Housing finance companies on a free fall, but valuations remain stretched

In recent times the Indian market has experienced some turbulent times impacting most of the sectors. The housing finance sector has been among the worst affected with significant headwinds. 

The housing finance sector has multiple growth drivers like underpenetrated housing loan market, underleveraged household balance sheets, pent-up housing demand and urbanisation. The housing loan market is extremely underpenetrated. The penetration for house loans is as low as 6% of GDP. Overall outstanding household credit in India is about 11% of GDP, significantly lower compared to 48% of China, 17% of Indonesia and 68% of Thailand. Similarly, household balance sheets are underleveraged with an average annual household savings rate at 16.5% of GDP as compared to the outstanding household credit of 11%.

By conservative estimates, India has a shortage of 19 million urban homes and Indian cities are likely to add over 400 million people by 2050. This shows how migration, urbanisation and pent-up demand for housing can boost the demand for home loans. The housing market is emerging from the disruption caused by demonetisation and Rera (Real Estate Regulatory Authority); according to a recent report, both sales and launches are at the highest level since demonetisation approximately 124,000 and 92,000 units, respectively, further boosting the demand for house loans.

Companies providing house loans can be broadly classified into two categories: banks and NBFCs (non-bank financing companies). While banks are the traditional providers of home loans, NBFCs especially housing finance companies (HFC) too are significant providers of home loans and have gained market share in the recent past when bank credit growth has been low. 

This puts HFC in a bright spot, but its major concerns are liquidity crunch and asset quality concerns. Housing finance companies lend to customers for longer durations, but fund themselves using short term instruments like commercial paper, creating the need for frequent refinancing. In case of a liquidity crunch in the system, the need for refinancing can lead to a squeeze on margins and can potentially lead to a rise in non-performing assets (NPA) and defaults. 

The recent rise in credit demand and the reversal of interest rate cycle by the RBI has led to a rise in interest rates leading to pressure on HFC’s margins. Concerns about margins rose significantly following two events: a) default by IL&FS and b) sale of commercial papers (CPs) by mutual funds at high yields, indicating redemption pressure.  

Due to the liquidity pressure, HFCs have started selling down the book and securitisation of their books to banks and other interested parties. According to Crisil, securitisation has almost doubled YoY in the first half of this fiscal against the first hafl of  FY18. It should be noted that HFCs’ have exposure to risky property developers, LAP (loan against property) and small business funding. At an industry level, HFCs exposure to risky LAP book is around 15-16% as HFCs were chasing higher yields. These raise asset quality concerns. 

As the HFCs are adjusting their balance sheet to adjust for changing business environment, return on equity (ROE), which averaged to 20.8% for these firms, is likely to decline. The decline in their share prices reflects these concerns. The valuation of these firms remain high with a price to book value of 2.3x as compared to 2.4x for banks, where the fundamentals are improving. 

Despite the decline, we believe that it may be too early for investors to buy shares in this sector as further valuation adjustment is needed. 

The writer is CEO - stock broking, Karvy