The Centre’s clampdown on black money through demonetisation is expected to have a great impact on the real estate market. There could be a correction in prices across the country. This could impact housing finance companies (HFCs) as property prices (aside from volumes), to some extent, underpin the loan growth. Also, demand for property is likely to slacken in the coming months, particularly in pockets where transactions have mainly been cash-based.
Weighed by these concerns, the stock prices of HFCs have fallen over the past two months. While the sector will see some pain in the coming quarters, the long-term prospects of a few companies remains sanguine, providing a good opportunity for long-term investors.
Market leader HDFC (Housing Development Finance Corporation) has been delivering healthy growth in retail loans, steady margins, and very low delinquencies over the past couple of years, despite the slowing property demand. While the pace of loan growth for HDFC has slowed in the last two years, in line with the overall trend in the sector, it has still managed to outpace the industry. In the last five years, HDFC’s retail loan book has grown at a rate at least 5 percentage points above banks’ growth in this segment. The company’s leadership position in the housing finance market, a predominantly first-home buyer and salaried class target segment, negligible exposure to the riskier loan against property (LAP) segment and sound fundamentals should continue to hold it in good stead.
Investors with a two to three years’ time horizon can buy the stock. The stock is trading at about 3 times its one year forward book value, far lower than its historical average of 4 times. The stock has fallen by about 12 per cent post demonetisation.
Loan growth for HFCs is a function of price and volumes. The demonetisation move, taking a toll on home prices, will have a greater impact on players that have grown their loan book by price (home loan size) increases rather than volumes. For HDFC, though, the growth in its retail loans (about 23-25 per cent annually over the last three years) has mainly been driven by volumes. Net of loans sold to HDFC Bank, the growth has been a healthy 16-17 per cent. The average loan ticket size has gone up by about 6 per cent annually over the past three years. The strong demand from the mid-income group has kept volume growth steady. Currently, HDFC’s average loan size is about ₹25.7 lakh and hence the target segment is middle-income salaried employees, and first-home buyers. While demonetisation could lead to deferring deferred purchases, impacting demand in the December and the March quarter, over the long run, as transparency in deals increases, the loan ticket size can move up sharply. This is because HDFC, catering mainly to the salaried class, gives loans based on the agreement value. This value, if it is closer to the actual market rates, will mean an increase in loan amounts. Also, the rising unsold inventory could force developers to cut prices. This should see demand pick up with a lag.
The LAP segment — lending for business or personal use with homes as collateral — will be the most affected by the fall in real estate prices. HFCs accepting EMIs in cash could see a rise in delinquencies. But for HDFC, the exposure to this segment is minimal (less than 5 per cent of loans).
In the latest September quarter, the company’s 14 per cent growth in core net interest income was led by 17 per cent growth in retail loans (net of loans sold to HDFC Bank). This could moderate in the coming quarters.
Growth in the high-margin non-retail (developer) segment inched up in recent quarters, but it is likely to remain subdued in the near term. Retail loans, forming 70 per cent of the loan book, will continue to drive growth.
Funding cost to fallOne of the key strengths of HDFC is its ability to diversify its source of funding. The high liquidity in the banking system will likely lead to rates softening in the coming months, resulting in lower cost of funds for HFCs and accelerating the fall in home loan rates.
Besides the flexibility to switch between different funding sources, new funding sources such as external commercial borrowings (ECB) and masala bonds (rupee denominated bonds) should help lower HDFC’s funding costs. The ability to maintain very low level of delinquencies is also a key positive. The gross non-performing assets (GNPA) as of September end stood at 0.76 per cent of loans.
The merger of Max Life and HDFC Life is pending approvals. Any future unlocking from HDFC’s other insurance subsidiaries will also be a trigger for the stock.