Are housing finance stocks on a shaky ground?

Here’s something that could lift your spirits in a falling market, hypothetically speaking, that is. Had you invested ₹1 lakh in stocks of housing finance companies (HFC) beginning FY11 — that is, April 2010 — the money would have trebled to ₹3.3 lakh today, despite the meltdown. This would be far in excess of the Sensex, which would have fetched an additional ₹50,000.

In fact, there is hardly any well-known investor who hasn’t invested in housing finance stocks. Be it Rakesh Jhunjhunwala, Raamdeo Agrawal or Mohnish Pabrai, all of them have taken a fancy to these stocks, and most are sitting on huge gains, as the stocks, on average, have delivered close to 230% return — the highest recorded by Can Fin Home at 566%, followed by Gruh Finance at 522%.

Traditionally, the housing finance market had been largely catered to by banks and very few specialised companies, such as HDFC, Dewan Housing Finance (DHFL) and LIC Housing. That apart, public sector banks were not very active and private banks had a limited presence and resources, opening up the space for newer and nimble HFCs. “HFCs have developed expertise in sourcing and appraisal of housing loans. They have, over the years, evolved as specialists in the home loan market and acquired the skill sets to quickly identify and address the needs arising out of property purchase and financing formalities,” points out Sunita Sharma, MD and CEO, LIC Housing Finance.

Despite a higher cost of funding as compared with banks, HFCs gathered pace because of the reach, aggressive marketing and the size of the market led by a property boom in the country. HFCs have taken over from banks in terms of growth because of the need for specialised housing products, the lending constraint of banks and the government’s emphasis on promoting housing finance by setting up the National Housing Bank (NHB) in 1998. NHB is wholly owned by the RBI, which monitors housing finance lending and provides funds at subsidised rates to HFCs to promote housing for the low-income group. 

While the two old players in this industry, HDFC and LIC Housing, together account for 65% market share, smaller companies are making their presence felt too. Chennai-based Repco Housing, a niche player catering to the medium and low-income group, today boasts a loan book of close to ₹6,000 crore, while larger and established players such as LIC Housing and HDFC are at ₹108,360 crore and ₹227,000 crore, respectively. What is so exciting about these businesses? Gagan Banga, MD of Indiabulls Housing Finance, says, “Housing finance is a fast-growing, scalable and low-risk business because of the mortgaged back-financing. It is a good business that can keep on compounding over the next 10-15 years.”

According to NHB data, banks, which are the biggest competitors today, have only 7% of their housing loan portfolio coming from rural areas and 16% from semi-urban areas, where smaller and medium-size HFCs are active. “It is not that banks cannot do what HFCs can do. Banks have more experience to do so, given their in-house risk management systems. However, the process is labour-intensive and banks may not be interested in the small portfolio that HFCs are catering to. That apart, why would a bank be so interested in housing finance, which is the least yielding product for them? They would prefer personal loans at 14-15% interest or corporate loans, which yield close to 12-13%,” explains Sudhin Choksey, MD, Gruh Finance.  

With a little help from the state

What is helping the case of the HFCs is a mix of government and regulatory initiatives. While the government, under the Sardar Patel Urban Housing Mission, is looking at providing 30 million dwelling units for the socio-economically weaker segment, banks are now including stamp duty, registration and other documentation charges in computing loans to value for low-cost housing loans (up to ₹10 lakh). Further, an increase in deduction for repayment of housing loan (both principal and interest) has also helped matters. More importantly, the low-ticket housing segment is no longer lucrative for banks, given their high operating and collection costs. Also, higher NPA (non-performing assets) levels are prompting banks to remain focused on high ticket size home loans in metros and urban areas.

Against such a backdrop, HFCs have aggressively grown their portfolio at an average of 28% between FY11 and FY15 (see: Home is where the growth is). Notably, they have taken the lead over banks, whose market share is now at around 61%, while that of HFCs is at 39%. That apart, with the growing size and market, the companies have also gained due to higher scale, leading to better return ratios. Better ratios and higher earnings growth have helped some of these companies attract higher valuations, contributing to the overall stock price performance. Gruh Finance has seen its return on equity improving from 28% in FY10 to close to 33% currently. Similarly, CanFin Home has seen close to a 400 basis point improvement in its RoE.

Higher valuations on strong earnings growth had a multiplier effect on the share prices. Companies such as Gruh, Repco, DHFL and CanFin Homes have seen their earnings compounding in the range of 21-32% in recent years. Growth has been especially higher in the case of companies such as Gruh and Repco because of their exposure to high-growth segments and markets, such as the low- and medium-income group and tier 2 and tier 3 cities. Over FY11-15, mid and small HFCs have grown their advance books at 33% annually, compared with 23.5% in the case of larger HFCs. 

Pick and choose

It is no wonder, then, that Dalal Street gurus have bought niche players such as DHFL (Rakesh Jhujhunwala, Manish Bhandari), GIC Housing (Mohnish Pabrai), Gruh Finance ( Agrawal) and Repco (Basant Maheshwari). These largely regional-focused HFCs not only enjoy a lower cost of funds (because of NHB exposure), low operating expenses, high growth and less competition from banks but also have the ability to price loans at higher rates. The average ticket size of Gruh and Repco is around ₹10 lakh-11 lakh, compared with ₹20 lakh-22 lakh in the case of HDFC and LIC Housing.

Kolkata-based Maheshwari, who also runs equitydesk, feels niche players do not have competition because the customers they are servicing are typically neglected by the banks. “Many of their customers do not have a bank account or PAN card. And on top of that, the banks will not take the risk of managing so many accounts with different credit profiles for a portfolio of ₹5,000 crore-8,000 crore,” says Maheshwari. 

Catering to small borrowers also means that there is a better chance of enjoying higher margins, but not without some hiccups. Repco, at 1.5%, has one of the highest NPAs in the industry, compared with 0.7% for LIC Housing. “Considering its target segment, NPAs are going to be high relative to other HFCs but, at the same time, the company enjoys a higher net interest margin (NIM, the spread between borrowing and lending funds) because it prices its loans at higher rates,” points out Maheshwari. Indeed, Repco’s NIM is close to 5%, compared with 2.3% in the case of LIC Housing. This is also attributed to the low cost of funds, where Repco gets almost 25% of its funds from NHB at subsidised rates, compared with 4% of the total fund for LIC Housing. Further, it also enjoys pricing power: the average yield on advances disbursed by Repco is at 12.5%, which is far higher compared with 10.7% in the case of LIC Housing. This indicates that smaller HFCs such as Repco have the ability to price their loans at higher rates and, thus, cover up some risks that they deal with in self-employed segments (see: When small is beautiful). This comes as a result of its strong niche, particularly catering to the self-employed and low-income group. Over 50% of the company’s loan portfolio comprises self-employed people, as against banks, which typically have 15-20% of their portfolio in this segment because of the ease of assessing salaried customers. Repco, so far, has been catering to southern states with about 125 branches, but it intends to move into west and east India. 

On the western side, companies such as DHFL are already doing brisk business. The company witnessed a CAGR growth of 35% in its AUM over FY11-14 and is targeting to double its AUM by FY17E (to ₹ 100,000 crore) by increasing its presence across the country and setting up branches in untapped markets. Manish Bhandari of Vallum Capital Advisors, who invested in DHFL around mid-2012, believes that the best for DHFL is yet to come. “In the upcoming years, operating cost will look lower relative to size and because of that, incremental growth in income will reflect in better profitability,” he says.

Most HFCs have devised their own models while catering to certain sections of the markets which are untouched by banks. “We have 40% of our portfolio coming from self-employed buyers and close to 20% comes from customers who draw their salary in cash,” points out Harshil Mehta, CEO of DHFL. Self-employed customers such as tailors or shopkeepers are some of the target borrowers for DHFL. “Assessing the needs of self-employed customers and their credit profile without much track record is a difficult task, which not all can do. So, banks will largely neglect this group, where we see an opportunity. We have an in-house team and specific policies to assess the credit profile of such customers,” adds Mehta.

In some segments, such as non-salaried borrowers and others, the yields are high by as much as 200-300 basis points. That apart, most of these companies have an exposure to builder loans, which earns them high yields. Companies such as Indiabulls Housing, for instance, give loans to the builder and other bulk segments where the yields are quite high. This may sound risky, as many analysts say, but Banga points out that since it is only about 25% and that, too, is backed by assets. “Indiabulls does not see a risk in this business, which many of the players have been ignoring,” explains Banga. 

What lies ahead

The potential for housing notwithstanding, the future will get increasingly competitive. Many new NBFCs are looking at housing finance and PSU and private banks have become aggressive by expanding their reach into tier-2 and tier-3 cities. This has narrowed down the gap with many HFCs, which earlier grew in smaller cities and towns due to a lack of competition. 

The initial signs of higher competition are already visible, with the moderation in growth of HFC disbursements from 27% in FY13 to 18% in H1FY15. On the contrary, during the same period, the pace of banks has increased from 14% to 20%. “Banks were focused on corporate lending. Over the last one-and-a-half years, mortgage and home loans have gained increased importance and have become key thrust segments for many banks. Consequently, the home loan book for banks have grown at a higher pace as compared to previous years,” says Vibha Batra, who tracks the sector at leading rating agency ICRA. Also, banks have started to price their loans attractively, which has led to some of the business being shifted to banks.

Yet, HFCs are trading at an average of 21X P/E ratio and 4X book value (see: No longer cheap). “I think there are huge opportunities in the housing finance sector, but the problem is that there is very limited choice in the market to buy individual companies and stocks, given their valuations,” points out Raamdeo Agrawal, managing director and co-founder of Motilal Oswal. Given that most HFCs are trading at very high valuations, there is very little margin of safety. “Look at Gruh: at 10-12X its book value or market cap close to its loan book, it is simply unbelievable,” adds Agrawal.

Given that valuations are looked at from the perspective of growth, business growth is far from assured. Crisil, in its note on the sector, expects HFCs’ growth rate to decline to around 17% in FY15, compared with 19% in FY14 and 24% in FY13, citing reasons such as increased competition coupled with a fall in home loan sales. 

Home loan specialists are cognisant of this fact. “There is a slowdown across the board irrespective of cities and towns, except certain pockets where demand is still coming up, but that is a small portion of the overall market. The high-value market is at a standstill as there are no buyers. Real estate prices are high and builders are sitting on a huge debt. Demand in the metros is already saturated and there are very marginal disbursements happening,” points out Choksey of Gruh Finance. The company expects growth to come back over the next 12-15 months with expectations of higher economic growth, employment and lower interest rates. 

To put it in perspective, India’s largest HFC, HDFC, with a market share of close to 17%, has seen its advance growth falling from 21% in FY13 to 16% in FY15. Similarly, the second-largest player, LIC Housing, too, has seen advances growth declining from 23% to 18% during the same period, and smaller players such as Gruh have seen growth falling by 600 basis points to 27%. Repco, though it reported 29% growth in advances during FY15, still pales over last year’s near-32% y-o-y growth. Except HDFC, whose interest margins remained flat in FY15 compared with last year, most HFCs have seen their margins falling. In FY15, GIC Housing reported a 40-basis-point decline, while Repco saw a 20-basis-point drop in its margins. Though the RBI has cut interest rates by 75 basis points, it is yet to show up on the performance of HFCs, but more critical would be the growth in advance. What is worrying is the MET forecast of deficient rains this year, which is likely to impact rural income and, hence, demand for retail loans.

However, stock-pickers such as Maheshwari, who had picked up Hawkins Cookers and Page Industries very early on, are sitting on huge gains, with Maheshwari gaining 250% on his investment in Repco and thinking long-term. “Even though Repco fetched a handsome return, I don’t think I will sell it for the next ten years or so because of the sheer size and scalability of this businesses,” he explains.

Manish Bhandari of Vallum Capital Advisors, who invested in DHFL around mid-2012, shares a similar optimism. “Given the long-term opportunities, I still believe there is value in these stocks, particularly the fact that most of these companies have a small base and, as they grow, the operating leverage will start to kick in and we can expect higher earnings growth on top of industry growth,” he says.

But given the slow puncture that began early this year in HFC stocks  — down over 10% on average — it seems short-term challenges cannot be wished away.