LIC Housing Finance must fix margins as earnings cuts loom

LIC Housing Finance reported a 1 percent year-on-year drop in its core interest income for Q2FY23, but the sequential decrease was a larger 8 percent. It also showed a contraction in net interest margins and stressed loans remained elevated. Simply put, the lender’s revenues aren’t living up to expectations, it is earning less interest from loans it gives and its stress isn’t coming down as fast as that of peers.

These are all the signs that dim the outlook on profitability. Analysts believe that a 10-15 percent erosion in earnings can be seen for the current year. Morgan Stanley noted that most metrics were way below its expectations and has kept an underweight rating on the stock.

The margin conundrum

For lenders, a key indicator of profitability is margins. LIC Housing Finance reported a sharp 74 basis points contraction in net interest margin to 1.80 percent for the September quarter. One basis points is one-hundredth of a percentage point. This was unexpected as most analysts had pencilled in stable margins or even a small improvement owing to hikes in loan rates. What bothered investors more was the fact that margins contracted despite the lender hiking its loan rates by as much as 60 bps.

In a call with analysts, LIC Housing’s management explained that a bunch of loans with fixed rate were converted into floating rate loans that led to margin erosion in part. The housing finance company was motivated to keep loan rates benign in this conversion in order to retain high quality retail borrowers.

“For full year FY23, we are confident to deliver better margins,” said managing director Vishwanatha Gowd.

That said, analysts are still reserving their judgement here. “Q3 NIM improvement is given with 115 bps rate hike coming into play and assuming there is no significant NPV loss entailing loan repricing. However, whether and when co. will regain 2.4-2.5% NIM level would be difficult to estimate,” wrote analysts at Yes Securities Ltd.

Gaurav Jani, analyst at Prabhudas Liladher believes the outlook on margin is still hazy. “We would be conservative in our estimates than we were before,” he said.

One reason is that the lender’s borrowing is unlikely to come down. For Q2 alone, its borrowing cost has gone up 34 bps. Since more than 30 percent of LIC Housing Finance’s liabilities are bank loans where pass-through is faster now, its cost of borrowing would only go up.

Yet another problem is the loan mix. The company has been consciously reducing the share of margin-friendly project loans and even loan against property. More so, it wants to pursue retail customers with high credit scores that typically borrow at fine card rates. In essence, margins are likely to remain under pressure.

That pebble in the shoe

For investors, a major irritant has been delinquencies from the lender’s project loan portfolio. Loans to developers has historically shown an elevated delinquency ratio. As of September, 42 percent of project loans were non-performing.

To be fair, LIC Housing Finance has been pruning its project loan portfolio (a 20 percent contraction in a year) and the share of the safe retail home loans is now a neat 83 percent in its total loan book.

That did not prevent slippages in the September quarter and the lender’s restructured book stands at Rs 3,400 crore, which majorly are project loans. Further, the lender wrote off Rs 1,900 crore worth of loans.

Despite this, provisions went up as the lender sought to increase its insurance against future risk. Analysts warn that the restructured book would need close monitoring.

The bright spot for LIC Housing Finance is the growth in its retail housing loans (15 percent for Q2FY23). To get back into investors’ good books, the lender needs to deliver on its margins.

Jani believes that further downside to the stock is limited as the outlook from here on is positive. As such, its beaten down valuation multiple is sure to inspire bargain hunting among investors.