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Spark Capital : Sector Note on Housing Finance Companies; Downgrade HDFC to SELL, Maintain SELL Rating on LIC HF




Spark Capital Advisors(India) Private Limited


14 Jan 2013





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Sector Note on Housing Finance Companies; Downgrade HDFC to SELL, Maintain SELL Rating on LIC HF Unsustainable reflexive relationship between asset price inflation and real estate loan growth Easy housing credit has large, positive, immediate and widely distributed benefits, whereas all the costs lie in the future. It has a pay-off structure that is precisely the one desired by politicians, which is why so many countries have succumbed to its lure. It pushes up house prices, making households feel wealthier and allows them to finance more consumption” – Raghuram Rajan, Chief Economic Advisor, GoI in his book ‘Fault Lines’. We regard his views extremely important, as, if our reading is right, he should succeed Dr. Subbarao as the next RBI Governor later this year. We have a negative view on Housing Finance Companies (HFCs) for reasons explained below. Downgrade HDFC to Sell (from Buy) and retain Sell on LIC Housing. It has been a decade of indulgence on real estate loans in India - Retail home loans extended by banks and larger HFCs are up 10.7x to Rs. 5.5tn whereas Commercial real estate loans are up >16x to Rs. 1.7tn over this decade. We observe that close to 67% of the loan growth during this phase is from ticket size increase indicating the huge extent of asset price inflation driving loan growth. In fact, our analysis suggests that ~80% of HDFC’s loan growth over the past decade is due to increase in its average ticket size of its loan book. The number of outstanding home loans in the system are up only 3x during this phase and importantly, it has been flat for many lenders since end of FY11. We do not see real estate asset price inflation having sufficient legs to continue its uptrend going forward due to which volumes need to be the only growth driver. Volumes are unlikely to pick up unless prices trend down sharply, which should create challenges on growth, profitability and asset quality of HFCs, esp. the CRE book. Indices, which measure affordability across 375 cities globally on the basis of EMIs to Net Income, Mortgage to Annual Net Income and rentals to home prices parameters rank 10 key Indian cities on bottom quartile. Significant slowdown seen in absorption rates of apartments over the past year with demand-supply largely matched in the segment with the maximum supply. Office and retailing space show similar trends. Anecdotally, employees of the IT sector have driven >50% of incremental housing demand over the past decade. Fresh domestic hiring by IT companies are at the same level now to that seen in 2006. Wage hikes have trended down and importantly, ‘onsite stints’, which contribute in funding the equity of a home purchase, have been falling. Limited room for tenor increase going forward, given that most loans have high tenors already. A 1% drop in lending rate can increase borrowing capability by only 4% while tenor increase by 5 years increases the same by ~20%. A 10% drop in home loan prices will mean that home loan disbursement volumes need to grow 33% to retain a 20% overall loan book growth. With no penal charges on prepayments, pressure on volume driven disbursements get higher to as much as 40%, not likely in our view. Moreover, increased competition has meant that the economics of a home loan are unattractive for a HFC with sub-optimal RoE unless the CRE proportion is atleast 15% of total loans. Moreover, we see leverage levels of HFCs are too high given the monoline inflation-fuelled loan book, w...

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