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Home Markets Feature Are housing finance stocks on a shaky ground?

Are Housing Finance Stocks On A Shaky Ground?

Housing finance companies have had a good run thus far but rich
valuations are unlikely to sustain in future

Jitendra Kum ar Gupta

JUN 26 , 2015

Illustration by Kishore Das

Heres 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.
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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 hasnt 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 governments 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
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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 socioeconomically 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.

Home is where the growth is

Housing finance com panies hav e seen a robust growth on their loan books
in recent y ears

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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
Source: Companies, analyst reports
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.

Bad loans [of Repco] will be high relative to other HFCs but,
at the same time, it enjoys higher margins Basant
Maheshwari, founder, equitydesk

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 crore8,000 crore, says

Maheshwari.
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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,
Repcos 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
companys 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.

When small is beautiful

Niche housing finance com panies such as Gruh and Repco are focusing on
sm aller incom e brackets and, hence, enjoy good m argins

Source: Companies

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
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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
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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 cofounder of Motilal Oswal.
Given that most HFCs are
Though the housing finance opportunity is huge, there is
very little opportunity for investors, given the high valuations trading at very high
valuations,
there is very
stocks Raamdeo
Agrawal, co-founder
MD, Motilal STRATEGY
THE BIG STORY ofSPECIALS
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little margin of safety.
Oswal
Look at Gruh: at 10-12X
Search Here..
its book value or market cap close to its loan book, it is simply unbelievable,
adds Agrawal.

EVENTS

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.

No longer cheap
Most prom ising housing finance com panies already appear richly v alued

To put it in perspective, Indias largest HFC, HDFC, with a market share of

close to 17%, has seen its advance growth falling from 21% in FY13 to 16% in
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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 years 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 longterm. Even though Repco fetched a handsome return, I dont 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.
housing finance
Gruh Finance

Rakesh Jhunjhunwala
Dewan Housing Finance

Raamdeo Agrawal
HDFC

Mohnish Pabrai

LIC Housing

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