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Scrips of housing finance companies (HFCs) — HDFC and LIC Housing Finance — are on an upside. Fall in bond borrowing rates is a key reason for this rally, as it leads to lower borrowing costs for these HFCs and improves their overall profitability. Lower spread (difference) between banks' home loan rates and base rates (at 15 basis points) is another positive factor, as banks cannot cut home loan rates below their base rates. Thus, HFCs would have more leeway on home loan rates, enabling them to push loan growth on the one hand, while lower cost of funding will support their margins on the other.
Though the two stocks have seen minor correction last week led by the selling in broader markets, they are once again looking up and are trading a tad short of their all-time highs made in the last two-three weeks. HDFC, for instance, trades 4.4 per cent lower than its high of Rs 1,177 made on November 28, while LIC Housing trades 10.6 per cent below its high of Rs 463 made on December 10. Both the scrips have outperformed the S&P BSE Sensex in the past month, a trend likely to sustain going ahead.
While the developments on the business front will benefit all HFCs, LIC Housing stands to gain the most, believe analysts. This is because bonds form about 70 per cent of its funding versus 56 per cent funding via bonds and debentures in case of HDFC. Lower borrowing costs will rub off favourably on the margins and consequently earnings per share of these companies.
"We forecast meaningful NIM (net interest margin) expansion in FY16 and FY17 for LIC Housing Finance, driving FY15-17 EPS (earnings per share) CAGR (compound annual growth rate) of 31 per cent," write analysts at Morgan Stanley in a recent report. The brokerage expects LIC Housing Finance's NIM to expand 18 basis points each in FY16 and FY17 to 2.4 per cent and 2.6 per cent, respectively. For HDFC, standalone NIMs are expected to improve eight basis points to 3.9 per cent in FY16 and to 3.92 per cent in FY17.
UBS analysts, too, share a similar view and prefer LIC Housing in this space.
In a December 18 report, they say with easing liquidity and lower inflation, wholesale rates have fallen faster than retail term deposit rates with three-year AAA rates declining by 130 basis year-to-date (in-line with fall in 10-year G-Sec rates of Rs 100 basis points) versus Rs 35-50 basis points fall in 1-3 year retail term deposits rates, which is positive for HFCs. UBS economy and strategy team expects wholesale rates to further decline and believes that HFCs will be the biggest beneficiaries among NBFCs, as cost of funds will fall faster than lending rates.
Operationally as well, both these companies have continued to post consistent financial performance. Loan book has grown at a healthy clip at 15-16 per cent for HDFC (net of loans sold) and 16-17 per cent for LIC Housing over the past few quarters. Strong traction in individual loans fuelled overall loan growth and also enabled asset quality to remain largely stable amidst a slowing economy. Both these companies have managed to keep their asset quality strong with both gross and net non-performing assets (NPA) ratios at negligible levels. The gross and net NPA ratios stood at 1.02 per cent and 0.53 per cent, respectively, for HDFC in the September 2014 quarter. For LIC Housing, these metrics stood at 0.63 per cent and 0.33 per cent, respectively, in the quarter.
Going ahead, the companies will benefit from improving loan growth as well as profitability.
"Mortgage growth has remained resilient for leading HFCs and we expect growth to remain strong at 19-20 per cent over FY16-17. Loan growth in non-mortgage segment has been subdued; however, this should pick up in H2FY15/FY16. This coupled with improvement in margins would boost earnings growth of HFCs," say UBS analysts. The brokerage has a target price of Rs 1,300 for HDFC and Rs 550 for LIC Housing.
Most analysts remain positive on the prospects of both these companies but believe near-term positives are reflecting in valuations. At current level, HDFC trades at about 5.3 times FY16 estimated book value, while LIC Housing trades at 2.1 times FY16 estimated book value. Nevertheless, investors can consider corrections to buy these stocks, as the long-term prospects of these companies remain good considering their dominant position in the business, strong financials and brand equity, and vast growth opportunity in the domestic market. Also, for HDFC, there is potential for value-unlocking in the form of listing of its insurance subsidiaries, which is expected in one-two years.
