LIC Housing Finance: BUY

If there is one segment that sprung surprises during the year, it was the home loan segment that continued to deliver steady growth despite macro headwinds. The inherently strong demand in the housing loan market has held the performance of LIC Housing Finance (LICHF) — one of the largest mortgage lenders in the country — in good stead. Despite intense competition, LICHF continued to show strong momentum, delivering loan growth of 20 per cent in the September quarter.

Contrary to expectations, the company was also able to maintain stable net interest margin (NIM) in spite of volatility in interest rates, thanks to increase in lending rates.

Till a few quarters back, declining margins and hence pressure on the company’s return on equity, was a big concern for the stock, which has lost close to 25 per cent in the last one year.

However, with interest rates returning to normalcy in the bond market and the company hiking its lending rates recently, pressure on NIM is now minimal. Also, LICHF is seeking to increase its exposure to the high-yielding developer loan segment, which should aid margins.

With an earnings growth expectation of 17-18 per cent, the stock trades at an attractive valuation of 1.3 times its one-year forward book value, lower than its five year historical average of 1.6 times. The stock is also trading at a steep discount of 65 per cent to its peer HDFC. Investors with a two- to three-year investment horizon can buy the stock at current levels.

In spite of increasing competition from banks, LICHF has been able to grow its loan book by 30 per cent annually during the last four years.

Growth momentum continues Focus on dual rate loans, offered mainly to the salaried segment, has made this possible. The outstanding mortgage portfolio stood at Rs 83,216 crore as of September.

The retail loans, which constitute 97 per cent of overall loan portfolio, grew 21 per cent. Disbursements in this segment declined1 per cent during the September quarter, which was mainly due to the management’s conscious decision to cut lending as the cost of funds shot up. Easing of liquidity conditions and festive discounts will see the disbursements in the retail segment pick up in the quarters ending December 2013 and March 2014.

The developer loan portfolio, which is just 3 per cent of total loans, saw disbursements more than double during the September quarter. The management has indicated increasing the share of higher yielding developer loans to around 5 per cent in the 2014-15.

The outlook for the housing finance industry over the next three-five years remains sanguine on account of strong demand from the mid-income group and favourable demographics. The Indian mortgage market continues to remain under-penetrated vis-à-vis other Asian countries. The home loan-GDP-ratio loans in India is around 8 per cent which indicates huge opportunity for both banks and housing finance companies (HFCs).

We expect LICHF to grow its loan book by 19 per cent annually over the next two years, driven by the retail segment. The developer segment, however, may take some more time to pick up as macro headwinds persist.

Margins to remain stable In the last two to three years, HFCs have witnessed heightened competition. With banks moving to the base rate mechanism, the cost of funds for HFCs went up as they borrowed at the minimum benchmark rate for onward lending. Also, banks have started to price their products aggressively. This led to decline in margins for HFCs.

In the last two years, LICHF saw its NIM decline by 100 basis points from 3.1 per cent to 2.2 per cent in 2012-13. As a result, the RoE for the company declined from 25 per cent to 17 per cent. However, in the last two quarters, the company has been able to keep its margins steady at 2.2-2.3 per cent. Even in the September quarter when borrowing costs shot up owing to tight liquidity, the NIM declined by only 8 basis points. This was due to a rise in lending rates during the quarter, which offset the increase in cost of funds.

LICHF also has a diversified funding mix. The flexibility to switch between these resources has helped the company maintain its margins.

LICHF’s share of funding from bank borrowings went up during the September quarter to 29 per cent from 25 per cent in the previous quarter, which helped handle the interim tightness in liquidity.

As the bond market returns to normalcy, LICHF will incrementally borrow through non-convertible debentures (NCD), reducing its dependence on bank borrowings to 24-25 per cent. This should bring down the cost of funds from 9.7 per cent in the September quarter. The average cost of borrowing through banks is 10.7 per cent, while cost of borrowing through NCDs will be 9.4-9.5 per cent.

Concerns on asset quality ease Owing to the secured nature of retail loans and a conservative loan-to-value ratio, LICHF has been able to maintain good asset quality in the retail segment. The gross non-performing assets (GNPAs) as a percentage of retail loans declined to 0.4 per cent as of September from 0.6 per cent last year.

LICHF did see some pressure on its asset quality the end of 2012-13, when three accounts went delinquent in the developer segment. Even now, nearly 40 per cent of the total GNPAs are from the developer segment, amounting to Rs 236 crore from three accounts.

But since the first quarter of 2013-14, there have been no fresh slippages in this segment and the company is in the process of recovering the amount from the delinquent accounts. Overall, the GNPAs as a percentage of total loans continue to remain below 1 per cent.

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