Housing finance companies (HFCs) have had the best run over the last one year with their valuations soaring, especially after the government’s demonetisation exercise. The fact that in the wake of falling corporate loans, retail-focused lenders and HFCs in particular have the healthiest businesses has contributed a lot to these valuation increases.
Default rates in home loans are much lower than in corporate loans and the lowest among various retail loan segments. Notwithstanding the impact of the currency withdrawal on the real estate sector, home loan repayments haven’t been derailed while all other loans have succumbed to rising defaults. For instance, Housing Development Finance Corp. Ltd’s (HDFC’s) bad loan ratio was 0.81% as of December while that of Dewan Housing Finance Corp. Ltd (DHFL) was 0.95%. Bad loan ratios of banks are massive compared to these, courtesy their corporate loan book.
But the valuation of a business has a lot to do with future earnings and this is where the going will get tougher for HFCs.
Here is a line of caution that investors should focus on. The home loan market is getting extremely crowded, with most banks aggressively expanding their portfolio. The largest home loan lender is still a bank, State Bank of India (SBI), and it has been aggressive in the market for the past five years. SBI’s home loan book has grown at a 16% capital adjusted growth rate during the said period despite the large size, while its market share has remained at 15%.
But SBI is an old player and the new lenders who had jumped on the home loan bandwagon are all banks that were struck by rising corporate bad loans and shrinking credit growth. Bank of India, Bank of Baroda, Axis Bank Ltd, Kotak Mahindra Bank Ltd and others have laid out plans to expand mortgage loans. Further, predominantly corporate lenders, who had reduced their exposure to the home loan market, are now making a second entry.
The ensuing competition will begin to squeeze margins and this has already begun. Banks have aggressively cut their lending rates and once they begin fixing their bad loans, rates will drop further. SBI’s home loan rate has dropped 100 basis points (A basis point is one-hundredth of a percentage point) in the last one year and both SBI and HDFC currently give home loans at 8.5%. HFCs such as DHFL, CanFin Homes Ltd and Repco Home Finance Ltd lend at slightly higher interest rates.
Analysts at Kotak Securities Ltd note that spreads and margins for HFCs will narrow as the decline in their cost of funds too will be limited.
Incremental business growth too could get slower as banks garner market share. Axis Bank’s market share has risen by 60 basis points in the past two years while that of Kotak Mahindra Bank has grown by 50 basis points.
HFCs’ rich valuations are sure worth a second look.