Home loan majors face profitability threat

The housing finance sector's overall profitability is likely to come under pressure since the incremental return on equity (RoE) is very low.

According to a Crisil study, the incremental RoE for banks is at best 9.01 per cent as compared to a RoE of 18.8 per cent in the financial year 2002-03.

It is even lower at about 6.93 per cent for housing finance companies (HFC) compared with 20.53 per cent in 2002-03.

The rating agency said such low returns are unsustainable in the long run and could push up interest rates by 50 to 100 basis points. This increase could be lower if the players are able to contain their non-performing loans (NPL).

The incremental returns are low because competitive pressures in the housing finance industry have driven down yields and NPLs are fairly high.

Competition has contributed to a sharp decline in housing finance rates and an improvement in service standards, which in turn has led to the expansion of the market.

Apart from pushing down lending rates, competitive pressures have compelled players to reduce their administrative costs and processing fees. These fees are even waived off in several cases.

All these factors have put significant pressure on the lenders' spreads, the study observed. Low yields on housing loans and high NPLs are adversely affecting the players' profitability.

The low profitability has also suppressed the housing finance players' RoE significantly. One of the reasons for these low returns is that banks are flush with funds but have limited deployment avenues. Since the housing finance segment is showing good growth rates, banks are diverting funds here.

Also, the sector is a better alternative to parking funds in g-secs, where the RoE is negative. Moreover, a large number of players seem to be looking at only the marginal cost rather than the full cost of their housing loan products.