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Steering through near-term headwinds for a robust franchise ahead

Improvement in product mix to offset the adverse impact on NIM

* PNB Housing Finance (PNBHF) plans to transform from a prime housing financier into a lender that offers a wide bouquet of mortgage products across cohorts of product and customer profiles. In addition to its existing affordable housing loans (Roshni) vertical, it will also enter the emerging market vertical from FY25.

* PNBHF has restructured its business model and prioritized the retail segment by reducing corporate loans in the overall loan mix to ~4% in Dec’23 from ~21% in Mar’20, through down-selling, recoveries, and ARC sales.

* All the three Credit Rating Agencies (CRA) – India Ratings, ICRA and CARE – have upgraded PNBHF to AA+ within the last three months. This credit rating upgrade can help PNBHF reduce its cost of borrowings by 20-25bp.

* However, there could be a near-term pressure on its NIM because of the much lower revenue contribution from the corporate loan books and higher competitive intensity. However, its pivot towards affordable housing and emerging vertical will help PNBHF improve its product mix that can mitigate the impact on its NIM.

* PNBHF has made notable enhancements to its collection framework, including the introduction of digital channels to streamline the collection process. Improvements in GS3 should sustain, and we model credit costs of ~30bp each in FY25E/FY26E. It has a written-off pool of ~INR17b and ~INR5b in corporate and retail, respectively. Recoveries from this pool (if executed well) could result in further reductions in credit costs and improvements in profitability

* We had earlier stated PNBHF as our Top Pick for CY24 (refer to: Tide has turned, smooth ride ahead). We remain constructive on the company. Our conviction in PNBHF is predicated on: 1) the visibility of a healthy retail loan growth trajectory from FY25 onwards, 2) the ability to mitigate near-term NIM compression through improvement in product mix and decline in CoB, and 3) normalization to steady-state credit costs of ~30bp.

* We expect PNBHF to deliver a PAT CAGR of ~26% over FY24-26 and an RoA/RoE of 2.5%/13.0% in FY26. Reiterate BUY with a TP of INR1,000 (based on 1.4x FY26E P/BV).

Building capabilities for healthy retail loan growth from FY25

* PNBHF has scaled up to 212 branches (as of Dec’23) and guided its branch network to increase to ~300 (including ~160 affordable housing branches) by Mar’24. Branch additions and gradual productivity improvements in new branches will drive healthy retail loan growth for the company.

* From FY25 onwards, PNBHF will also embark on its Emerging Market Strategy, wherein the customer segment will be in the Tier 2/3 markets between prime and affordable housing. Effectively, PNBHF will now operate across Prime, Affordable and Emerging markets. We estimate retail loan CAGR of ~17% over FY24-FY26.

Better product mix and lower CoF to offset the near-term impact on NIM

* Loss of interest income from the sharp rundown in the corporate loan book has led to a near-term hit on NIM. We expect this adverse impact to sustain for the next few quarters and subsequently be mitigated through an improvement in the product mix.

* The company plans to come up with 40-50 emerging-market branches that will focus on a product/customer segment where yields will be 35-40bp higher than that of prime customer yields. This will help improve the blended yields.

* India Ratings upgraded PNBHF’s credit rating to AA+ (Stable) in Jan’24. Subsequently, ICRA and CARE also upgraded the company’s credit rating to AA+ in Mar’24. We expect PNBHF’s borrowing costs to decline ~20-25bp from the credit rating upgrades. Moreover, the company has again started receiving sanctions from NHB in FY24, which will further aid the CoB. We model NIM of 4.1%/4.2% in FY25/FY26E (v/s. 4.0% in FY24E).

Minor uptick in opex despite the pivot towards affordable housing

* Management guides a minor uptick in opex as it develops the affordable housing vertical. This is because it is incrementally only required to invest in branch premises and manpower to buildout its affordable housing vertical.

* The opex-to-average assets ratio is likely to be 1.0% in FY24 (vs. 0.8%/0.7% in FY23/FY22) due to investments in physical branch distribution and technology. We expect opex ratio to remain stable at similar levels over FY25-FY26E.

Asset quality stress behind; write-backs to further support profitability

* PNBHF has successfully navigated through the asset quality stress in its retail and corporate segments, which had earlier made it ineligible for NHB borrowings. Through a combination of recoveries, ARC sales, and write-offs, the company has improved its asset quality, with GS3 at 1.7% as of Dec’23 (vs. the peak of 8.2% in Dec’21).

* PNBHF now has a tiered collection framework, with dedicated teams for Xbucket, pre-NPA, NPA, Recovery and SARFAESI. Further, the company has a written-off pool of ~INR17b and ~INR5b in corporate and retail, respectively. Recoveries (if executed well) from the written-off pool and the consequent write-backs can result in credit costs below ~30bp in FY25E/FY26E.

Valuation and view: Risk-reward attractive for a strengthening franchise

* PNBHF is well equipped to successfully navigate the near-term headwinds in its NIM profile, and further offset them with product mix improvement. We expect the company to deliver a healthy ~18% CAGR in AUM and ~26% CAGR in PAT over FY24-26, with an RoA/RoE of 2.4%/13.0% by FY26.

* The company trades at 1.1x FY26E P/BV, and the risk-reward is favorable for a further re-rating in the valuation multiple as investors gain more confidence in its sustained execution in retail (both prime and affordable).

Reiterate BUY with a TP of INR1,000 (based on 1.4x FY26E P/BV).

* Key risks: a) a slowdown in the economy leading to lower demand for housing and moderation in loan growth, and b) subsequent seasoning in the affordable loan book leading to asset quality deterioration.

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