HDFC/LICHF: Borrowing cost declines sharply :: Kotak Sec, links

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Borrowing cost declines sharply. Bond borrowing rates for high-rated housing finance
companies and NBFCs have declined by about 60 bps in the past two months. Incremental spreads
in the housing loan segment have expanded sharply as lending rates are stable. This decline puts
housing finance companies in a strong footing even as we expect home loan rates to moderate.
We raise estimates, increase TPs for HDFC to `1,210 (from `1,100) and LICHF to `450 (from
`375). Post the sharp rally, we downgrade LICHF to ADD from BUY. Retain ADD on HDFC.

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Sharp decline in bond borrowing cost
Sharp decline in marginal bond borrowing cost will boost margins for housing finance
companies. Exhibit 1 shows that yield on 5-year AAA-rated bond has declined by 60 bps in the
past two months. Exhibit 3 shows that marginal bond borrowing cost for LICHF for tenure of 3-
5 years has declined by about 70 bps since October 2014. Exhibit 4 shows that HDFC’s
borrowing cost for commercial papers has declined by 40 bps in October 2014.
Home loan rates may decline but moderately; marginal spreads expand
Home loan rates have been stable since July 2014. Exhibit 5 shows that most large players offer
home loans at 10.15%, about 15 bps premium over the base rate of these banks. As such,
home loan rates have a scope to decline by about 15 bps unless banks cut their base rates. Thus,
marginal spread of housing finance companies will be higher by 35-50 bps.
We believe that 30-50 bps decline in borrowing cost is more positive for housing finance
companies as compared to other NBFCs. Housing finance companies operate on thin spreads:
in 1HFY15, LICHF reported 1.2% spreads and HDFC reported spreads of 1.97% in its individual
loan book. The benefit for other NBFCs may be lower as (1) the overall spread of NBFCs is
higher and (2) the decline in debt market borrowing cost will be gradual for lower-rated
companies.

Raising targets prices, ADD
HDFC: ADD with TP of `1,210. We are raising our estimates for HDFC and LICHF by 1.5-
2.5%. We retain ADD rating on HDFC with target price of `1,210 (average of March 2016E
and March 2017E-based fair value estimate). We factor our revised target price for HDFC
Bank and roll over to September 2016. At our target price, HDFC’s core business will trade
at 3.8X PBR and HDFC Bank will trade at 3.7X PBR. We value the insurance business at 2X
EV, i.e. `160 bn and `180 bn for FY2016 and FY2017E, respectively; the life insurance
business adds 6% to our SOTP.
LICHF: ADD with TP of `450. We are raising our estimates for LICHF by 2% and target
price to `450 from `375. We are factoring higher NIM, medium-term growth and roll over
to September 2016. At our target price, LICHF will trade at 2.1X PBR. We expect LICHF to
deliver 18% earnings growth and 18-20% medium-term RoE during FY2014-17E. In our
forecast, we factor interest spreads of 1.25% for FY2015-17E as compared to 1.2% in
FY2014 and average of 1.7% between FY2010 and FY2013.

LINK
http://www.kotaksecurities.com/pdf/indiadaily/indiadaily04122014ad.pdf