HUDCO: Primary offer - Developing the plot

While the offer’s valuation is attractive, loan growth needs a close watch

The initial public offer (IPO) of Housing and Urban Development Corporation (HUDCO) — a wholly-owned government company with nearly half a century experience in providing loans for housing and urban infrastructure projects in India — offers a bitter sweet opportunity for investors. On the one hand, the company’s primary focus on lending to State governments and their agencies, aside from lowering credit risk, opens up prospects for the company in the Centre’s various initiatives in the affordable housing segment. On the other hand, the somewhat modest growth in loans and earnings over the past few years calls for tempering down expectations from a returns perspective.

The biggest draw for investors is the asking price for the issue. At the upper band of ₹60, the valuation works out to about 1.3 times the book value as of December 2016 and 1.4 times as of FY16. While there are no comparable listed peers for the company, a look at valuations of housing finance companies suggests that the issue is attractively priced.

Valuations for players in the housing finance space vary from 1.5 times (Dewan Housing) to about 2.3-2.5 times (LIC Housing, Indiabulls Housing) and three times (HDFC and Repco Home) to as high as 11 times (Gruh Finance) one- year forward book.

Wide loan portfolio

HUDCO operates in two broad segments — housing and urban infrastructure finance. Housing finance loans are further classified into social housing, residential real estate and retail finance (branded as HUDCO Niwas). Under social housing, the company caters to the economically weaker sections (EWS) and low-income groups (LIGs), with an annual income of up to ₹3 lakh and ₹6 lakh, respectively. Under residential real estate, it offers loans for housing and commercial real estate projects.

Under HUDCO Niwas, the company offers housing finance to individuals directly and bulk loans to State governments, their agencies and public sector undertakings.

Under urban infrastructure finance, HUDCO gives loans for projects relating to water supply, roads and transport, and power, among other sectors. This segment constitutes a chunk 69 per cent of total loan portfolio as of December 2016.

However, over the past two years, the share of housing finance loans has been inching up. From 26 per cent in FY14, these loans constitute 31 per cent of total loans as of December 2016. Between FY14 and FY16, loans in this segment have grown by 21 per cent annually.

The company expects to drive growth in the housing finance segment by playing a key role in various schemes of the Centre, particularly in the affordable housing segment. The Centre’s ‘Housing for All by 2022’ and recently announced interest subvention scheme present huge opportunity for players such as HUDCO. But given the limited success under schemes for EWS and LIG so far, the pace of pick-up in credit offtake needs to be watched. Under the earlier scheme for EWS and LIG ₹413.4 crore subsidy was given by the nodal agencies to only about 22,500 beneficiaries.

In the urban infrastructure finance space, loan book has grown by just 4 per cent annually between FY14 and FY16, leading to a modest growth in the overall loan portfolio of 9 per cent during this period.

A substantial increase in loan growth will be imperative to drive earnings that have also grown by about 5 per cent annually between FY14 and FY16.

Reducing credit risk

Under both social housing and residential real estate, the company lends primarily to State governments and their agencies. As of December 2016, about 90 per cent of the loan portfolio comprised loans to this segment. In light of the increasing credit risk of private sector entities, HUDCO, in 2013, decided to stop sanctioning housing and urban infrastructure finance loans to private sector entities.

HUDCO’s gross non-performing assets (GNPAs) for loans made to private sector entities stood at 5.98 per cent of loans as of December 2016 compared with a far lower 0.75 per cent for loans extended to State governments and their agencies. By not sanctioning new loans to the private sector and maintaining a healthy provision cover (78.9 per cent as of December 2016), the company has been able to bring down its net NPA (gross NPA adjusted for provisions) from 2.5 per cent in FY14 to 1.5 per cent as of December 2016.

Continued focus on the low risk segment should keep bad loans under check for the company, as apart from the State government guarantees, loans are also subject to repayment through allocations in Budgets.

Low-cost funding

A significant advantage that HUDCO enjoys is access to varied sources of funding at low cost. It enjoys the highest rating of AAA on its long-term borrowings and is also among the few companies that can issue tax-free bonds.

The net interest margin has however been under pressure over the past two years, due to the bad loans that existed within the private sector.

While strong capital position is a positive, the low return on equity of around 10 per cent is a dampener. Substantial pick up in loan growth will be essential to drive earnings, going ahead.

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