. THE PROJECT

A. ProJect Obiectives

4.01 The main project objectives include:

(a) Support of HDFC's lending in a period of transition in thecapital markets in order to extend the benefits of market-oriented housing finance to a wider geographical area and toa broader group of middle and lower-income beneficiaries;

(b) further institutional development of HDFC's roles as an inno-vator and advocate of market-oriented finance, and as sectorleader assisting the entry and development of similar insti-tutions;

(c) sector development of a supportive regulatory framework toensure the financial integrity of housing finance institu-tions and their capacity to mobilize resources at marketrates.

B. Project Description

4.02 The preposed project helps finance housing through a line ofcredit to HDFC. The Bank loan equals about 30X of HDFC's mortgage lend-ing program (paras 2.02, 2.07-2.09) over a 3-1/2 year period, fromOctober 1987 (the start of retroactive financing) until March 1991. Aprofile of HDFC housing loans is given in Annex 6. Technical assistancesupports HDFC's efforts in: (a) institutional development (paras 4.06-4.08); (b) branching to new geogzaphical areas including training ofrequired staff and deployment of co'puter systems for the expanded net-work (para 4.05); and (c) and deveZopment of innovative mortgage andborrowing instruments, especially for lower income groups (para 4.04).The project also supports HDFC's own technical assistance to new housingfinance corporations for their start-up activities and establishment ofprocedures and controls (para 2.23). Details and costs of the technicalassistance component are given in Annex 2.

HDFC' Lending Program

4.03 Resource Mobilization - The Bank loan funds cannot exceed30Z of HDFC's loan disbursement total, thus requiring HDFC to mobilizethe balance of 70Z of resources at market rates in a period when itsoverall portfolio will be-growing by about 20Z a year. HDFC's resourcemobilization strategy and manpower constraints have been reviewed care-fully and the present financial projections realistically convey HDFC'sgrowth potential for a lending program of about US$840 million over theproject period. (See Annex 1).

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4.04 Lending to Lower-Income Groups - The longer-term borrowingavailable through the project enables HDFC to develop alternative mort-gage instruments for poorer households. Although HDFC lending isexpected to remain concentrated on the middle-income group (paras. 2.11-2.13), at least SOX of the Bank loan will finance mortgages for house-holds with incomes below the urban median, currently estimated to be atleast Rs 1700 per month; this figure will be adjusted annually accordingto the consumer price index in India. As part of the reimbursementrequests to the Bank, HDFC will confirm its lending to below urbanmedian-income groups. Back-up documentation on the beneficiaries willbe maintained in HDFC offices, and will be subject to review by theauditors. Technical assistance supports study trips abroad to help HDFCreview potential mortgage instruments and savings plans for lower-incomegroups. HDFC will finalize plans by June 1989, and furnish them to theBank, to broaden lending to lower-income groups.

4.05 Geographical Expansion - A major component of HDFC's stra-tegy is to develop a more flexible national mortgage market, withgreater access to housing finance for consumers. To achieve this, HDFCmust expand its geographical presence. With the greater financial flex-ibility provided by the long-term Bank loan, HDFC plans tentatively tostart five new full branches, four sub-branches, and 12 representativeoffices under the branches ;and sub-branches. HDFC will confirm itsannual branching plan to the Bank at the beginning of each fiscal year.

HDFC's Institutional Development

4.06 Decentralization - Key to the success of HDFC's branching isthe concurring effort in institutional and management development toensure that procedures for lending, resource mobilization and internalaudit are standardized throughout the network. Project technical assis-tance supports training of about 200 staff, purchase of computers andequipment, and preparation of procedure manuals, all required for thenew branches over the next three years. In addition, the technicalassistance component supports HDFC's development and full deployment ofmore comprehencive computer control and internal audit systems, neededwith greater decentralization. An organizational study under the proj-ect helps HDFC determine any appropriate modifications of regional mana-gement and cost centers.

4.07 Financial Controls - The project continues thte financialcovenants agreed between HDFC and IFC, including a debt to equity ratioof 17.5, no liens being attached to assets and interest coverage of 1.2.In addition, HDFC administrative costs will be limited to 1.5Z of out-standing loans; this should be sufficient to allow for the plannedgrowth and branching while protecting HDFC's spread.

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4.08 Self-Insurance - HDFC has well formulated lending proceduresand criteria. However, with growth of the loan portfolio, expansioninto new geographical areas and greater exposure to lower-income groups,HDFC will be required to take precautions to ensure that arrears do notrise. Arrears over 12 months will not exceed 0.4Z of HDFC's outstandingloans. Also, in lieu of official mortgage insurance schemes, HDFC willmake provision for contingencies, equal to at least 0.4Z of outstandingloans.

Sector Development

4.09 The loan will be structured in two tranches (paras 4.19-4.20), conditional upon steps taken to help the regulatory frameworkevolve in a manner which is both market-oriented and fiduciarily sound.The following conditions will be appli*.' o the tranches.

4.10 For the first tranche, GDI nas already taken satisfactorysteps before negotiations to initiate r'.e sector enabling environment.The Seventh Plan has accepted the concept of the National Housing Bank(NHB) as a body established to help regulate housing finance institu-tions. In its sector policy statement to the Bank, as a condition, forappraisal of this project, GOI stated that NHB would help promotemarket-oriented housing finance and resource mobilization for the sector(para 1.22).. The current year's budget authorizes a Rs 100 croresallocation for the establishment of NHB, and the NHB Act was passed byParliament during the winter session.

4.11 For the second tranche, the Bank will satisfy itself thatthe NHB is implementing specific proposals to: (a) regulate the finan-cial standards, lending and operating procedures of heusing financeinstitutions; and (b) promote resource mobilization instruments (such asnotice accounts and provident fund investments) to encourage market-oriented intermediation in the housing finance sector (para 1.23).

4.12 In addition, a sitting committee,7 which represents thediverse interests in the sector, will reach agreement and finalizerecommendations for establishing an insurance system for mortgages andfor adjudication of mortgage claims; and submit both proposals to theInsurance Department, Ministry of Finance. Within six months ofreceiving the committee's proposals, GOI will inform the Bank of thestatus of these recommendations. Once the Government has officiallyreviewed the recommendations, they can be released to the Bank forcomment. Since the Government is considering a separate bill on theadjudication of bank loan recoveries, it is recognized that any actionon the mortgage adjudication proposal would be delayed until the formatof the bank bill is determined.

7/ Includes representatives from relevant public agencies (GIC, HUDCOand MUD) and from HDFC, representing market-oriented institutions.

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C. Project Costs and Financing

4.13 The project is estimLted to cost about US$841 million: aboutUS$839 million for HDFC's mortgage lending program over a 3-1/2 yearperiod and US$2 million for technical assistance. Almost all projectfunds would be expensed in Rupees; only about US$1.1 million of technlcalassistance will be required in foreign exchange (about US$0.4 million forforeign consultants and study trips abroad, and about US$0.7 million forequipment and material). A World Bank loan of US$250 million equivalentis to be lent directly to HDFC with the guarantee of India. A guaranteefee of not more than 1/2Z will be charged to HDFC. Repayment will be in20 years including five years' grace, with interest at the Bank'sstandard variable rate. The Bank will cover about US$248.4 million, orabout 302, of HDFC's mortgage loan disbursements during the projectperiod, and about US$1.6 million or 95Z of the technical assistancecosts, including all of the foreign exchange requirement. HDFC willfinance the remaining US$591 of project costs through its regularresource mobilization efforts (paras 2.14-2.16). Retroactive financing,equivalent to US$25 million or 10Z of the World Bank loan, is availablefrom October 1987.

4.14 A summary of project costs is given in Table 4.1; details oftechnical assistance costs are given in Annex 2.

Foreign Exchange Risk

4.15 As Ihe borrower, HDFC is legally responsible for covering theexchange risk of the Bank loan, and according to recent history and Bankestimates of Indian foreign exchange risks, HDFC can cover this risk8 .While maintaining HDFC's current margin for long-term borrowings(para 2.03), and considering the Bank's lending rate, the loan commitmentfee, and GOI's guarantee fee, there is about a 4Z spread directlyavailable to HDFC for th.e coverage. This spread would allow for about a4Z annual devaluation rate in the Rupee. Current financial projections(see Annex 1) indieate that in FY 1991, the year of HDFC's maximumexposure to the Bank loan,9 if the foreign exchange risk coverage of theBank loan required a two-fold increase in the interest spread to about8Z, HDFC would cover this increase with profits after tax and dividendpayout. However, this higher coverage would reduce the FY 1991contribution to retained earnings by about half. The cumulative effect

8/ By the end of 1991, the Bank loan would represent HDFC's onlyexposure to foreign exchange risk; the $4.0 million IFC loan wouldhave been repaid, and all foreign exchange obligations under the AIDprogram were already traded, at the time of the original borrowings,for Rupee loans through Indian banks and institutions (para 2.15).

9/ In FY 1991 the Bank loan would represent 20Z of HDFC's outstandingborrowings; this percentage would subsequently decrease relative tothe increasing size of the rest of HDFC's obligations denominated inRupees.

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Table 4.1: Summary of HDFC Project Costs by Year

Fiscal Year 1988 1989 1990 1991 Total(ending June 30)

COSTS (Rs Lacs in Current Prices)1 0

Housing Mortgage Loans 17312 29341 35074 29799 111526

Technical Assirtance 15 76 91 53 235

Total in Rupees Lacs 17327 29417 35165 29852 111761

Total in US$ Hillions 134.3 224.6 262.4 219.5 840.8

FINANCING (USS Million in Current Prices)

HDFC 95.3 157.4 184.1 154.0 590.8

IBRD 39.0 67.2 78.3 65.5 250.0

Total in USS Millions 134.3 224.6 262.4 219.5 840.8

10/ Contingencies and exchange rates have been applied according to Bankguidelines.

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The cumulative effect of continuing such high risk coverage for the Bankloan over many years would be retarded growth in retained earnings and acorresponding increase in the Debt/Equity ratio. To keep the Debt/Equityratio below 17.5 (it is currently about 14), HDFC could lose someflexibility by possibly having to reduce current lending up te 8Z a year,or to issue more equity than is currently planned (para 2.04). It shouldbe noted that very high devaluation rates would at some point affectinternal market rates, and would allow HDFC to adjust its own lendingrates accordingly.

4.16 Regardless of its ability to cover high risks, the question offinancing costs remains sensitive for HDFC given its need to protect itsinterest spread and capacity to grow. Since none of its business ishandled in foreign exchange, HDFC feels it advisable to make financialarrangements to cover the exchange risk of the Bank loan. The financialmanagement of HDFC already has experience in 'swapping' foreign loans.HDFC is taking steps, satisfactory to the Bank, to protect itself fromthe exchange risk. GOI will assist HDFC in trading the foreign exchangeobligation of the World Bank loan so that the effective interest rate forthe Bank loan to HDFC (including coverage of the foreign exchange risk,GOI's guarantee fee and loan commitment fee) will not exceed HDFC's thencurrent long-term market borrowing rate.

! D. Procurement and Technical Assistance

4.17 Direct project procurement relates only to the TechnicalAssistance component (see Table 4.2). Only the contract for purchase ofcomputers (about US$0.7 million) is expected to be large enough towarrant international competitive bidding. Other contracts for materialand equipment will be executed locally. Foreign manufacturers areadequately represented by local agents and suppliers. For most of thecontracts, which are valued under US$50,000, HDFC will purchase thematerial and equipment according to its own procurement procedures whichgenerally include competitive bidding. The HDFC procedures have beenreviewed by the Bank and found to be satisfactory. All consultancieswill be contracted according to World Bank guidelines.

E. Disbursement of the World Bank Loan

4.18 The proposed Bank loan of US$250 million is expected to befully committed to HDFC over a three-year disbursement period startingaround April 10, 1988. Retroactive financing extends the length of theproject period to three and one-half years. The estimated schedule ofdisbursements is given in Annex 3. The project completion date is forMarch 31, 1991, and the closing date for September 30, 1991. Because theloan is mainly a line of credit for mortgages, the disbursement period issubstantially less than the Asia Region profile for urban projects (9years) or for industrial development and finance projects (6 years).

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Table 4.2: Procurement Method for the HDFC Project

Project Element ICB LCB Other N.A. TotalCost

-------- US$ million --------HDFC Housing Mortgage Loans 839.0 839.0

1 (248.4) (248.4)

Technical Assistance 0.7 1.1 1.8(0.7) (0.9) (1.6)

TOTAL 0.7 1.1 839.0 840.8(0.7) 0.9 (248.4) (250.0)

Note: Figures in parenthesis are the respective amounts financed by theBank.

Disbursements will be made on the basis of: 30Z of HDFC's mortgage loandisbursements; 10OZ of training and consultancy costs; 10OZ of foreignand local (ex-factory cost) expenditures for equipment and material; and602 of local expenditures, for equipment and material.

4.19 As indicated above (para 4.09), the loan will be made avail-able for disbursement in two tranches based on conditions tied to sectordevelopment. Up to US$150 million will be available under the firsttranche, and a further US$100 million under the second tranche. Itshould be noted that, in order to eftect a reasonable level of forei'gnexchange swap (paras 4.15-4.16), HDFC may accumulate its expenditures for3-4 months before claiming reimbursement.

4.20 The tranche amounts are consistent with HDFC's financial pro-jections for the project period (see Annex 1) and the loan disbursementcriteria. If HDFC's resource mobilization falls below the expectedlevels, the loan would take longer to disburse. However, if the trancheconditions and project covenants are met, and HDFC's lending is largerthan projected, the loan could be drawn down faster than the anticipatedthree year period. To allow for this possibility, the tranches are nottied to a certain timeframe. If HDFC qualifies for more disbursements

- 25 -

than were available under the first tranche, the additional disbursementswould be made as soon as the second tranche conditions are met. In thismanner, flexibility can be introduced into the project timetable withoutsacrificing the validity of the tranche conditions.

4.21 Through HDFC mortgages, the loan indirectly finances civilworks and goods contracts for new infrastructure and housing construction

11

. Technical staff from HDFC evaluates each loan made to determine thatland and contract prices are consistent with market rates, and thatconstruction is handled efficiently. HDFC's own loan and supervisionprocedures are well defined and ensure that the disbursements, done instages according to progress in construction, are utilized only for theintended purpose (para 2.09). On average, the HDFC mortgage covers 45Sof land and housing costs, and the Bank loan finances about 14? of thesecosts. Since the housing component equals between 60-80? of total costs,including an estimated 102 of duties and taxes, Bank funds can safely beassumed to be utilized only for housing costs and not for land, or dutiesand taxes.12

F. Audits and Prolect Monitoring

4.22 HDFC's financial accounting system and internal controls aresufficient to monitor its operations and financial condition. The prepa-ration of HDFC's yearly financial statements and professional audit arecompletely satisfactory. The auditors (S.B. Billimoria and Co.) gaveHDFC an unqualified opinion in the FY 1987 report. HDFC's accounts andfinancial statements will be audited annually by an independent auditorsatisfactory to the Bank, and that the audit will be submitted to theBank within six months of the end of each Fiscal Year. The auditor'sopinion will include certification that the Bank loan funds have beenused for the project work identified, and that the underlying files anddocuments support the disbursement requests made through the Statementsof Expenditure.

4.23 The Bank will monitor project implementation through regularsupervision missions and quarterly reports prepared by HDFC and sent to

the Bank within one month of the end of each quarter. At the end of theproject period, HDFC will prepare a project completion report accordingto Bank guidelines.

11/ Housing construction in World Bank urban projects in India has beencontracted through local competitive bidding.

12/ Based on urban project experience, housing construction in Indiaincludes about 10? of costs for taxes and duties: 8? from localcontracts and 2? from foreign. Indirect foreign costs are notionallyabout 10? of total housing cost with 25? duties and taxes.

- 26 -

V. PROJECT BENEFITS AND RISKS

A. Project Benefits

5.01 The central project benefit is support of a market-orientedsystem for housing finance during a critical period of change in thecapital markets. The institutional development of HDFC as the leadagency in the sector is expected to have long-term benefits on currentsector policies and the start-up of similar institutions. Importantly,the development of sector policy is expected to cultivate a more effi-cient and competitive financial system and to extend financial serviceswith lower risks and lower costs to a broader range of people. HDFC hasinitiated a system whereby resources for housing can grow and savings canbe encouraged through financial intermediaries. Instead of being syste-matically rationed out of the formal financial system, households wouldbe given more opportunity to bid competitively for the most importantasset in the household portfolio. With the development of a moreflexible national mortgage market, funds can be sought from a diversifiedand more stable base, and be more easily directed to different areas ofdemand.

5.02 The Bank loan finances about 70,000 mortgages, or a maximum302 of HDFC's mortgage lending program over 3-1/2 years. At least 50? ofthe beneficiaries of the loan funds are households with lower than theurban median income. During the project period, HDFC will significantlyexpand its branching network and develop new mortgage instruments to makehousing finance more available to lower-income groups. Over the projectperiod, HDFC is,expected to continue to make at least a 232 return on itsequity and distribute to shareholders dividends equal to 16X on par.

5.03 According to other Bank housing projects in India, theEconomic Rate of Return (EROR), based on imputed rental values and salesfigures for urban middle-income housing, is between 20-30Z. Due to thenationwide excess demand for housing finance, returns are expected toremain high for a long period. As long as households can afford the debtservice, borrowing for the housing investment would be warranted. Thecosts of borrowing, however, are sensitive to transaction costs and therisks of long-term lending. Such activities are subject to significantreturns to scale and diversification that cannot be realized by smallinformal lenders which now dominate housing lending. Hence, the develop-ment of formal intermediaries, such as HDFC, in this sector, can permithousing investments to be more affordable and the high returns to berealized by more people.

B. Project Risks

5.04 HDFC's performance record and procedures are well establishedand there is little institutional risk associated with HDFC's ability todisburse the proposed loan over a three-year period or to meet projectcovenants. Although the project design is consistent with policy

- 27 -

developments underway by GOI. there is some risk that implementation ofthe tranche conditionr and the enabling environment could be delayed bypolitical considerations, provoked by a more significant market positionof housing finance, or by adverse economic conditions caused by a factorsuch as a sharp rise in world interest rates. Indian financial historyindicates that reforms to improve maiket efficiency would be secondary tothe pursuit of macroeconomic stability. A resulting retreat to re-strictive regulations or to a higher degree of directed credit mighthamper HDFC's mobilization of sufficient resources. In this case, therewould be a slower than expected disbursement of the Bank loan, which isdirectly tied to HDFC's capacity to raise funds.

VI. AGREEMFNTS AND RECOMMENDATION

6.01 The following assurances were received at negotiations:

Tranche Arrangements

(a) The loan will be made available for disbursement in twotranches based on conditions tied to sector development. Thecondition for the first tranche, initiation of the enablingenvironment for housing finance, has been met through thecreation of the NHB (para 4.10). For the second tranchet

- The Bank will satisfy itself that the NHB is implementingspecific proposals to: (a) regulate the financial stan-dards, and lending and operating procedures of housingfinance institutions and (b) promote resource mobilizationinstruments (such as notice accounts and provident fundinvestments) to encourage market-oriented intermediation inthe housing finance sector (para 4.11).

- In addition, a sitting committee (including representativesof GIC, HUDCO, MUD and HDFC) will reach agreement andfinalize recommendations for establishing an insurancesyetem for mortgages and adjudication of mortgage claims;and submit both proposals to the Insurance Department,Ministry of Finance. Within six months of receiving thecommittee's proposals, GOI will inform the Bank of thestatus of these recommendations (para 4.12).

Project Beneficiaries

(b) At least 50Z of the loan proceeds utilized for mortgages willbenefit households with income below the urban median, cur-rently estimated to be at least Rs 1,700 per month; thisfigure would be adjusted annually according to the consumerprice index in India (para 4.04).

-28 -

(c) HDFC vill finalize plans by June 1989, and furnish them to theBank, to broaden lending :o lower-income borrowers(para 4.04).

HDFC Operations

(d) HDFC's tentative plans for branching and expansion will befinalized on an annual basis and confirmed to the Bank at thebeginning of each Fiscal Year (para 4.05).

HDFC's Finances

(e) HDFC's debt/equity ratio vill not exceed 17.5:1 (para 4.07).

(f) HDFC will maintain an interest coverage ratio of at least1.2:1 (para 4.07).

(g) No liens will be allowed to be attached against HDFC's assets(para 4.07).

(h) HDFC's administrative costs will not exceed 1.52 of outstand-ing loans (para 4.07).

(i) Arrears over 12 months will not exceed 0.4Z of HDFC's out-standing loans (para 4.08).

(j) HDFC will make provision for contingencies, equal to at least0.4Z of outstanding loans (para 4.08).

(k) HDFC is taking steps, satisfactory to the Bank, to protectitself from the foreign exchange risk of the loan (para 4.16).

Audit

(1) HDFC's accounts and financial statements will be auditedannually by an indeperdent auditor satisfactory to the Bank,and the audit will be submitted to the Bank within six monthsof the end of each Fiscal Year. The auditor's opinion willinclude certification that the Bank loan funds have been usedfor the project work identified, and that the underlying filesand documents support the disbursement requests made throughthe StatementR of Expenditure (para 4.22).

6.02 Subject to the above agreements, the proposed project is suit-able for a Bank Loan of US$250.0 million equivalent to the Housing Devel-opment Finance Corporation, Ltd., to be guaranteed by India, acting byits President.

INDIA

HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

PROJECTED HDFC FINANCIAL STATEMENTS

Assumptions For Financial Statements

(Rs in lacs)

1986-87 1987-88 1988-89 -1989-90 1990-91

(Actuals)

Loan Approvals 23751 30100 36160 39776 43754

Loan Disbursements 17552 23082 29341 35074 39732

Average Rate of Interest:Individual Loans 13.77% 13.70% 13.70% 13.69% 13.68Z

Corporate Loans 14.74% 14.75% 14.75% 14.75% i4.75%

Incremental Deposits (Net) 8965 7000 8000 9000 11500

incremental Term Loans 6068 5500 6500 8000 12500

Incremental Bond Proceeds 1500 1500 2000 2500 3000

Incremental IBRD Loan - 5000 8800 10500 8900

Dividend Rate on Par 16% 16% 16% 16% 16%

Additional Share Capital 979 21 - - iooo

n

INDIA

HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

PROJECTED HDFC FINANCIAL STATEMENTS

Income Statements

(Rs in lacs)

1986-87 1987-88 1988-89 1989-90 1990-9l

(Actuals)

INCOMEInterest on Housing Loans 5874.8 8020.6 10736.5 13955.5 17527.1

Fees and OMier Charges 544.3 775.5 931.1 1050.7 1172.9

Income from Investments 1222.3 1547.4 1869.3 2418.4 3160.4

Lease Rentals 45.0 174.6 409.9 713.5 1093.0

TOTAL INCOME 7686.4 10518.2 13946.8 18138.1 22953.4 0

EXPENSESInterest on Deposits 3215.8 4204.6 5384.8 6093.0 7321.5

Interest on Term Loans 1997.9 2627.7 3294.4 4105.5 5164.9

Interest on Bonds 475.8 656.3 875.0 1125.0 1468.8Interest on LBRD Loan - 156.3 1175.0 2381.3 3593.8

TOTAL INTEREST PAID 5689.5 7644.9 10429.2 13704.8 17548.9===am= man==== Samoan= =Ma.nm..

Gross Income 1996.8 2873.4 3517.5 4433.3 5404.5

General Administrative Expenses 759.6 1028.7 1342.1 1707.2 2118.7Pre-operacive Expenses Written off 5.0 5.0 5.0 5.0 5.0

Depreciation on Leased Assets 37.4 106.3 231.3 418.8 681.3

PROFITS BEFORE TAX 1194.9 1733.4 1939.1 2302.3 2599.6

Income Tax Provision 270.0 344.2 331.0 345.3 336.8

PROFIT AFTER TAX 924.9 1389.3 1608.1 1957.0 2262.8 ' z

Retained Earhings 738.1 1071.0 1288.1 1637.0 1862.8Dividend 186.8 318.3 320.0 320.0 400.0 0o

INDIA

HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

PROJECTED HDFC FINANCIAL STATEMENTS

Cash Flows

(Rs in lacs)

1986-87 1987-88 1988-89 1989-90 1990-91(Actuals)

SOURCESProfit Before Tax 1194.9 1133.4 1939.1 2302.3 2599.6

Add: Non-Cash Charges 5.0 5.0 5.0 5.0 5.0

SUB TOTAL: 1199.9 1738.4 1944.1 2307.3 2604.6

Net Increase in Deposits 8964.6 7000.0 8000.0 9000.0 11500.0

Net Increase in Term Loans 5757.0 4818.0 5816.0 7130.0 9788.6

Net Increase in Bonds 1500.0 1500.0 2000.0 2500.0 3000.0

Net Increase in IBRD Loan 0.0 5000.0 8800.0 10500.0 8900.0

Increase in Share Capital 978.8 21.3 0.0 0.0 1000.0

Repayment of Principal onHousing Loans 4310.7 6086.4 8555.4 11174.7 12771.1

TOTAL 22711.0 26164.1 35115.6 42611.6 49564.3

USESDisbursements: Housing Loans 17551.7 23081.9 29341.3 35073.6 39732.5

Increase in Net Fixed Assets 967.1 1000.0 1500.0 2000.0 2500.0

Net Increase in Investments 2144.3 1200.0 1400.0 1600.0 1800.0Taxes 270.0 344.2 331.0 345.3 336.8

Dividend 186.8 318.3 320.0 320.0 400.0

TOTAL 21119.9 25944.4 32892.3 39338.9 44769.3

Increase/Decrease in

Net Current Assets 1591.1 219.7 2223.3 3272.7 4795.0 w x

Opening Balance 3556.0 5147.1 5366.8 7590.1 10862.8 -

Closing Balance 5147.1 5366.8 7590.1 10862.8 15657.8

I~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

INDIA

HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

PROJECTED HDFC FINANCIAL STATEMENTS

Balance Sheets

(Rs in lacs)

1986-87 1987-88 1988-89 1989-90 1990-91(Actuals)

LIABILITIESShare Capital 1978.8 2000.0 2000.0 2000.0 3000.0Retained Earnings 2331.2 3402.2 4690.3 6327.4 8190.2NET WORTH 4310.0 5402.2 6690.3 8327.4 11190.2

Deposits 34221.6 41221.6 49221.6 58221.6 69721.6

IB6D Loan 0.0 5000.0 13800.0 24300.0 33200.0Term Loans 18447.1 23265.1 29081.1 36211.0 45999.6Bonds 4500.0 6000.0 8000.0 10500.0 13500.0TOTAL BORROWINGS 57168.7 75486.7 100102.7 129232.6 162422.2

TOTAL 61478.7 80888.9 106793.0 137560.0 173611.4

ASSETSHousing Loans 48416.9 65412.3 86198.2 110097.4 137058.8Investments 6456.5 7656.5 9056.5 10656.5 12456.5Net Fixed Assests 1437.2 2437.2 3937.2 5937.2 8437.2Net Current Assets 5476.8 5876.8 8310.2 11822.9 16887.9Less: Provision for

Contingencies (330.0) (510.0) (720.0) (960.0) (1230.0)Others 21.3 16.3 11.3 6.3 1.3TOTAL 61478.7 80888.9 106793.0 137560.0 173611.4 z

,,,,,,M M... .. ---n-- '''='''=* _

INDIA

HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

PROJECTED HDFC FINANCIAL STATEMENTS

Key Financial Ratios

1986-87 1987-88 1988-89 1989-90 1990-91

(Actuals)

Debt Equity Ratio 13.3 14.0 15.0 15.5 14.5

Interest Coverage Ratio 1.2 1.3 1.2 1.2 1.2

PAT/Average Net Worth (Z) 26.8 28.6 26.6 26.1 23.2

Gross Income/AverageTotal Assets (Z) 3.8 4.0 3.8 3.6 3.5

Total Income/AverageTotal Assets 14.6 14.8 14.9 14.9 14.8

Financial Expenses/AverageTotal Assets 10.8 10.7 11.1 11.2 11.3

Margin 3.8 4.1 3.8 3.7 3.5

Interest Income/AverageLoans Outstanding 14.1 14.1 14.2 14.2 14.2

Cost of Debt/Average DebtOutstanding 11.6 11.5 11.9 12.0 12.0

Spread 2.5 2.6 2.3 2.2 2.2 a' x

0

ANNEX 2- 34 - Page I of 5

INDIAHOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

SUMMARY OF TECHNICAL ASSISTANCE COMPONENT AND COSTS

I. HDFC INSTITUTIONAL DEVELOPMENT

A. Operation and Management Systems

(a) Objectives: To ensure appropriate organizational structure andconsistent application of operational procedures in the face ofthe growing size and complexity of operations.

(b) Activities: Review, compilation, and computerization of procedures andguidelines for operational procedures, techniques, internalcontrols, etc. Review of organizational structure to ensurequality control and opportunities for innovation and staffdevelopment.

(c) Inputs and Costs: Total Rs 1,890,200.

(i) Local consultants : 12 man-months Rs 240,000

(ii) Foreign ConsultantsManual Preparation : 4 man-weeks in two tripsInternal Control Systems: 6 man-weeks in two tripsOrganization Development: 3 man-weeks in one trip

Sub-total Rs 832,600

(iii) Overseas study trips by HDFC officersManual preparation : 2 officers for 3 weeksInternal Control Systems: 2 " 3 "Organization Development: 1 " 3 "

Sub-total Rs 667,600

(iv) Others: Manual production, meetings, and miscellaneous.Rs 150,000

B. Computerization

(a) Objectives: To expand automation to all branches and all functionalareas of operation.

(b) Activities:- Installation Lf additional micro/mini computers in all

branches;- Development and modification of application programs;- Modification of data formats for computer input;- Development of computer-based packages of operational manuals

and training;

ANNEX 2- 35 - Page 2 of 5

(c) Inputs and Cost Total Rs 11,089,000

(i) Local Consultants : 25 man-months Rs 500,000

(ii) Foreign Consultant : 6 man-weeks in 2 tripsRs 375,500

(Mii) Overseas Study Trip: I officer for 3 weeksRs 133,500

(iv) Equipment and Supplies: 56 personal computers, peripherals,com ercial software , new forms, etc.

Rs 10,080,000(Estimated duties and taxes Rs 1,023,400)

C. Training

(a) Objectives: ITo develop training curricula and organization antd train newand existing staff in technical and human relations skills neededfor branch expansion, systems development, and computerization.

(b) Activities:- Development of standardized training moduies using computers

and audio-visual equipments;- Training of in-house trainers responsible for formal and on-

the-job training;- In-house and external training of selected staff on specialized

topics.

(c) Inputs and Costs Total Rs 1,120,000

(i) Local consultants: 18 man-months Rs 360,000

'(ii) Equipment and Supplies:Projector and Synchronizer 1 set Rs 25,000TV/VCR 10 sets Rs 250,000Audio-visual accessoriesand supplies Lump Sum Rs 25,000

Sub-total Rs 295,000(Estimated duties and taxes Rs 24,400)

(iii) Training Expenses:Travel and Subsistence Rs 300,000Rents, course fees, etc. Rs 160,000

ANNEX 2- 36 - Page 3 of 5

D. Others Total Cost Rs 3,989,600

(a) Equipment for branches:

(i) 6 Fax machines for HQ and 5 major branches Rs 1,200,000

(ii) 9 Vehicles for outreach programs Rs 1,350,000

(Estimated duties ard taxes Rs 470,500)

(b) Overseas Study Trips to study sector policy issues, including mortgageinsurance, mortgage adjudication, and innovative lending andresource mobilization tools.

12 trips of 2 weeks duration each Rs 1,439,600

II. TECHNICAL ASSISTANCE TO NEW INSTITUTIONS

HDFC will provide technical assistance to new housing financeinstitutions. The three institutions listed below have been identified forassistance, but other institutions being set up during the Project periodcould also share in the development and training work The total assistancewould include:

(i) Development of operatingsystems and procedures: (about 62 man-months) Rs 994,000

(ii) Operational a'ssistanceduring start-up : (about 33 man-months) Rs 504,000

(iii) Staff training : (about 36 man-months) Rs 690,000

Total Rs 2,188,000

- 37 - ANNX 2Page 4 of 5

INDIAHOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

III. SUMfARY OF COSTS FOR TECHNICAL ASSISTANCE COMPONENT

VI LY5f 1YUY 1Y9U LYYL -------total------------------ ---- ---- ---- Local Foreign Total Total

RsOOO RsOOO RsOOO Rs000 Rs000 RsOO RsOOO US$000

I. HDFC - INSTITUTIONAL DEVELOPMENT

A. Operation and Management Systemsa. Local consultancy 12 84 96 48 240 0 240 19b. Foreign Consultancy 0 291 375 167 182 651 833 65c. Overseas Study Trips 135 223 234 77 0 668 668 52d. Miscellaneous 8 38 60 45 150 0 150 12

B. Computerizationa. Local consuit;ncy 25 175 200 100 500 0 500 39b. Foreign Consultancy 0 131 169 75 84 292 375 29c. Overseas Study Trips 0 134 0 0 0 134 134 10d. Equipments & Supplles 464 3246 3710 1855 5434 3622 9274 719

C. Traininga. Local Consultancy 18 126 144 72 360 0 360 28b. Equipments & Supplies 11 79 90 45 189 81 225 17c. Training Expenses 23 161 184 92 460 0 460 36

D. Othersa. Vehicles & equipments 280 498 746 420 1456 624 1944 151b. Overseas Study Trips 0 484 484 484 0 1451 1451 112

--- ~ ~ ~ ~ . .; .... ....--- - -

Base Cost Subtotal I 975 5668 6491 3479 9055 7521 16613 1288Physical contingency 98 567 649 348 906 752 1661 129Prlce Contingency 32 528 1076 845 1353 1123 2481 141

Sub-Total I 1105 6763 8216 4672 11313 9397 20755(sub-total in US$000) 85 516 613 344 849 709 1558 1558

II.TECHNICAL ASSISTANCE TO NEW INSTITUTIONS

A. Housing Promotion Finance Corporation, Ltd.a. Training 29 88 103 73 293 0 293 23b. Management Assistance 90 210 180 120 599 0 599 46

B. Gujarat Rural Housing Finance Corporation, Ltd.a. Training 33 55 77 55 221 0 221 17b. Management Assistance 81 190 163 108 542 0 542 42

C. CANFIN Homes, Ltd.a. Training 18 62 62 35 176 0 176 14b. Managemnt Assistance 54 107 107 89 357 0 357 27

~~~~~~~.. ......... .... ...... ... ---- ... ---- ---... ....

Base Cost Subtotal II 305 711 691 481 2188 0 2188 168Physical contingency 30 71 69 48 219 0 219 17Price Contingency 10 66 115 117 308 0 308 19

Sub-Total II 345 849 875 646 2715 0 2715(sub-total in US$000) 27 65 65 48 204 0 204 204

GRAND TOTAL I + IIBase Cost* 1280 6379 7182 3960 11243 7521 18801 1456Physical contingency 128 638 718 396 1124 752 1880 146Prlce Contingency 42 594 1191 962 1660 1123 2789 160

I ---- -- - ---- ---- ..... ---- ....... ... ... _

Total Cost in Rs 000 1450 7611 9091 5318 14028 9397 23470US$ 000 111 581 678 391 1053 709 1762 1762

Note: * base cost as ot Uctober I957i; includes management overnead andexcludes duties and taxes. total duties and taxes are estimated to beRs 1,518,000 or 8.1% of total base cost.

ANNEX 2- 38 - Page 5 of 5

Note: RATES FOR COST ESTIMATION for both institutional dbvelopent of HDFCend technical assistance to new institutions.(Beee cost as of October 1987, including duties and taxes)

(1) ConsultancyRs 20,000 per man-month, local;US$ 13,000 - , foreign,Rs 8,000 N N (HDFC manager);Rs 6,000 (HDFC officer).

(2) SubsistenceRs 800 per day for local staff in India;Rs 2,000 per day for expatriato consultant in Bombay;US$ 150 per day abroad for HDFC staff.

(3) Travel including incidental expensesRs 1,000 per dometic travel, round trip;US$ 2,200 per foreign round trip.

(4) Course fees and related expenses:Rs 5,000 per course in India;US$ 5,000 per course abroad.

ANNEX 3

- 39 -

INDIA

HOUSING DEVELOPMENT FINANCE CORPORATION LIMITED PROJECT

ESTIMATED SCHEDULE OF DISBURSEMENTS

------- DISBURSEMENTS----(lBRD) F1 cal Year and (in US$ million)

Quart r Ending Quarterly Cumulative

1988 e

June 30, 1988 25.0* 25.0

1989

September 30, 1988 21.4 46.4

December 316 1988 17.6 64.0

March 31, 1989 18.2 82.2

June 30, 1989 18.8 101.0

1990

September 30, 1989 19.4 120.4

December 31, 1989 20.1 140.5

March 31, 1990 20.7 161.2

June 30, 1990 21.3 182.5

1991

September 30, 1990 21.9 204.4

December 31, 1990 22.5 226.9

March 31, 1991 23.1 250.0

*Includes retroactive financing of US$25.0 million.

ANflE 4

- 40 -

INDLAHOUSING DEVELOPMENT RNANCE CORPORATION PROJECT

DlgoUm d HDOCs OegoankoN> Shuck

, ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~No~ d Sat

1 h A h 1 ~~~~~36

-1 9 } ~~~~~~~~~~~~~~~~

(A) crew `16

B G I Act9 lYPICAL 17

4

rl ntRmc 4

Irdituioal Rnno 5

R Tcl |

M | l h&F~~~~~~Deosh l 14

H I 1~~~~~~~

-F-t R12

Human~~~~~~~Uti 0i-14:

-41- ANNEX 5

INDIAHOUSING DEVELOPENT FINANCE CORPORATION PROJECT

PROFILE OF HOUSEHOLD INCOME DISTRIBUTION:URBAN INDIA versus HDFC BORROWERS

1986-87

Houswhold Urban HDFC HDFC LoanIncom Households Borrowers Volu

Rs/month Cumul. I Cunul. I Cunul. Iupto .... ----- .....

400 1.3 4.5 3.1800 12.9 9.4 6.4

1200 30.9 17.2 11.21600 47.2 31.4 20.3

1700 50.0 34.7 22.62000 61.0 44.9 29.52525 71.1 58.4 43.03350 82.4 77.9 63.65025 91.0 93.7 87.8

*Source: For urban India income distribution,the estimate for 1976 by National Council ofEconomic Research was updated by growth rate ofall India household income.

100 -

70 - --

40 - -

20

0 12 3 4 5(Thousands)

Household Income. Rs/month0 Wbon India o HDFC Borrowers 0 HDFC Loan Volume

-42 - ANNEX 6Page 1 of 2

INDIA

HOUSlNG DEVELOPMENT FINANCE CORPORATION PROJECT

PROFILE OF HDFC HOUSING LOANS(as at June 30, 1987)*

A. APPROVED LOANS BY CATEGORY

Current Year Cumulative-- - - - - - - - - - - ...... .............. ....

No. of Amount No. of AmountDwelling Rupees % Dwelling Rupees %Units Crore Units Million

Individuals 35,906 182.6 76.9 151,385 680.6 80.2

Individual Borrowers 28,074 144.6 60.9 129,313 592.7 69.9Group P:ojects 0 0.0 0.0 1,738 5.3 0.6

Line of Credit 7,832 38.0 16.0 20,289 82.6 9.7

Corporate Bodies 6,415 43.0 18.1 38,179 139.6 16.5

Construction Financing 3,702 11.9 5.0 8,470 27.9 3.3....- ------. . ... ........... .......... ... ......... ...... ..............

46,023 237.5 100.0 198,034 848.1 100.0

Aa. DISBURSEMENT BY CATEGORY

Individuals 30,939 140.0 79.8 118.117 480.1 80.2

Individual Borrowers 25,473 119.1 67.9 103,241 433.8 72.5Group Projects 0 0.0 0.0 1,739 4.1 0.7

Lin4 of Credit 5,466 20.9 11.9 13,137 42.2 7.1

Corporate Bodies 6,216 26.9 15.3 31,051 99.7 16.7

Construction Financing 3,268 8.5 4.8 5,820 18.7 3.1... . - - - . . . . . . - - - .....

I 40,423 175.4 100.0 154,988 598.5 100.0

Note: * On the basis of cumulative approvals not of cancellationsunless noted otherwise

_43 - ANNEX 6Page 2 of 2

B. DISTRIBUTION OF UNITS FINANCED BY SIZE**

Area No. of Total Amount Avearge LoanSq. M. Units % Rs.crore a Rs. 000

------ ~~ ... . -- - - - - -.- - -- - -

up to 50 78,314 45.6% 225.4 30.3% 29,000-80 51,883 30.2% 234.3 31.5% 45,000-95 11,527 6.7% 69.1 9.3% 60,000

above 95 22,888 13.3% 173.8 23.4% 76,000Not Classified 7,179 4.2% 41.6 5.6% 58,000

Total 171,791 100.0% 744 100.0% 43,000

C. Distribution of Loans by Region(in Rs Crore)

Current CumulativeYear %

North 40.7 17.1% 118.1 13.9%South 57.4 24.2% 231.6 27.3%East 16.7 7.0% 53.2 6.3%West 122.7 51.7% 445.1 52.5%

237.5 100.0% 848.0 100.0%

D. The Avearge Loan Profile

Individual CorporateAverage unit Loan Loan

a. Loan per Unit Rupees 45,000 37,000b. Cost per Unit Rupees 109,000 67,000c. Loan/Cost Ratio 0.41 0.54d. Cost/Income Ratio 3.59 n/ae. Rate of Interest %/year 13.64 14.84f. Maturity years 13.7 6.3g. Age of Borrowers years 37 n/a

Note: ** Excludes undisursed Line-of-Credit; Corporate Loans areclassified by averages

Source: HDFC

- 44 - ANNEX 7

INDIAHOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

DETAILS OF HDFC RESOURCE MOBILIZATION FOR FY 1987(in Rs Lac)

Net Increase % of_During Year Total

TERM LOANS ........... ...........Scheduled Banks 1,891.4 8.5%USAID Housing GuarantyProgram (Last Tranche) 3,000.0 13.5%Life Insurance Co. 1,000.0 4.5%General Insurance Co.and Subsidiaries (100.0) -

International Finance Co. (31.8) -

Industrial Credit andInvestment Co. of India (2.5) -

Subtotal 5,757.0 25.9%

BONDS 12.5% Notes 1,500.0 6.7%

DEPOSITSCertificates of Deposit 8,769.4Loan-Linked-Deposit 98.3Home Savings Plan 96.9

Subtotal 8,964.6 40.3%

TOTAL BORROWING 16,221.6 72.9%

SHARE CAPITALPaid-Up Equity Shares 1,000.0Less: Call-in Arrears 21.3

Subtotal 978.7 4.4%

RETAINED EARNINGSSpecial Reserve 440.0General Reserve 298.1Capital Reserve

Subtotal 738.1 3.3%

REPAYMENT OF HOUSING LOANPRINCIPAL 4,310.7 19.4%

TOTAL RESOURCES 22,249.2 100.Ct

Note : Entry in parentheses indicates net repayment.Source: HDFC Annual Report FY 1987

- 45 - ANNEX 8

INDIAHOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

SUMMARY OF COMPARATIVE TERMS OF DEPOSITS ATHDFC, COMMERCIAL BANKS, AND NON-FINANCIAL CORPORATIONS

Period Interest Rates % per annum HDFC---------------------------- Deposit

Months Commercial Corporate HDFC as at 4/30/87From Up to Banks Bodies Rs. Crore

... ....... ----. .......... ------- -------...... -------........ ................. ......

1 - 2 3 to 4 NA 6.0

2 - 3 4.0 NA 7.0

3 - 6 6.5 NA 9.0 ) 38.4

6 - 12 8.0 NA 9.5 43.4

12 - 24 9.0 12.0 10.5 47.0

24 - 36 10.0 13.0 11.0 7.7

36 - 60 NA 14.0 11.5 16.0

60 or More NA NA 12.0 159.6

Note- HDFC offers educational and charitable trusts and institutionsadditional interest of 0.5% p.a. to the above specified rates.- Current regulation allows the maximum deposit rate of 14% p.a.- NA indicates that the institution does not normally offerdeposits of the particular maturity.

- 46 - ANNEX 9

INDIAHOUSING DEVELOPKENT FINANCE CORPORATION PROJECT

SUMMARY OF COMPARATIVE TERKS OF HOUSING LOANSIN THE INDIAN FORMAL SECTOR

Instctutions ana Loans nzturlty *axL U lntlor-st Rs. 000 % per yr

-- - - - - - - - - . ....... ....... ..................... ...... ------................. ...HOUSING DEVELOPMENT FINANCE CO.

Individual Housing Loansand Line of Credit 15 years 20 12.5

50 13.5100 14.0150 14.5

Home Savings Plan 12 years 60 8.5

Corporate Loan 3 to 7 years NA 14.0to 15.5

LIFE INSURANCE CO.Mortgage Loan 15 years 150 13.5(inc. home equity loans) Above 15.0

Home-ownership Policy 30 yearsLoans (Single or Multi- or until 250 13.0Family Units) retirementFor home value < Is 75,000and family income < Rs 25,000 p.a. 50 11.0.

Corporate orCooperative Societies 5000 12.5

or 13.5............ ....................................................

HOUSING AND URBAN DEVELOPMENT CO. (Borrower' sKonthly IncowsMaximum in Rs.)

Housing Loan through 15 to 700 7.0state Housing Boards 22 years 1500 9.0

2500 12.5above2500 13.5

Corporate orCooperative Societies 15.0

...........................................................COOPERATIVE HOUSING FINANCE SOCIETIESRepresentative Loans uoto

210 years 50 13.5............................. ..............................COMKERCIAL BANKSIndividual Housing 7 to 50 13.5

Loans 10 years above 50 15.0...... ................ _.. ... ............ ..............................

OTHER KFY RATESGeneral Lending Ceiling 17.5Prime Lending by Term Lenderssuch as ICICI IDBI 14.0

Deposit Rates 1 to 5 years 4 .0to 13.5

source: RDB Re port on currency ana rinance, lY5-5b;HDFC and LIC reports.

ANNEX 10

- 47 -

INDIAHOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

DIagrom d Fownal Internediation In Indian Housing Finance Sector

COo | Household Capoqotion Tx PotWit Furi

HLK= APEX ~~~~~~~~~~HDFC

HmdWV BOOrM pdffxxy ~~~~~~HOFC

|~~~ \ v l n n C/FH

HouSeholdS & COqnaratlOn

World Bank - 4114 2

- 48 - ANNEX 11Page 1 of 3

INDIA

HOUSING DEVELOPMENT FINANCE CORPORATION PROJECT

GOVERNMENT OF INDIA'S SECTOR POLICY STATEMENT

TO THE WORLD BANK

No.F.4/1/S6-FB.V

WTTW a

s~~~~~~~~~~~~~~3T4 wrft foP.V. Bhid. Government of India (Bharat Sarkar)Deputy Secretary(FB) Ministry of Finance (Vitta Mantrailya)Tel.. 3013183 Department of Economic Affairs (Arthik Cary Vbha)

;f fbPu'/ Neow Delhi 19t

Dear t

Kindly find enclosed a note Indicating the existing

policy scenario ln tho Housing Finance Sector.

Wlth Lq

Yours

(P. Bhlde)

Ms. Nina ShapiroThe World Bank

ANNEX 111Page 2 of 3

With the onset of the Sevonth Flve Year Plan, the

Government has declared Its intention to combat the housing

problem in an effective manner. Several measures have recently

been Initiated to provido the pecossary boost to encourage housing

activity lh the country. As a mattor of fact the Prime Minister

while prosenting the Budget proposals for 1987-88 highlighted

that Housing is hlgh on our list of prioritios ( vido extract

from his Budget Speech of 1987-88 enclosed). Several new lnitLa-

tivew wero elaborated in tho Budget speech delivorod by the

Prime Minister. Implementation of thoso is being taken In several

ways, as indicated belows-

1. The Government has formulated and circulated

for the flrst time a draft of a comprohonsive

National Housing Policy.

2. Establishmbnt of the National Housing Bank

Is presently undor active consideration; NHB

will holp towards dovoloping a regulatory

framework As also creating an enabling environ-

ment to encourage housing finance institutions

to raise funds and engage In markot oriented

financing. The National Housing Bank has

been concelvod as a flnancial Institution.

It would also serve as a promotional agency

and seek to regulate the housing financo credit

sector. An initial *quilty capital of Rs.100

crores has beon indicated for allocation to

the NHB.

- 50 ANNEX 11Page 3 of 3

3. To reduce the credit risk that housing finance

companios inherently face the Govornment

has appointed an expert group to go Into

issues rerating to mortgage lnsuranco.

4. A National Commdssion on Urbanisation has

recently submitted its interim report and

its detailed report is expectod to be finalised

shortl y.

In the light of the above sconarlo It to clear that housing

finance and the houslng sector would continue to receive lmportanco

In tho immediate foreseeable future with a view to lmpleennting

programmes and strategies directed towards meting the housing

shortage.

ANNEX 12- 51 -

INDIA

HOUSING FINANCE CORPORATION PROJECT

LIST OF DOCUMENTS IN THE PROJECT FILE

1. HDFC's Annual Report FY 1986, FY 1987.

2. HDFC's Statement of Operating Policy.

3. India Housing Finance Review, The World Bank, February 1987 (ReportNo. 6453-IN).

4. Copy of the National Housing Bank Act, GOI, 1987.

5. Report on the National Housing Bank--GOI High-Level Commission on HousingFinance, 1987.

6. Draft National Housing Policy, Ministry of Urban Development, GOI,January 1987.

7. Report on a Proposed Investment in HDFC in India, IFC, March 1978(IFC/P-287).

8. Proposal for a New Institution for Housing Finance in Eastern India,HDFC. March 1985.

9. HDFC Promotional Material and Sample Loan Applications.

10. Indian Newspaper Clippings on Housing Finance.

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