Homeward Bound

Even if real estate prices are zooming, housing finance players will continue to do well as the demand for home loans will remain strong.

Housing and housing finance have been in the news lately. With prices rising around 50 per cent across the country in the past year, home buyers are confused on the future direction of prices, and more importantly, how they will finance the purchase.

The Reserve Bank of India is worried about unabated growth of housing loans, and has also warned home loan players, whose fortunes are tied to what home buyers do.

Despite property prices having zoomed over the past three years, the housing finance industry, which comprise of specialised institutions like HDFC, Dewan Housing, LIC Housing and even the banks, has also bloomed. Or is it the other way round?

In any case, all the four parties involved--individuals, home loan lenders, real estate developers and investors have gained, and this is expected to continue though at a moderate rate going forward.

Home finance companies say that the demand for housing loans continue to be strong at 25-30 per cent. But the stock prices seem to have factored in all the good news, especially for larger players like HDFC and ICICI Bank.

The upside story
Overall, real estate prices have almost doubled in last three years. While top major cities like Mumbai, Bangalore, Chennai, Hyderabad, Pune and Delhi have seen their prices doubling up or even more, Tier-II and Tier-III cities have seen a growth of 50 per cent. There are several reasons for the skyrocketing prices:

Robust growth in the economy leading to rising disposable income of Indian people

Relatively low interest rates--from about 15 per cent in 2000 they had falen as low as 7-7.5 per cent, and are still less than 10 per cent at present.

Fiscal incentives from the government (Rs 1.5 lakh for interest repayment and Rs 1 lakh for principal repayment)

Increasing urbanisation and aspiration levels

Structural factors like nuclear families, changing demographics (70 per cent of the population below the age of 35)

Despite higher property prices, housing finance companies like HDFC, Dewan Housing or banks financing home loans like ICICI Bank have also gained a lot with the industry growing at over 30 per cent CAGR in the last five years and profits jumping by 20 per cent every year. How has this happened?

Says Gulam M Zia, national director-research and advisory services at real estate consulting firm Knight Frank, "Though home loan rates have risen by 3 per cent in the last three years, salary levels have grown at even higher rate of 25-30 per cent leading to robust growth in demand for home loans."

For example if the property value in a Mumbai suburb has grown at an annualised rate of 16.7 per cent in last five years, annual income of individuals have also grown at a higher rate of 17.8 per cent.

However, given the recent rate hikes by lenders, warning signals of RBI through increased risk weights on housing and real estate loans in various monetary policies and high property prices, is the party for housing lenders going to last?

Most industry experts feel that the party will go on. Says Kapil Wadhawan, managing director, Dewan Housing Finance, "India's most important strength today is its population itself and most of the home loan buyers are around 25 years of age."

Moreover, there is a huge demand-supply gap of 22 million units which is expected to further expand to 40 million units in the next 10 years, thanks to rapid increase in population and urbanisation. About Rs 1.5-1.75 lakh crore will be required to bridge the gap.

Also, mortgages to GDP is 4 per cent in India, which is very low compared to the US, the UK and even other Asian emerging economies like Thailand and Korea.

Adds Conrad D' Souza, senior general manager, treasury, HDFC, "Despite rate hikes, the effective interest rates for an individual are still lower in single digit (about 6 per cent in 2006) compared to over 11 per cent six years ago (2000)."

Says Dipan Mehta, member BSE and NSE, "There has been a wage hike of 20 per cent which gives a positive signal of higher purchasing power."

However analysts have toned down their expectations about the growth rates of housing finance companies mainly due to high real estate prices.

Kotak Securities expects the growth rate of the housing finance sector to moderate to 20-25 per cent. CRIS-INFAC expects housing finance to grow at 21.4 CAGR between FY06-10E. With a base of about Rs 1.2 lakh crore, this growth is not bad at all.

However, there is a fear of some industry experts that if the real estate prices go up further, then the demand might slow down as buyers will postpone their purchases and wait for right prices.

But this is unlikely to happen. Says Zia, "In cities like Mumbai, Delhi and Bangalore prices are unlikely to go up very substantially though in certain locations of Pune and Kolkata, the direction of prices is still up. In Tier-II and Tier-III cities, prices are expected to repeat the growth of 50-80 per cent witnessed in the last three years due to more job opportunities and rise in incomes."

The share of aggregate personal loans (which mainly consists of home loans) to non-food gross bank credit has increased from 18 per cent in FY03 to 25 per cent in FY06. But competition is heating up as banks are aggressively pushing housing loans as part of their retail strategy. Does this mean that margins and profitability will fall?

In this case, specialised housing finance companies and the larger banks are well placed as compared to smaller banks as the former have the domain knowledge. Though banks have the advantage of low costs deposits and branch network, being aggressive on housing loans can lead to asset liability mismatch and they already operate on thin margins.

Unlike a few years back, pricing power of home loan players is back as most of players are in a position to pass on the costs.

Says Rajeev Sabharwal, head-retail assets, ICICI Bank, "Margins will be protected as about 80 per cent of total home lending is on floating rate basis. Moreover, interest rates should also remain stable going ahead."

Even analysts don't see any problem on the margins front as they feel that home lenders have regained the pricing power. So the performance of housing finance companies should be good going ahead. 

BUILDING ASSETS
Rs crore	HDFC		LIC Housing		DHFL		ICICI Bank
	H1FY07	% chg	H1FY07	% chg	H1FY07	% chg	H1FY07	% chg
Net Interest Income	977.00	21.56	192.82	4.80	43.60	21.10	3052.00	49.70
Other Income	12.35	126.20	14.40	3.90	22.10	7.17	2847.00	29.30
Operating profit	854.00	22.00	138.47	1.38	26.50	23.30	2843.00	41.00
Net Profit	664.80	22.00	113.39	4.47	21.36	24.60	1375.00	23.90

However this does not necessarily mean that even their stock performances will mirror the financial performance as most of them like HDFC and ICICI Bank have shot up phenomenally in the past few months and are fairly valued.

Thus, on a valuation basis, Mehta feels that Dewan Housing looks attractive at current levels while a head of research of a leading broking firm is positive on LIC Housing Finance. A closer look at the home loan players.

HDFC
HDFC, the biggest home loan lender of the country, with the highest RoE of about 30 per cent and an asset size of Rs 56,496 crore in September 2006. The company's disbursements grew 27 per cent year-on-year in H1 FY07.

Similarly, its margins were also intact at 2.2 per cent despite a 30 basis point increase in the cost of funds.

Says D'Souza, "We are confident of maintaining overall loan approval and disbursement growth of 25 per cent. Despite rising costs, we have been able to maintain our margins while achieving our targeted growth in approvals and disbursements."

The stock trades at 5.7x and 4.8x estimated FY07E and FY08E book value respectively after excluding the value of investments in insurance, bank and asset management. Analysts feel that the company is fairly valued and investors can look at the stock as a long term investment for over a year.

Dewan Housing Finance (DHFL)
Unlike bigger players like HDFC and ICICI Bank, DHFL caters to less competitive lower and middle class segment in the income group of Rs 5,000-15,000 per month and urban and semi-urban areas through 60 odd service centres and 50 branches.

The company's loan book has grown at a CAGR of 28 per cent in last five years and is targeting to grow by 25-30 per cent for next few years. Similarly its profit grew 20-25 per cent in H1FY07 and is expected to be maintained.

Says Wadhawan, "We will be able to maintain the net interest margins at 3-3.5 per cent and are comfortable with a capital adequacy ratio of 13.5 per cent." The stock trades at 1.9x and 1.7x estimated book value for FY07E and FY08E respectively.

LIC Housing Finance
LIC Housing Finance is the second largest housing finance company with good presence in Tier-I cities in North and South India. Its loan book of Rs 14,690 crore as on March 2006 has grown at a CAGR of about 25 per cent over the last three years.

In Q2 FY07 though its total disbursements grew marginally, its retail loan book grew 20 per cent year-on-year and net interest margins improved 80 basis points to 2.6 per cent, thanks to the effect of interest rate hikes.

The stock trades at 1.4x and 1.2x estimated FY07 and FY08 book value respectively. Its low valuation is also because of its higher NPAs of about 2 per cent and comparatively lower return on equity of 16 per cent.

However, the company has targeted an NPA of one per cent by the year end, which is a positive development.

ICICI Bank
ICICI Bank, India's largest private bank, is also the largest player in the housing space among banks. Of its total retail loans of Rs 1.08 lakh crore, housing loan poertfolio accounts for about 40 per cent.

In Q2 FY07, its net profit grew 30 per cent due to higher net interest income and robust fee income even as NIMs remained flat at 2.5 per cent due to a 42-basis point rise in deposit costs.

Analysts expect the bank's margins to improve as the bank has raised its lending rates in the past few quarters. The bank has raised its home loan and other retail loans by 250 basis points in last 12-18 month period.

The stock trades at 2.5x and 2.2x estimated FY07 and FY08 book value respectively excluding the value of investments in subsidiaries.