A primer to understanding Affordable Housing Finance (long read)
Before we begin, a quick shout-out to my Research offering. I am a SEBI Registered Research Analyst. Folks interested in my fundamental research can learn more up here: https://gsninvest.com
While we have covered all details in this post, folks interested in a video deep-dive on Indian Affordable Housing finance, can access it here: https://easebuzz.in/link/IIL6F
With that, let’s get started!
As the lending markets have turned choppy over the last few quarters, investor interest has moved towards secured lenders. Two spaces stand out here - Gold & Housing. Both give out over-collateralized loans backed by an asset which generally appreciates in India, making it a safe space in choppy times.
Affordable housing finance still captures 50%+ of all housing loans (<15 lakhs). Focused HFCs - also known as affordable housing finance cos, capture 38%+ of this lucrative end market.
The space has also seen regulatory and government support, which have further helped growth.
SARFESI: Bringing HFCs under the ambit of the SARFAESI Act has helped them accelerate recoveries (Initiated in 2015, cemented in 2021)
RERA: Greater transparency in the real estate sector, helps with greater consumer confidence
PMAY (U/G): Government focus towards financing affordable housing across the country for EWS
With the broad overview of the sector understood - let us now dive in deeper - and understand key concepts via case studies.
If you're more comfortable learning via an audio-visual medium, we also have our complete slide deck and 3 hour webinar which you can access here: https://easebuzz.in/link/IIL6F
1. AUM (Assets Under Management) Total advances that the business currently has Outstanding. AUM growth will be a critical driver of valuation Slows with scale, however currently all quality AHFCs are small given size of the end market
2. Disbursements Amounts of loans given to clients in any particular period Since these are flows - gives you a better idea of how competitive environment or risk are changing
Multiple drivers of change in disbursement growth. Always tie what management mentions in con-calls to what peers are reporting
+management sees stress in particular end markets (voluntarily reduces growth) +competitive intensity in the end market rises, reducing the amount of good growth you can do
+internal changes like switching a database management system can lead to a few quarters of slower growth
For folks taking tactical positions, studying rate of change of disbursement - especially after a few weak quarters can often been a great catalyst
3. Yield on assets Yields on Advances Interest and fee income you are able to earn on your loans
Yield on assets is generally a function of the riskiness of the loan book given
thumb-rules:
unsecured> secured
self employed>salaried
tier 2/3>metro
Businesses with greater self-employed & tier 2/3 mix get the advantage of both greater yields as well as greater defensibility against larger competitors Always look at yields in relation to cost of funds - flat yields during periods of increasing cost of funds is a bad sign
4. Cost of Borrowing Interest you have to pay for your borrowings
Key drivers
+Rate environment in the country
+Source of funds (Banks, NHB, NCD)
+Credit rating
+Tenure of loan
+Other factors to keep in mind ALM (asset liability management) ensure that the % of short term financing availed isn’t too high
+Credit rating performance: Track credit reports - both rating and outlook; changes in outlook are quickly priced in
+Asset quality: Weakening in asset quality will almost certainly be passed through via higher CoB Diversified funding - preference to Banks driven financing
Some businesses also make strategic changes to the business model to get cheaper financing Eg: Housing with solar rooftops get more subsidies funding from global lenders (IFC) - this helps cut cost off part of the business book
5. Spreads Yields on Advances Interest and fee income you are able to earn on your loans Cost of Borrowing Interest you have to pay for your borrowings
Spread =Yields on Advances - Cost of Borrowing Key ratio to track if increasing competition or scale is compressing spreads
6. LTV (Loan to value) Determines the value of the loan amount disbursed to the value of the collateral against which the loan is given
Eg: 1cr Property 48L Loan 48% LTV
Key ratio to track to see if lenders are becoming loose with lending
Becomes critical at three times:
+ Regulatory change in LTV (either for entire industry for for a subsector/industry) - early 2010s, sharply different LTVs for banks and NBFCs for gold loans led to NBFCs losing market share
+ Sharp decline in value of asset
+ Companies being too aggressive with LTV (too high) - either sign of increasing competitive pressure or more aggressive underwriting, any sharp spike is non ideal
Given secured lending in India is generally against appreciating assets - origination LTV is generally higher & improves with time Emotional nature of asset (family gold, self occupied primary residence) provide greater comfort over and above value of collateral(to be continued)
7. DPD (Days past due) 1
DPD - Payment delayed by even 1 day
Key ratios reported/tracked in the industry include 30 DPD, 60 DPD, 90 DPD
Key ratios to track how borrowers are behaving with respect to timely repayments.
+90 DPD is a key ratio tracked by most market participants
+However 30/60+ DPD can also be a critical number to track (SARFESI provisions kick in post 90DPD, hence many times customers will keep making payments with 1-2 month lag to stay out of the 90DPD bucket)
+Reporting standards also provide insight into credit quality (very few AHFCs report 1DPD)
8. Gross NPA, Net NPA Loans not repaid of 90 days are classified as Gross NPA The business then provisions for these GNPA based on expected credit loss The NPA remaining post provisioning is your Net NPA
9. Key man risk Founding members and early core team is critical in any financial
More so in businesses catering to niche end markets (self employed, tier2+) where specialized insights about geography, customer behaviour, collateral nature may be known to management that guides lending pace through cycles
Businesses will often undergo sharp corrections when key men leave Important to understand how many systems have been put into place such that the business can operate even in their absence Can often be an entry trigger if you've studied the business well in advance.
While this thread will cover a lot of the theory - concepts are always solidified when discussed along with live case studies of actual businesses. We have recorded a 3 hour+ workshop, to help you with just that: http://easebuzz.in/link/IIL6F
10. Institutional ownership Indian AHFCs have been secure high growth lending businesses Consequently, they are heavily owned by institutions (PEs, DIIs, FIIs) This presents both a challenge (high valuations) and an opportunity (market uncertainty during times of flux.
When large investors exit - they generally don’t do so directly - they will trim gradually from year ~5 to year ~8 of their ownership cycle Markets generally start penalizing businesses once this trimming starts, presenting an interesting entry point into quality businesses
Given that most private equity entities have set fund cycles, there is generally sufficient visibility on when the next cycle of churn will appear
11. TAT The ability to process loans quickly is an advantage in the industry This is even more critical in AHFCs, because the diligence process often can take time given that the collateral is a house in a Tier2/3 city Key: maintain low TAT without compromising on asset quality
12. Non tangible value of collateral Primary residency preferred (Higher the primary residency mix the better) Time to habitability (Lower the better)
These are not reported frequently, but managements will occasionally mention them in con-calls etc. Market veterans (Sushil Agarwal) frequently stress on the criticality of these non-tangible factors
13. Rejection ratio % of loan requests that are rejected Important to track to understand when companies might be loosening their lending criteria to chase growth Softer aspect - often ignored by the street
There is often a wide spread in rejection ratios:
Top tier AHFC: Login to sanction (38%)
Mid tier AHFC: Login to sanction (62%)
14. Balance transfer The % of customers that move out to another financier (generally for lower rates or top-up loans) via a refinancing option Critical to track competitive environment and how well business is able to retain its top customers
Most of the large AHFCs have a BTout number around 6% Be careful when this number spike too much - good customers leaving faster Businesses also come up with ways to reduce BT-out like offering top-ups and lower rates (matched) to premium customers.
15. Asset Liability Management Critical to ensure that maturity of near term assets more than adequately covers near term liabilities Even more critical for businesses without strong parentage, which can face extreme capital scarcity during down turns
Although currently not in focus, Asset Liability (mis)management (one of the major sources of the past ‘18 crisis)
16. Origination Origination of loans can either be in-house or via DSAs DSA (Direct selling agents are intermediaries who work on a commission for HFCs.
This helps scalability (lower branch level origination teams etc needed). Payment only on successful disbursements. However control over lending process, customer understanding etc is hampered.
Quality AHFCs have historically focussed on 100% inhouse origination - maintaining discipline and control over the process.
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