LICHF’s individual mortgage book is now 75% floating rate vs 35-40% floating in the last cycle when rates spiked (CY13). With 85% of funding in bonds vs 65% in last cycle, the existing book repricing should have a favourable impact on NIMs.
LICHF has underperformed NIFTY by 48% and peer HFCs by 10-80% in last 12 months, due mainly to pressure on incremental spreads. Historically, LICHF has been more sensitive than peer HFCs to incremental mortgage spreads, leading to the larger de-rating. While incremental mortgage spreads have remained under pressure for some more time, we now see value in LICHF, as: (i) Back book assets reprice faster than liabilities— LICHF is different in this cycle with +70% floating loans vs 40-45% floating loans in last cycle; (ii) improving core mortgage trend; (iii) with a 50% de-rating from the peak, valuations at 1.4x FY20 book are undemanding with +15% growth CAGR and at least 16-17% RoEs. Our revised target price of `600 is based on 1.75x Jun-20F book.
LICHF different in this cycle: back book repricing to be favourable
LICHF’s individual mortgage book is now 75% floating rate vs 35-40% floating in the last cycle when rates spiked (CY13). With 85% of funding in bonds vs 65% in last cycle (fixed rate liability), the existing book repricing should have a favourable impact on NIMs and aid in offsetting the pressure seen on incremental mortgages. So while we believe that incremental spread pressure will remain for FY19F, the back book repricing should help offset the negative from lower incremental spreads. Thus, we now expect overall spreads to remain flat at 140bps over FY19-20F.
Valuations reasonable for 16-17% RoE and 15% CAGR growth
With stable spreads, we expect LICHF’s RoEs of 17% and with 15% CAGR growth expectations, valuations at 1.4x FY20 book are undemanding. Incrementally, core mortgage growth trend for LICHF has improved and on a system level demonetisation/GST/RERA drags on mortgage growth are behind. In CY2013, LICHF multiples cracked to 1.1-1.2x 1 year forward book but given the higher share of floating rate assets now, we expect spreads and multiples to hold up better for LICHF in this cycle. Improvement in liquidity situation should spread further and could lead to upside medium to long term.
Back book repricing to offset incremental spread pressure: what’s different now?
Historically LICHF’s spreads have been most sensitive to tighter liquidity conditions, as they have had a large part of their asset book being fixed rate; hence in a rising rate environment, the negative impact of lower spreads on incremental lending significantly outweighed the positive impact from faster asset pricing vs liabilities on the existing book. This reflected in higher margin pressure and higher stock volatility. Even in the last 12months, LICHF has underperformed peers by 10-80%.
LICHF’s asset book is now 70% floating and with majority of borrowing being bonds, rising rates will have a larger positive impact on LICHF’s existing book in this cycle rather than last cycle and should aid in offsetting the pressure from lower incremental mortgage spreads. LICHF has taken +30bps hike in lending rates which will have a positive impact on +70% of the asset side, while liability repricing will be gradual as 85% of their book is bond-funded. The company expects `210 bn of bonds to mature in FY19F, where the yields are 8.5% which could be funded by a similar cost of liabilities today.
Incremental mortgage spread pressure remains
Incremental mortgage spreads have been under pressure since Jan-18 and that was the key reason for our cautious view on HFCs. Incremental mortgage spreads have come off from 130-135bps pre demonetisation to ~50-60ps now. With current global and local macros, we do not expect the rate cycle to turn benign; hence incremental spreads should remain under pressure. This is the reason why our target multiple for LICHF at 1.75x book (Jun-20F) is lower than the long-term average.