Housing Development Finance Corporation, India’s largest mortgage lender, has largely remained a mute spectator in the bull run in the Indian stock markets during the past 18 months.
“HDFC has underperformed the NIFTY Bank/Property index by 15 percent/40 percent over the last one year due to multiple concerns over fundamental business drivers due to competitive headwinds, as well as asset quality challenges during the pandemic,” global brokerage Goldman Sachs in a recent report.
The contribution of core mortgage value to market capitalisation remains depressed at 45 percent but this could change as business prospects for core mortgages improve, the brokerage added.
Brokerages attributed the underperformance to factors such as the current growth in home loans due to low interest rates. Experts said disbursements are likely to face headwinds once the interest cycle reverses.
“With a turning rate cycle, the best of margins for HFCs (housing finance companies) like HDFC is behind; with a high base, we expect net interest income growth to lag AUM (assets under management) growth,” CLSA said in a report.
Net interest income grew at a subdued 2 percent on-year in the third quarter of FY22 due to a high base a year earlier and increasing reserve requirements.
The underperformance was also due to the tepid show of shares of group companies HDFC Bank, HDFC Asset Management Company and HDFC Life Insurance Company.
Demand in the real estate sector is reviving, with strong traction in property sales, falling inventory levels, new launches and consequently, improving confidence on asset quality.
Earnings growth
Goldman Sachs said HDFC’s improving asset quality, strengthening balance sheet, healthy lending spreads and expanding market share in the retail business make for improved visibility on earnings growth.
It said earnings would grow at a compounded annual growth rate (CAGR) of 14 percent from FY22 to FY25, resulting in a core RoA (return on assets) of 2 percent by FY25.
According to CLSA, “Stage-3 assets increased from 2 percent to 2.3 percent due to a change in the Reserve Bank of India’s non-performing asset recognition policy. Adjusted for the change, stage-3 assets reduced to 1.8 percent with a meaningful drop in non-individual NPAs (from 4.7 percent to 3.9 percent).”
Buzzing market
The realty market gained strong traction during the third quarter, with the residential segment growing 10 percent YoY and 30 percent on-quarter. Office space leasing was almost back to pre-COVID levels.
Strong focus enabled HDFC to increase the percentage of loans to developers in its portfolio. Its developer book grew at about 15 percent CAGR over FY16-21 and while the asset quality in this segment has been better than that of peers, it has also proactively cleaned up portfolios.
“We are baking in a healthy pick-up in corporate demand driven by a turnaround in the real estate cycle and assume loan growth at an 18 percent CAGR through FY21-25,” Goldman said in its report.
Maintaining leadership
HDFC has gained market share by 200 bps since May 2019 and now accounts for about 18 percent of total retail loans.
“We calculate that in the recent quarters post-COVID, the company has actually grown faster than the banking industry, suggesting share gains from not only other HFCs but also from the smaller banks,” Goldman said in its report. “We believe that HDFC’s retail loans can grow at about 15 percent CAGR over FY21-25, on the back of increased market share gains.”
As a result, individual mortgages are expected to account for 74 percent of the total loan book in FY25, up from 68 percent in FY15 and 72 percent in FY20. The brokerage expects the mix of developer loans to increase to 19 percent in FY25 from 17 percent in FY22.
“We expect this to have an accretive impact on margins, given the higher yielding nature of this book, while supporting overall loan growth,” Goldman said.
Margins likely to sustain
With increasing competition and banks trying to gain market share by aggressively cutting rates, spreads have come under pressure. The spreads between home loan rates offered by major lenders and G-Sec yields have reached their lowest in almost a decade.
Still, the brokerage said that with a liability mix that has a higher share of fixed-rate borrowings, superior treasury management as well as some pricing power given its significant market share, HDFC can deliver healthy margins of about 2.9 percent over the next three-year period.
Strong investment case
Based on these factors, the risk-reward ratio for HDFC has become much more favourable, especially since valuations have depressed considerably.
Goldman estimates the mortgage lender currently trades at a “16.1x FY23E P/E and 2.0x FY23E P/B on a standalone basis (after adjusting for current market valuations of subsidiaries), which is significantly below long-term mean multiples of 22.6x P/E and 3.5x P/B (standalone).”
Sustained market share gains, stable spreads on account of better liability management and better pricing power, benign credit costs and sufficient provision buffers will fuel earnings growth and improve ratios.
“With an improvement in loan book mix to retail at about 74-75 percent of total portfolio, we expect lower RWA (risk weighted assets) density to translate into sustainable returns, and we are baking in core RoEs (return on equity) of around 14 percent over FY23-25,” Goldman said, setting a target price of Rs 3,081 over a 12 month period.
HDFC shares closed at Rs 2,437.05 on the National Stock Exchange on February 23.
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