Gradual re-rating to continue
Tailwinds to spreads
Over the last two years, LICHF has diversified its borrowing profile significantly. Share of bank borrowings has declined from ~25% to ~10%, while the share of market borrowings has increased to ~90%. In the last 18-24 months, while the repo rate has been cut 175bp, banks have cut rates only by 75-100bp. G-Sec yields have fallen more. As a result, HFCs with large share of bank borrowings have not benefited as much as LICHF, which predominantly borrows from the market.
In 2014 and 2015, inflation was high; to counter this, the RBI sold bonds worth INR1t in the market, causing liquidity deficit. With easing inflation, the RBI started purchasing bonds through open market operations (OMOs) in December 2015. Since then, its overall bond purchases have been close to INR1.9t. The OMOs have resulted in G-Sec yields dropping 100-120bp in the past 6-9 months (see exhibits 1 and 2). Our Economist expects further OMOs of INR700b over FY17.
Repo rate and G-Sec yields are highly correlated. Over 2001-03, when the RBI cut repo rate significantly, G-Sec yields fell even more sharply (see exhibit 3). Our Economist expects at least one repo rate cut by the end of FY17, with another 1-2 rate cuts in FY18. When we published our last update on LICHF in August, G-Sec yields were 7.1%; since then, they have fallen to 6.7%. Given continued RBI OMOs and reduction in repo rate over the next 6-12 months, we believe G-Sec yields could drop further over the next 12 months. LICHF has NCDs worth INR220b (~20% of total outstanding borrowings) maturing in FY17 and FY18, which would help it to save 30-40bp in cost of funds over the next two years. Among all HFCs in our coverage, we believe LICHF would be the biggest beneficiary of falling yields.
Another big impact of the RBI OMOs has been that AAA bond spreads over GSec yields have narrowed significantly. While the average spread has been ~80bp in thepast one year, it had increased to 1.5% in March 2016 due to the liquidity deficit. However, since then, spreads have come off significantly to around 35bp today (refer Exhibit 5), with most of the spread compression in August and September. Given the liquidity situation today, we expect spreads to sustain at these levels.
Over the last five quarters, LICHF has grown its LAP book rapidly. The share of LAP increased from 4.6% in 4QFY15 to 9.3% in 1QFY17. On an incremental loans basis, the share of LAPs increased from 17% in 1QFY16 to 37% in 1QFY17. Incremental spread increased from 1.74% to 1.98% over the period. This has helped shore up NIM to 2.6-2.7%. However, the management has indicated that it would not increase the share of LAP any further. While this would put pressure on incremental yields, LICHF would get the benefit of lower incremental cost of borrowings due to falling G-Sec yields. We believe LICHF would maintain incremental spread above 2%. We believe consistently achieving 2% incremental spread over the next few quarters would be a trigger for the stock to re-rate in line with peers.
LICHF is currently originating pure floating rate loans at ~9.5% and other home loans at ~10%. Banks are also originating loans at 9.3-9.5%. We believe banks would be averse to reducing home loan rates further, as they would have to reduce MCLR, as a result of which the whole loan book would get re-priced. Hence, we believe LICHF would not need to reduce rates substantially to remain competitive.
LICHF has a granular loan book with retail home loans comprising ~88% of the total book and the LAP book comprising an additional ~10% of the total book. Since around two-thirds of its loan sourcing is from LIC agents, LICHF is able access the length and breadth of the country. We believe LICHF would be a big beneficiary of the tax incentives announced in the FY17 Union Budget. It could gain some share from banks due to competitive pricing. We expect loan book CAGR of 19% over FY16-19.
LICHF has robust asset quality, with GNPA of 0.59% and NNPA of 0.29%. Asset quality in individual loans is even better, with GNPA of 0.35%. This compares very well with its private-sector housing finance peers. The company has sustained good asset quality over the past several years due to its stringent underwriting discipline. Loan-to-value ratio on incremental disbursements is 47%, down from 50% in FY15. Installment-to-income ratio is 32%, down from 34% in FY15. Asset quality is expected to remain stable, which would support RoE and drive re-rating.
LICHF stands to benefit significantly from the growing demand for mortgages coupled with falling interest rates. Over the past few quarters, change in loan mix has led to 2%+ incremental spread. We expect 2% incremental spread to continue and believe that the stock price does not factor in sustained spread improvement due to falling G-Sec yields and narrowing AAA spreads. Post an earnings growth of 22% in FY16, we expect this momentum to sustain and model 23% PAT CAGR over FY16-19. RoE is set to cross 20% in FY17, which would drive further re-rating. The stock trades at 2.4x FY18E BV, a discount to peers. Buy with a target price of INR758 (3x FY18E BV).
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