Are Housing Finance Stocks on a Shaky Ground_ _ Outlook Business

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

Housing finance companies have had a good run thus far but richvaluations 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.

Are Housing Finance Stocks On A Shaky Ground?

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2/13


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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. Thatapart, 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, ev olved 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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Higher valuations on strong earnings growth had a multiplier effect on theshare 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 FY 11-15, 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-basedMaheshwari, 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.

Source: Co mpanies, analyst reports

Bad loans [of Repco] will be high relative to other HFCs but,

at the same time, it enjoys higher margins Basant

Maheshwari, founder, equitydesk


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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 hou sing finance c om panies such as Gruh and Repco are focu sing on

smaller incom e brackets and, henc e, enjoy good margins

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

Source: Companies


6/13



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, whichearlier 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 thesector 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


7/13



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 outRaamdeo 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.

No longer cheap

Most promising housing finance com panies already appear richly valu ed

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

Though the housing finance opportunity is huge, there is

very little opportunity for investors, given the high valuations

of stocks Raamdeo Agrawal, co-founder and MD, Motilal

Oswal

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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 theRBI 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 dont think I will

sell it for the next ten years or so because of the sheer size and scalability ofthis 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 Rakesh Jhunjhunwala Raamdeo Agrawal Mohnish Pabrai

Gruh Finance Dewan Housing Finance HDFC LIC Housing

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Are Housing Finance Stocks on a Shaky Ground_ _ Outlook Business

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