In today’s Finshots, we explain why a niche segment of housing finance is getting attention from investment analysts.

The Story

₹60,000 crores.

That’s the quantum that India might set aside to provide subsidised loans for affordable urban housing in the next 5 years. At least that’s what the rumour mill this week says.

And that could be a big deal for one set of listed stocks — we’re talking about a niche class of Affordable Housing Finance Companies (AHFCs).

You see, if you’re looking to buy your dream home and need a loan, you might approach a large public or private sector bank. Maybe you’ll check the rates at a dedicated housing finance company (HFC). But for most people in the Low Income Group (LIG) or Economically Weaker Section (EWS), those options may be a pipe dream. Because this segment typically runs their own small businesses. Or they might be employed in a small and medium enterprise at a low pay. So they don’t seem like a very lucrative target market for large institutions.

And that’s where AHFCs come in.

These specialists set up shop on the outskirts of large towns or in rural areas, study the micromarket intently in just a few states or regions and then dole out loans. The average ticket size for a home loan is roughly ₹10 lakhs. And over the past year, everyone’s been eyeing this segment that’s growing much faster than the overall housing finance industry.

Last year, the international investment house Jefferies published a report stating “Housing Financiers — Well Poised for Structural Growth”. Then six months ago, Morgan Stanley penned a note saying “AHFCs — at affordable valuations”. And this week, Centrum put out a 75-pager saying “Building a profitable future”. Everyone has been pointing to 3 stocks — Aavas Financiers, Aptus Value, and Home First Finance.

Now the central thesis of housing finance has revolved around 3 things.

Firstly, there’s the low mortgage penetration. Yup, it’s the typical ‘underpenetration’ argument but we’re just telling you what big brokerages are saying. Anyway, mortgages are just 11% of nominal GDP when compared to Thailand with 20% or Malaysia with 34%. And if you dissect the Indian states, you’ll find that major markets such as Tamil Nadu, Uttar Pradesh, and Andhra Pradesh are all below the national average of mortgages. So that’s a potential pool of customers for housing finance companies.

Secondly, there’s the affordability factor. More and more developers have turned to setting up properties under the ₹50 lakh threshold in the past few years. In fact, such projects made up over 50% of new announcements and sales in 2019. Add to this the fact that disposable incomes have risen in the past decade and you can see the overall “affordability index” improving.

And thirdly, there has been a continual push from the government through its ‘Housing for All Project’. It wants to promote urban housing to solve the shortage issue. And previously, it even provided interest subsidies as well as lower GST rates on affordable housing projects.

So all these together made investors turn positive on the housing finance segment.

And within this space, betting on AHFCs made intuitive sense over the bigger players in the space. Simply because AHFCs have better pricing power.

You see, large HFCs are in direct competition with banks. They serve the same target market. And since banks can raise low-cost deposits from customers, they can pass that along in the form of lower rates on home loans too. So that puts pressure on HFCs that can’t raise deposits for further lending.

On the other hand, AHFCs have concentrated on the smaller ticket size home loans in cohorts that require more granular credit assessment — self-employed and informal salaried segments that are new to credit and have less documentation. That means the segment doesn’t have the same competitive intensity. It’s their own little fiefdom. And that’s why Jefferies points out that in times when interest rates are falling (like it did during COVID), AHFCs can continue to charge a higher rate and get away with it. They don’t compete with banks. So this keeps their margins quite tidy despite the higher operational cost of setting up more physical touch points.

Now you might be thinking, “But extending credit to this segment is also inherently risky. The bad loan situation could be quite dicey”.

Well, you’d probably agree that COVID was a great stress test to figure this bit. And the thing is, the listed AHFCs that are on most people’s radars all held up quite well. Sure, the stressed assets inched upwards, but that happened even at big banks. And it wasn’t alarming at all. There hasn’t been a big spike in bad loans. And as Morgan Stanley says, “It’s an important validation of the business model.”

So yeah, that’s how AHFCs claimed the spotlight in the past year or so.

And if the government does decide to launch a new scheme to subsidise affordable home loan interest, then the demand could perk up quite a bit.

But here’s the thing. Some of these listed AHFCs haven’t had a great run despite the noise around them.

So you have to wonder what’s going on. Especially when you consider that the opportunity is huge — there’s already a shortfall of urban housing with nearly 30 people migrating to the cities every minute. And this could get worse (or lucrative for AHFCs) as India’s urban population swells to 60 crores by 2030.

And one reason could be that despite the lacklustre returns in the past year and a half, AHFCs continue to trade at a premium compared to their financial services peers.

See, one of the most often used metrics to gauge whether a financial company is overvalued or not is something called price to book value or P/B. Simply put, the book value is what you get after deducting the liabilities of a company from its assets. Think of it as the true worth of everything the company actually owns. And the P/B indicates how much extra investors are willing to pay over the company’s true worth — a P/B of 1 typically indicates a perfect fair value. Anyway, all the 3 stocks we’ve been speaking about trade at 4 times P/B at the moment. And the peers trade at around 1.5–3 times P/B.

Another possibility is people are still worried about the inherent risks of doling out these loans. And while they haven't yet buckled under pressure, a few bad quarters may see bad loans piling up. And AHFCs may have to pay a steep price.

So yeah, that might explain why the stocks haven’t really seen a big jump despite all the positives surrounding them. And that begs the question — is another rally due or have these stocks already run their course for now?

You tell us.

Until then…

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