Rising rates to hit smaller housing finance companies

In the last 2 months, the RBI has suddenly turned deeply hawkish. It hiked the rates by 40 basis points in its May 2022 special monetary policy announced and hiked by another 50 basis points in the regular June 2022 monetary policy. That is a 90 bps rate hike between May and June 2022 plus a 50 basis points hike in the cash reserve ratio (CRR). That is a lot of hawkishness and the consequence has been a sharp spike in bond yields which have already crossed 7.4%. That has obviously transmitted into higher lending rates too.

In the Indian market, it is the banks and the NBFCs like HDFC, LIC Housing Finance, GIC Housing Finance, Can Fin Homes, PNB Home Finance etc that have been the key players in the housing finance segment. However, while the Nifty has shed 9% since the rate hikes started in May, the NBFCs with a strong housing finance franchise have lost up to 35-40% in specific cases. What is the reason that smaller housing finance companies have taken such a  big hit in response to the rise in interest rates and the bond yields?

One reason for the sharp fall in the stock prices of housing finance companies is that investors have regarded them the most vulnerable to business contraction as a result of higher lending rates. Also, the higher inflation combined with the higher rates of borrowing were most likely to hit the smaller and mid-sized Housing Finance Companies (HFC) hard. This is, in turn, expected to have a trickle-down effect on the demand for home financing. It is estimated that the worst hit could be the smaller HFCs. But is that really true?

The reasons are largely justified. At a more fundamental level; banks with lower cost of funds and larger HFCs with their balance sheet strength, are better placed. They would be able to tide over the rate hike cycle better even as they can partially absorb increased interest rates and also partially pass on, without losing business. After all, the likes of HDFC and LIC Housing still have some pricing power which smaller HFCs really do not possess. Also, larger HFCs have protected margins due to floating rate assets and fixed rate liabilities.

In the month of April 2022, the home loan rates stood at around 6.5%. However, by June 2022, the median home loan rate has risen to 7%. Most of the larger HFCs and the banks have the ability to absorb this hike either in the cost or are able to pass on. The problem lies in the case of smaller HFCs that can do neither. In such cases, the higher rates would end up losing their business to competition. While the current situation may not be too alarming, the worry is that things could exacerbate if there are more calibrated rate hikes by RBI.
 

If you look for a granular response, then the really vulnerable lenders would be the HFCs that cater to the price-sensitive segment affordable housing segment. Here, some amount of margin erosion in the short-to-medium term is absolutely inevitable. More so, since this space is very crowded and also very competitive. For most borrowers, the cost of shifting from one borrower to another borrower is not too much. That is why brokers like Kotak Equities expect an impact of up to 70 bps in the NIMs of affordable housing lenders in FY23.

That may not be all because this compression may extend up to 100 bps in FY24 for these affordable housing companies. The pressure could also come because, most of these affordable housing lenders have the risk of higher NPAs in the medium term. Hence they did not pass on the entire benefits when rates were falling. Hence, they may absorb the hit for some time, leading to margin compression. This is likely to offset the credit recovery gains.