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.....proxy play on housing sector growth

LIC Housing Finance (LICHF) is one of the largest deposit taking Housing Finance Company (NBFC – HFCs) in India. It has different product verticals of LAP and Developer Loans. Given its healthy liability franchise, low cost of funds, stable return ratios and promoter backing, we believe LICHF shall emerge stronger by the end of FY22. Meaningful pent-up demand in Metros & Tier 1/2 cities and lower interest rate environment should drive growth going forward. The growth in 1QFY22 was meaningful as disbursement was 2.5x of 1QFY21 in spite of regional lockdowns and Covid 2nd wave, although stress formation (GS3: 5.9% v/s 4.1% in the previous quarter) was higher than our expectation. However, resumption of economic activities since June suggest that the up-gradations and recoveries may occur sooner than anticipated. Inexpensive valuation (1x PBV) makes the stock lucrative factoring FY22/23 ROE of 12.2%/12.5%.

FY22 is likely to witness robust growth in Housing credit; LICHF to take the driving seat: The Covid-19 induced disruptions has created many challenges for housing finance companies (HFCs) in FY21. With the gradual pick-up in demand for housing credit in the industry in second half of FY21, most of the NBFCs/HFCs have already reached near pre-covid level disbursements. However, 1QFY22 was challenging for lenders because of partial lockdowns and micro containment zones. Conversely, considering management commentaries, channel checks and our scuttlebutt; we believe, the growth hurdles are behind us. We estimate the industry to witness double digit (~10%) growth in FY22 on the back of healthy disbursements and lower base of FY21. LICHF has been consistently contributing more than 10% share in housing credit and growing above the industry growth rate. Factoring the gradual economic recovery, we estimate the company to clock a growth rate of ~12% in FY22.

A strong liability franchise; cost of funds lower among peers: LICHF is reducing its dependence on market borrowings (NCDs). The share of NCDs decreased to 55% in 1QFY22 from 65% at the end of FY20. Moreover, the share of bank borrowings improved to 26% from 22% in the same period. As a result of this, the company is enjoying better NIMs supported by falling cost of funds. In FY21, Spreads improved by 58bps YoY to 1.93% driven by funding cost advantage – incremental funding costs are down 230bps YoY to 5.15%. Reported margins expanded 56bps YoY. Despite increasing competition from banks in housing finance and price competition at its peak (banks offering repo-linked loans), LICHF should witness strong delta to spreads going into FY22. We forecast NII growth of 12% over FY21-23E.

Sound capital position; Profitability to restore in 2HFY22: LICHF has approved fresh issue of 45.4mn equity shares to LIC (promoter) through preferential allotment. Capital infusion is expected to be ~₹24bn. LIC’s post-money stake will increase to 48% (from 40% currently). Separately, LICHF raised ₹18bn via Tier II bonds during FY21 to shore up capital adequacy. Given the loan book size and tier-1 ratio; the management believes, the capital to be adequate for growth and the stress would be absorbed by internal accruals. Factoring credit growth of ~13% in FY21-23E and stable interest spread; we estimate the company’s ROA/ROE to be stable at 12.5% in FY23E

Asset quality concerns persist; Secured Book a safe heaven: As per data given out by various companies in their Q4FY21 earnings release, the corporate and the housing segments have claimed a much lower NPAs, while developer, SME and vehicle financing segments have registered a higher proportion of bad loans. We also studied the historical segment-wise asset quality in terms of GNPA in which Housing Finance segment has been the best performing. As far as LICHF is concerned, we saw deterioration in asset quality with GS-3 assets increasing to 5.9%. Provisioning increased 15x YoY and flat sequentially. Total ECL coverage stands at about 1.8% (vs. 2.6% for HDFC). We think a higher ECL coverage at the cost of near-term profitability will provide a lot more comfort to investors. We emphasise the need for higher provisions by the company in few quarters to come. It may drag down the near term profitability, however, we believe the company will emerge strong by FY22 end and overcome the credit quality woes.

Outlook and Valuation

High liquidity and decline in interest rate bodes well for cost of funds, enabling LICHF to protect its margins despite heightened pricing pressure in mortgage loans. We model 5%/17% earnings growth in FY22/23 translating into ROE of 12.2%/12.5% in FY22/23 from 13.3% in FY21. We believe the current valuation factors the stress in the portfolio. Incremental Tailwinds like pace of vaccine rollouts, stamp duty cuts, flexible payment plans, all-time low interest rates and credit costs provide positive upside triggers. We have factored GNPA of 5% by end of FY22. Given inexpensive valuation, we maintain BUY with a target price of ₹529 valuing the entity at 1x FY23ABV.

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