Friday, February 26, 2010

>Indian Housing Finance companies: Ready for a takeoff once again

Given India’s rapid population growth, increasing urbanisation and rising affordability the housing finance market will continue growing. However, given increasing competition in the sector from banks, HFCs with access to low cost funds, better operational and credit cost control, and better service quality will find life easier. In a supportive macroeconomic environment and with competition from banks likely to reduce due to the new base rate regime, we initiate coverage on LIC Housing with a “Buy” stance.

Structural Growth Drivers in Place
An underpenetrated mortgage market (~Mortgage to GDP at 7% vs ~80% for USA and 12% for China), favourable demographics (60% of population <> years), increasing urbanisation and improving affordability will ensure that
demand for mortgage loans will continue to grow at a healthy pace (FY00-10 CAGR of 24%).

However the road ahead is not smooth
However, given the perpetual competition from banks, lower spreads, highly rate sensitive customers, HFCs need to exhibit the following key characteristics to compete successfully:

Access to low cost funds and liquidity: Whilst the importance of low cost of funds has always been obvious, Sep-08 brought home the importance of having access to liquidity.

Credit appraisal skills: This is particularly hard in India given the weakness of credit bureau data and difficulty in credit enforcement.

Quality of customer service: This is the key differentiator in a commoditised market where banks are bound to have lower cost of funds.

Cost efficient structure: Critical if an HFC is to competitively price its loans and still maintain profitability.

A growing and underpenetrated market
Against the backdrop of an economy growing at a 10 year CAGR of 7%, mortgage disbursements have risen at a CAGR of 24% over the last decade and the total mortgages outstanding have increased to ~Rs, 4,100 bn at Dec’09 (vs ~Rs. 1,200 bn five years ago). We see this trend continuing due a variety of reasons none of which are particularly contentious. At around 7%, the mortgage:GDP ratio in India is amongst the lowest in the world (see figure 2). A huge shortage of housing units (~25 mn), limited availability of housing finance, the limited reach of HFCs and Indians traditionally being averse to credit had been the major reasons behind low mortgage penetration in India. But this trend is changing, with more Indian households becoming more open to credit, increased availability of home financing and with increasing construction of affordable housing units.

Some socio-economic trends are also helping on this front:

Increasing urbanization and nuclearisation: India is increasingly becoming an urbanized country (urban population is~31% of total population vs 28% a decade ago) with people migrating to the cities in search of employment. This is leading to higher demand for household units in urban areas where availability of housing finance is higher than in rural areas. Moreover from being a nation of joint families, India is increasingly becoming a nation of nuclear families (average family size has come down to ~5 vs 6 in 1981) leading to higher demand for housing units.

Increasing affordability: Various surveys show that more Indian households are entering into higher income brackets leading to improving affordability despite increased in property prices. Whilst there is no independent data on long term affordability trends (CRISIL’s data dates back to FY02 – see Figure 3), the data provided by HDFC Ltd. shows that affordability has increased four-fold over last fifteen years as rise in salary levels have kept pace with the increase in property prices (see figure 4). Low interest rates and greater availability of housing finance has further improved the overall affordability factor.