1.22 Query:

Determination of timing of ‘commencement of operations’ for the purpose of prudential

norms in respect of rephasement of builders’ loans.

1. A housing finance company, sponsored by a nationalised bank with equity participation from National Housing Bank (NHB) (wholly owned subsidiary of Reserve bank of India) UTI, HDFC etc., is doing only housing finance business. The company’s sanctions of loans etc., are nearing Rs. 1000 crores.

2. As per he NHB prudential norms made effective as of 31.03.96, in respect of income recognition and provisions for nonperforming assets, the company has sought advice with reference to advances made to builders. The company gives loans to builders to construct dwelling units, who, in turn sell the same to various customers (This is different from individual housing loans given to individuals). Terms of disbursing loan to builders are as below:

            25%-   Initial contribution by the builder.

25%-   Financial institutions such as the company (disbursement in stages depending upon the progress of construction).

50%-   By the prospective flat owner.

Repayment Clause: In suitable instalments commencing one month after completion of the project.

3. The querist has submitted a copy of the prudential norms for the perusal of the Committee.

4. As per the NHB guidelines, a reference has been made towards rephasement of nonperfoming assets in paras no. 2.1, 2.2 and 2.3  which are reproduced below:

“Para 2.1 Standard Assets

Standard asset is one in respect of which no default in repayments of principal or payments of interest is perceived and which does not disclose any problems nor carry more than normal risk attached to the business. Such an asset is not an NPA.

Para 2.2 Substandard Assets

Substandard asset is one which has been classified as NPA for a period not exceeding two years. Such an asset will have well defined credit weaknesses that jeopardise the liquidation of the debt and are characterstised  by the distinct possibility that the HFC will sustain some loss, if deficiencies are not corrected. Terms loans, where interest and/or instalments of principal are overdue for six months as on March 31st, 1995 should be treated as substandard. An asset where the terms of the loan agreement regarding interest and principal have been renegotiated or rescheduled after the commencement of operations, should be classified as substandard and should remain in such category for atleast two years of satisfactory performance under the renegotiated or rescheduled terms. The classification of an asset should not be upgraded merely as a result of rescheduling unless there is satisfactory compliance of the above condition. (Emphasis added by the querist)

Para2.3 - Doubtful Assets

A doubtful asset is one which has remained NPA for a period exceeding two years. Term loans, where instalmets of principal have remained overdue for a period exceeding two years, should be treated as doubtful. Here too, as in the case of substandard assets, rescheduling does not entitle a HFC to upgrade the quality of an advance automatically. A loan classified as doubtful has all the weaknesses inherent in that classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.”

5. They querist has supplied the following additional information:

(i)         As per the norms, normally, the builder is required to invest first a minimum margin of 25% of the total project cost. After this is done the company starts disbursing the loan amount in stages depending upon the progress of the work.

(ii)        Interest is being demanded on the disbursed amount at the end of every month.

(iii)       Principal amount is payable in suitable instalments (monthly/quarterly) commencing immediately after the project execution period or one month after completion of the project whichever is earlier.

(iv)       The company may reschedule the loan during construction period before the commencement of the repayment. The company may even reschedule after commencement of repayment if the marketing of the units is delayed on account of genuine reasons.

(v)        NHB has not clarified with regard to ‘commencement of operations’ as to whether it will begin immediately after the foundation is laid or after completion of the building. However, they have clarified the position of reschedulement in respect of Standard Assets as follows:

“An asset may be classified as ‘standard’ if the instalments of the principal amount are rescheduled with the consent of the Board of the concerned HFC subject to the condition that such reschedulement should be one time and interest is regularly paid.”

6. The querist has sought the opinion of the Expert Advisory Committee on the following issues arising from the above:

(a)        Whether the time of determination in respect of ‘Commencement of operations’ will begin immediately after the foundation is laid by the builders to construct the building or after the completion of the building and occupancy certificate is obtained (so that the flat owners who buy from builders can occupy and also the builder realises the money to repay the loan).

(b)        Since no reference has been made for renegotiating or rescheduling terms of repayment clause under Standard Assets (para No 2.1), whether terms of repayments of the Standard Assets can be renegotiated/rephased more than once till the commencement of operations is achieved without affecting the nature of the asset classification. Thus, rephasement of Standard Asset before commencement of operations will continue to be a Standard Asset.

                                                                    Opinion                                       . October 17, 1997

1. The Committee notes that the expression ‘commencement of operations’ has not been defined in the relevant prudential norms of the National Housing Bank, a copy of which has been submitted by the querist. The Committee is, accordingly, of the view that the expression should have the meaning as is understood in the context of the nature of operations commonly carried on by a builder.

2.  The Committee notes that in the context of the nature of operations commonly carried on by a builder, ‘commencement of operations’ signifies the commencement of an action relating to the project under reference by the builder. For example, a housing construction project may commence with the action relating to procurement of land by the builder; in such a case, ‘commencement of operations’ should be considered from the date of the said action.

3. On the basis of the above, the opinion of the Expert Advisory Committee on the issues raised in para 6 is as below:

(i)         The project of a builder reaches the ‘commencement of operations’ stage, when the operations in respect of the concerned project commence.

(ii)        In the view of the Committee, the ‘rescheduling’ or ‘renegotiation’ of a loan referred to in the NHB guidelines would normally refer to a situation when an account reflects some weakness in respect of repayments of principal/interest or it discloses some problem or carries more than normal risk. This situation obviously would mean that the relevant asset cannot then be considered a standard asset.

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