13 January 2011

Citi: LIC Housing Finance - Risks Increasing at the Margin

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LIC Housing Finance (LICH.BO)
Risks Increasing at the Margin
 Maintain Sell (3M) on increasing risks to NIMs — We are reducing our target
price on LIC Housing to Rs170 per share (from Rs262) as we believe the
increasing risks to its NIMs, reducing mortgage profitability, and recent adverse
developments at the company will likely result in a contraction of its valuation
multiples. We expect the continuing rise in cost of wholesale funds to pressure
NIMs for wholesale borrowers and especially for LIC Housing due to the higher
competitive intensity in the mortgage segment. Our revised target is based on 1.6x
FY12E P/BV (from 2.5x earlier) and is at ~10% premium, to its 3yr average P/BV
multiple of 1.5x.

 Tight liquidity is impacting cost of funds — India’s banking system liquidity has
continued to remain tight and has significantly raised wholesale funding costs over
recent months – 1 year commercial paper rates have increased by 150bps to 9.8%
since Oct 2010. LICHF’s incremental cost of funding has also gone up and it
recently raised Rs7.5bn through 3-year non-convertible debentures at 9.4%.
 Higher fixed rate lending, competition likely increases NIM risks — LICHF’s
incremental lending is mostly under its fixed rate schemes - 9.5% fixed for 5 years
and floating thereafter – and over 10% of its total loans are now at fixed rates.
While it has raised its PLR in October 2010 (50bps, raises rates on outstanding
floating book), we believe, sustaining margins at current levels will be a challenge
as proportion of fixed rate loans is rising fast and also due to the high competition
in the segment, which is likely to keep lending rates under pressure.
 Minimal impact on loan growth, quality; raise earnings 2%-3% — LICHF’s new
management believes that there has been minimal impact of the recent
unforeseen developments on its business fundamentals – loan growth has
remained strong and so has asset quality (even on the loans allegedly provided on
graft by the previous CEO). We are raising our loan growth estimates to 35% for
FY11E (31% earlier) and our earnings estimates by 2%-3% over FY11-13E.


LIC Housing Finance
Valuation
We value LIC Housing shares at Rs170 per share based on 1.6x one-year
forward P/BV (FY12E). LIC Housing's historical trading range is 0.5x - 1.5x
one-year forward P/BV and the stock is trading at a premium to its own history.
We believe part of this is warranted going forward given the company's
significant improvements in its market position, asset quality and return profile.
However, we also benchmark LIC Housing to other non-banking finance
companies in India and believe that it should trade at a discount to peers due to
its lower return profile, weaker and inconsistent track record on asset quality
and significantly higher competition levels in the mortgage segment. Our target
price is also at a discount to our target multiples for private sector banks (2.0x –
3.0x one-year forward P/BV).
We also see a fair value basis for LIC Housing shares at Rs179 based on
CIRA's EVA model, which captures the long-term value of the business, and is
a standard valuation measure for the CIRA India Banking coverage. Our EVA
model assumes: a) risk-free rate of 8.0% in line with our assumptions for other
banks; b) longer-term loan loss provisions of 20bps given its low asset risk
profile, c) loan spreads of 170bps which is slightly lower than banking industry
averages of 200bps, and d) long-term fee income growth of 10%.

Risks
We rate LIC Housing shares Medium Risk, in-line with our quantitative riskrating
system, which tracks 260-day historical share price volatility. Key upside
risks that could cause the stock to continue to trade above our target price
include: a) Stronger-than-expected economic and more specifically mortgage
financing growth, b) Reversal towards a lower interest rate / easy liquidity
environment which could support its net interest margins, c) Continued robust
asset quality environment in the mortgage segment, d) Any decrease in
competitive intensity, and e) Any regulatory changes.

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