Affordable Housing: Big opportunity but challenges galore | The Financial Express

Affordable Housing: Big opportunity but challenges galore

Despite mortgages being an extremely competitive product segment, affordable housing finance companies (AHFCs) have found a niche in serving an inadequately serviced customer segment.

For the current set of AHFCs, productivity levels haven’t been very encouraging.

By Pankaj Agarwal

Affordable housing market is Rs 4 trillion and we expect it to grow at 15% CAGR over 10 years given shortage of housing, government push towards house ownership (under PMAY scheme)  and increased availability of finance. Housing finance companies focusing on this segment are natural beneficiaries of this growth opportunity.  However, long-term growth expectations overlook challenges that would come with scale, such as higher competition and operational intensity.

Mortgages have a long way to go

As of FY22, the size of the mortgage loans outstanding is estimated at Rs 25 trillion, representing 10.3% of GDP. This is lower than 60% and ~30% for US and China, respectively. Regionally, south and west have seen higher mortgage penetration, owing to their traditional status of being trade hubs. Central and north India seem to hold good growth potential given substantial contribution to population and GDP. Based on numerous data on Indian households’ balance sheet and income levels, mortgage affordability does not seem to be a significant challenge. 

Affordable HFCs better placed to serve the masses

Despite mortgages being an extremely competitive product segment, affordable housing finance companies (AHFCs) have found a niche in serving an inadequately serviced customer segment. As a result of their distinguished market focus, AHFCs have witnessed AUM growth of 25-30% YoY, even >30% in select cases.

Tier 3 markets have seen highest growth in mortgages over the last decade, at 19% CAGR compared to 11% in tier-1 markets. Given the banks’ large balance sheets, chasing small-ticket loans (~Rs1mn) with higher customer and credit risk, may not be optimally remunerative. Hence, AHFCs’ deep distribution has enabled them to better serve the demand in far-flung markets. Further, AHFCs’ customers are typically characterized as self-employed or cash-salaried without any or inadequate formal income proof, making it difficult for banks to underwrite. Most notably, Aavas and Aptus are the ones with higher share of business coming from tier-3 and below markets as well as self-employed informal income customers.

As AHFCs undertake the distribution and underwriting effort, they are able to compensate for the same by charging higher spreads, which is usually 3-4x of financiers operating in tier-1 markets.

But is the current performance sustainable?

We are at a vantage point where the base is low (Rs5-10bn AUM), capital structures are not fully optimised as leverage is low and cost ratios are elevated, fuelled by high business growth and distribution expansion. At this juncture, it would serve investors a great deal of benefit to reflect on historical performance of the non-bank sector, including HFCs. Warren Buffet once said: “In this business world, the rearview mirror is always clearer than the windshield.” Historically, non-banks have not grown at more than 15-19% CAGR over long periods of time as scale catches up. Therefore, given the highly competitive nature of the product segment, AHFCs are unlikely to maintain their current growth trajectory of >25% over the long-term as they attain a larger scale.

There is good evidence of banks becoming more active in this segment than they were before. Margins are unlikely sustain at current levels due to increasing leverage and competition. Historically, companies have mitigated margin pressure by improving efficiency. For example, Gruh experienced declining spreads but it was able to mitigate the profitability impact to some extent by improving efficiency. However, productivity improvement has an endgame too. Gruh/HDFC are good examples of how, despite improving productivity, operating profit margins declined, explained almost entirely due to competitive pricing.

For the current set of AHFCs, productivity levels haven’t been very encouraging. In view of granular and hands-on nature of the business, recurring growth investments are required. As a result, cost ratios are expected to remain elevated. Thus, it can be concluded that as AHFCs gain scale, their turf becomes more competitive, leading to an inevitable decline in structural profitability. In the current rate environment, higher cost of borrowings is likely to weigh on margins as competition from banks and inflationary environment would make full transmission of repo rate hike difficult.

High expectations, most common forerunner of disappointment

Growth expectations around AHFCs, seemingly overlooking the long-term competitive, scalability and profitability challenges, are likely to be met with disappointment. Besides the sector challenges, we observe company specific factors that would derail the current performance metrics over the medium-to-long-term. 

(Pankaj Agarwal, Analyst (Banking & Financial Services), Ambit Capital. Views expressed are author’s own. PLease consult your financial advisor before investing.)

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First published on: 05-03-2023 at 13:00 IST
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