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How smaller housing finance firms stay afloat

Gaurav Dua

With ambitious newcomers giving the incumbent housing finance companies a run for their money, it's a no holds barred battle in the mortgage business.

Operating through subsidiaries which were performing poorly, players like State Bank of India, Corporation Bank and others are aggressively pursuing the housing finance business and are increasingly eating into market share of housing finance companies. In fact, home loans now account for over 45 per cent of SBI's total personal loans portfolio.

Banks have the advantage of low cost funds raised through savings and current accounts, while housing finance companies typically depend on term deposits and borrowing from the wholesale debt market.

Thus, despite the lower operational cost, HFCs like Housing Development Finance Corporation and LIC Housing Finance have a cost income ratio of below 14 per cent as compared to over 50 per cent for some of the banks. The cost of funds for banks is much lower than HFCs.

Moreover, banks have the advantage of using their well developed infrastructure, in the form of bank branches.

So what is the future of housing finance companies? Despite intensified competition, most of the larger and established HFCs that have already built a critical mass, continue to show impressive growth in both their revenues and earnings.

But at the same time, the future of smaller and marginal players is increasingly becoming doubtful. The smaller players are already being squeezed out of business.

"The market is large enough for larger housing finance companies like HDFC and LIC Housing which will continue growing at decent rates, not withstanding the onslaught from the banks and other financial institutions," points out Puneet Srivastava, analyst, Enam Securities.

However, HFCs will have to focus hard on bringing down their cost of funds to protect their margins. Though larger firms will be able to access wholesale debt markets and borrow at lower rates from foreign markets, such options are not available for smaller companies.

The emerging scenario will further accelerate the consolidation in the housing finance industry.

Larger players are already taking advantage of this situation by acquiring asset portfolios of smaller and marginal players.

For instance, HDFC has acquired a 26 per cent stake in Gruh Finance, a niche player with a strong presence in the Gujarat hinterland.

While LICHF bought Gujarat Leasing Finance which had an asset portfolio of Rs 600 million.

Creating a niche

It does not mean that there is absolutely no future for smaller HFCs or players with considerably higher cost of funds. The answer lies in creating a niche for themselves. Market observers and industry experts feel that there is enough room for everyone if you focus on the untapped opportunities.

The case in point is the success story of co-operative banks like Saraswat Co-operative Bank and Greater Co-operative Bank among others. Not to be left behind, co-operative banks are also vying for piece of this Rs 400 billion market which is growing at a rate of over 30-35 per cent per annum.

Notwithstanding their higher cost of funds, these banks have rapidly expanded their asset portfolio by targeting that part of the population which finds it difficult to source home loans from HFCs and banks.

For instance, self employed or relatively small businessman have long-term relations with such banks who are unable to fullfil all the requirements for approval of loans from banks or HFCs.

But given their long-term relationship, it is easier for co-operative banks to offer loans to such customers.

"Co-operative banks have a particular set of customers who are reasonably loyal to them. Besides, co-operative banks have the advantage of rural reach," says Harsh Roongta, chief executive officer, Apnaloan.com

Similarly, there is a lot of scope in financing low cost income groups who usually look for residential property in the range of Rs 80,000 to Rs 200,000. "There are specialised products for such borrowers in developed markets," points out Roongta.

Customer is the king

With the fierce competition and the commoditisation of the mortgage finance business, means product innovation and quality of customer service will increasingly become the differentiating factor.

That's one area where HFCs are expected to score over banks and other financial institutions.

"Though banks have the advantage of lower cost of funds, HFCs have the edge when it comes to quality of customer services," feels Jignesh Shah, investment analyst, Ask-Raymond Securities.

That's also because HFCs have been in this business longer as compared to the banks. On the other hand, banks have the advantage of cross-selling home loans with other products.

LIC Housing Finance

LIC Housing Finance, the second largest HFC in the country, has not only been able to continue its growth momentum but have also significantly improved its quality of assets as well as margins in the past one year.

On the back of a 25.5 per cent increase in disbursals to Rs 20 billion, its net profit rose 21.5 per cent in FY02 to touch Rs 1.476 billion compared to Rs 1.215 billion in the previous year.

Apart from this, despite the increasing competition and the price war unleashed by the newcomers, the company managed to increase its overall interest margin for FY02 to 2.13 per cent from 1.81 per cent in the previous year.

That's largely due to the management's conscious decision to reduce its dependence on the parent to raise funds which has helped the company to considerably bring down the cost of funds.

High cost borrowings from LIC and NHB have been limited as the company has resorted to market borrowings at significantly lower rates.

In the last fiscal, it raised 38 per cent of its resources from market instruments like debentures and borrowing from wholesale debt market, reducing its dependence on LIC to 27 per cent as compared to 58 per cent as on March 2001.

It has re-written Rs 100 billion of its borrowings from LIC this fiscal. However, its average cost of funds at 11.33 per cent is still quite high.

Asset quality has also improved significantly. Total loans to builders have gone down from Rs 270 million in FY01 to Rs 120 million on net basis. Net NPAs to retail loans stand at just 1.3 per cent and cost to income ratio at 14 per cent is probably the lowest in the HFC segment.

Moreover, the management's strategy to actively scout for inorganic growth is expected to result in healthy growth over the next few years.

Although the scrip has run up significantly in the past few months, it appears attractively priced at Rs 81 which amounts to an price-earnings ratio of 4.26 times FY02 earnings (Rs 19 per share).

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