Housing finance companies to gain most as cost of funds fall faster than lending rates
Banking & Finance
Rating: BUY -LICHFL, HDFC, IHFL
Wholesale rates are down 100+bps YTD: 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 points YTD (in-line with fall in 10-year G-Sec rates of 100 bps) vs 35-50 bps fall in one-three-year retail term deposits rates. UBS economy and strategy team expects wholesale rates to further decline, with 10-year G-Sec rates touching 6.5% by Mar ’16 (vs 7.9% now) which could translate into 100-150 bps decline in banks’ lending and deposit rates.
Lending rates likely fall in-line with base rates: While the incremental cost of funds has fallen sharply, mortgage rates have remained stable YTD (down only by 0-10bps YTD) as banks are yet to cut base rates. For loans up to R7.5m, leading banks SBI and ICICI Bank are now charging interest rate of 10.15% (base rate + 0.15%.) Large banks have not cut their base rates significantly YTD (year-to-date), consequently home loans rates have remained largely stable.
HDFC: Bond borrowings constitute 56% of borrowings for HDFC and deposits and bank borrowings, 31% and 13%.Assuming similar liability composition, incremental cost of funds would decline by 50-55 bps (assuming 100 bps decline in rates) and spreads would expand by 40-45 bps (marginally lower). On the asset side, 68% loans are to the individual segment. Assuming HDFC does not pass the benefit of lower funds cost in the individual segment (wafer thin spreads), but passes on in non-retail segment (high spreads), overall spread expansion will be limited to 25-30bps.
LIC Housing: LIC Housing could be a big beneficiary of faster decline in wholesale rates given higher bond borrowings and higher share of low margin mortgage book. LICHF’s incremental borrowing costs in the bond segment (3/5-year bucket) have fallen by 100 bps since July 2014. New book could contribute 30-35% of FY16-end book, which could result in blended spread improvement of 15 bps in FY16.
Indiabulls Housing: Bond borrowings constitute only 40% of total borrowings for IHFL (bank borrowings 60%). Incremental cost of funds would decline by 40-45 bps and spreads would expand by 30-35 bps.On the asset side, only 50% of loans are individual housing loans.
Assuming the company does not the pass on benefit of lower cost of funds in the individual segment but passes on cost in non-retail segment, overall spread expansion will be limited to 20 bps.
Mortgage spread of HFCs to expand: We believe that housing finance companies (HFCs) will be the biggest beneficiaries among NBFCs as cost of funds will fall faster than lending rates. Mortgage rates for large players have remained stable (down just 0-10 bps YTD) as banks are yet to cut base rates. But incremental cost of funds for HFCs has fallen by 40-70 bps as bond borrowings constitute 40-68% of total borrowings of leading HFCs. As a result, incremental spreads have improved by 20-60 bps.
Robust demand and higher margins to boost earnings: Mortgage growth has remained resilient for leading HFCs and we expect growth to remain strong at 19-20% over FY16-17e. Loan growth in the 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. We expect HDFC’s earnings (standalone) to improve from 15% CAGR over FY12-14 to 20% CAGR in FY16-FY17e, whereas LICHF could report 29% earnings growth CAGR in FY16/17e.
LICHF preferred pick: LICHF remains our preferred pick (Buy, new PT of R550) on falling interest rate cycle and likely improvement in mortgage spread. We also upgrade our ratings on HDFC and IHFL to Buy with new PTs (price targets) of R1,300 and R575 on favourable business cycle.