Strong parentage, robust growth in loans, big-ticket housing loans driven by higher presence in larger cities, lower returns due to relatively higher cost and lower margins, and stable asset quality — this about sums up the story of PNB Housing Finance so far, a subsidiary of State-owned Punjab National Bank.

The stock’s post-issue valuation — 2.4 times its FY16 book value at the upper end of the price band of ₹750-775 per share — lies between the valuations of other housing finance companies (HFCs). From 1.9 times (Dewan Housing) to about 3.4 times (Indiabulls Housing and LIC Housing) and five to six times (HDFC, Repco Home and Canfin Homes) to as high as 14.8 times (Gruh), valuations are widely spread for players in this space. The PNB Housing Finance issue, which is priced close to the lower end of this range, offers a good opportunity for long-term investors with a high-risk appetite.

Nonetheless, with growth in loans for the company expected to moderate, intense competition in the space, exerting pressure on margins, possible rise in delinquencies due to higher proportion of non-retail loans and returns ratios to improve only gradually over the coming years, investors need to temper their expectations. For the stock to re-rate substantially from current levels, similar to the spectacular run seen in Repco, profitability has to improve notably.

Growth to moderate PNB Housing Finance has had a good run in the last couple of years, with its loan book growing by around 62 per cent and profit by 43 per cent annually between 2011-12 and 2015-16.

The company has benefited from branding and capital support from its promoter (PNB’s current holding of 51 per cent will fall to 38-39 per cent post-IPO). It offers housing loans to individuals, construction finance for real estate developers, and non-housing loans in the form of loans against property (LAP), loans for purchase or construction of commercial properties, loans against rental receivables, and corporate term loans.

The chunk of the company’s loan book comprises retail housing loans (61 per cent of total loans) and this segment has grown at a healthy pace of 55 per cent annually over the last four years. But the share of construction finance and non-housing loans has increased notably. From 3 per cent in 2011-12, the share of construction finance has gone up to 9.5 per cent of loans now, while that of non-housing loans has risen from 25 per cent to 29.7 per cent.

Going ahead, the stellar growth in loans that has mainly been led by a low base is likely to moderate. Nonetheless, the company should be able to grow its loans at a healthy clip due to geographical expansion and scaling down of loan size as it builds its presence in Tier I and Tier II cities.

PNB Housing Finance has the highest ticket size of housing loans at ₹32 lakh, far higher than the ₹20-25 lakh that HDFC and LIC Housing Finance report.

Needs watching The management has indicated that the current loan mix will more or less remain steady and it would follow a cautious approach to growing its loan book. For now, the company’s asset quality is stable and its gross non-performing assets as a percentage of loans at 0.22 per cent in 2015-16 (0.27 per cent as of June 2016), is among the lowest among other housing finance companies.

But given the rapid loan growth, particularly in the relatively riskier non-housing segment and construction finance portfolio (which accounts for around 39 per cent of the loan book), asset quality concerns may emerge.

Diversified funding mix PNB Housing Finance has a well-diversified funding mix. It The company has also been able to raise sizeable deposits, leading to over 100 per cent growth annually in the last four years.

But intense competition can continue to put pressure on margins which are already modest. PNB Housing Finance’s net interest margin at 2.98 per cent in 2015-16 is lower than the 4-odd per cent that HFCs, such as Repco, HDFC, and Gruh Finance, sport. The company’s relatively higher leverage (debt to equity) has also impacted margins.

As of June 2016, the company’s leverage stood at about 13 times. The management expects this to fall to 9-10 times over the next two to three years. Also, equity infusion, post-IPO, should bring down leverage to some extent.

The company’s higher cost-to-income ratio of about 25 per cent has led to moderate returns. This is higher than the 15-19 per cent of other HFCs. Return on asset is thus a lower 1.3 per cent against the industry’s 2-odd per cent. PNB Housing Finance has been investing in growing the business in the last couple of years. Going ahead, operational efficiencies that result in lower costs and better returns will be critical for it to offset the impact on earnings from a possible rise in bad loans.

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