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10th Oct,2014
The fortunes of the banking and finance sector are very dependent on the overall state
of the economy. When the economy is doing well, loan growth tends to be robust.
Moreover, the repayment capacity of the borrowers also remains strong. But when the
tide turns, financial institutions come under pressure not only to grow their business but
also to maintain their asset quality.
Before we go any further let us understand what asset quality is and why it matters to
shareholders. By asset quality, we mean the creditworthiness of a loan. The most
common parameter to assess the asset quality is non-performing assets (NPAs). This
indicator shows the quantum of loans that have been non-recoverable and therefore
would have to be written off by the banks.
As you know, the Indian economy has been facing a series of challenges. And this has
severely impacted the medium term prospects of the banking sector. Borrowers have
been hit hard by high interest rates and the poor business environment. This, in turn,
has resulted in a sharp increase in the quantum of bad loans. The end result is lower
profitability for the lender and poor shareholder returns.
Let's delve a bit more into the causes of bad loans. One major reason, as we discussed
above, is the poor business environment. Factors such as slowdown in demand, excess
capacity, regulatory hurdles, project delays, etc. tend to adversely impact the financial
health of a business and their capacity to service their loans.
Another reason for bad loans could be poor risk management and credit appraisal
systems followed by banks. There tend to be cases wherein banks fail to understand the
risks associated with a certain project or borrower and hence, end up burning their
fingers.
Among the banks that have been victims of wilful default, there is this one bank
called United Bank of India (UBI). The entity has been in the news recently after it
suspended its lending activity for an indefinite period following capital adequacy
concerns. As of December 2013, the bank's Gross NPA ratio was staggeringly high at
10.82% (as per company's 3QFY14 presentation), the worst level in the industry. The
state-run bank has also been under the scanner of the Reserve Bank of India (RBI) for
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alleged dubious lending practices. Having said that, there are several small private
sector lenders too that are in RBI's watch list for poor credit assessment.
It goes without saying that investors in small cap lending businesses are at the
maximum risk of exposure to value traps.
Managements that are more concerned about the quality of lending than growth
in loan book
Businesses that are keener to preserve lending margins than chase growth
Entities that have historically been very proactive in provisioning policies and
have adequate capital support
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rural areas have witnessed robust and steady increase in disposable incomes. Led by
government incentives, easier accessibility, greater connectivity and increase in food and
vegetable prices, these pockets have flourished like never before. Banking on the rural
story, RHFL has been tapping the non-salaried and non-professional segment based out
of Tier II/III cities.
RHFL enjoys a very low cost structure in terms of client acquisition and branch set-up
vis--vis its larger peers. With this lean branch model and strong branch network
expansion plans in place, RHFL's loan book is poised to generate significant growth
consistently going forward. Moreover, the expected increase in average ticket size of the
loan from current Rs 1 m to Rs 1.5 m places the company on a surer footing.
Given the company's small size, unique business model and scalability we believe that
RHFL is a stable long term player in the home financing space. Moreover, the
company's sustainable margin profile is among the best in the industry.RHFL's focus on
higher yielding loan segment (loans to self employed individuals) coupled with lower
costs of funds, helps it maintain net interest margins above 3.5% levels. Add to this
robust risk management systems and conservative lending metrics (loan to value ratio)
which can ensure good asset quality. That the total loan write-offs since inception has
stood mere 0.08% of total disbursements is indicative of the same.
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How Repco Home Finance Ltd will unlock its growth potential?
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Regulatory changes
Any adverse changes in regulatory stance are highly likely to impact the overall
business and financial profile of the company. Changes with respect to caps on
spreads, risk-weights or higher provisioning could possibly mar the profitability
of the company. Therefore, this risk cannot be ignored.
Macro turbulences
The continued economic slowdown and the consequent impact on the real estate
sector may hamper the business prospects of the company. Under prolonged
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phase of downturn, the company might face higher default rates. Additionally,
the higher interest rate scenario may also weigh down on the demand for
housing loans, thus stagnating credit growth for the company.
Risk Analysis
Regulatory Risk
Some businesses are subject to regulations by external government agencies.
These companies are subject to regulatory risk since they do not have the liberty
to operate in a free environment. Excessive regulations can create bureaucratic
hassles and impede growth. Thus, higher the regulation, higher is the risk for any
business. The housing finance sector is subject to various regulations imposed by
the Reserve Bank of India and National Housing Bank in terms of capital
adequacy, lending norms, provisioning requirements etc.
Cyclicality Risk
An industry cycle is characterized by an upturn as well as downturn. Businesses
whose fortunes typically swing with industry cycles are known as cyclical
businesses. Cyclical businesses do well during an industry upturn and vice versa.
On the other hand, there are some businesses based on consumption stories that
are non-cyclical. These businesses are immune to industry cycle changes and
have less risk. In short, if the business is cyclical higher is the risk. The housing
finance sector is extremely cyclical and is in fact a reflection of the macro
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economy. The sector typically witnesses average credit growth at 1.5 times GDP
growth.
Competition Risk
Every industry is characterized by competition. However, some industries where
entry and exit barriers are typically low have higher competition risk. Low
barriers means more players can enter into the industry thereby intensifying
competition. Low product differentiation also intensifies competition risk. The
Indian housing finance sector is already very competitive with most banks and
NBFCs offering mortgage finance. Plus the entry of new banks is expected to
intensify competition in the coming years.
Income growth
Over the eight year period (actual history of past 5 years and explicit forecast for
the next 3 years) Repco Home Finance's income CAGR is 23.1%.
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Net profit margin is a measurement of what proportion of a company's revenue is
left over after paying for all the variable and fixed costs inclusive of interest and
depreciation charges. Net margin is the final measure of profitability. It reflects
the total profits the company takes home. Higher the margin, better it is for the
company as it indicates better pricing power and effective cost management. The
average net margins over the 8 year period (actual history of past 5 years and
explicit forecast for the next 3 years) stand at 18.2%.
Transparency
Transparency is the key to any business. Transparency can be gauged by
assessing the past dealings of the company with various stake holders be it the
customers, suppliers, distributors or shareholders. The easiest way to gauge the
same is checking the level of disclosures in the company's quarterly financial
updates and communication with minority shareholders. Most importantly, the
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management's willingness to explain its stance if there is a negative development
in the company or stock shows its forthrightness. Transparent managements
would get a higher rating. The management of Repco Home Finance has been
reasonably transparent in its operations. However there is room for improvement
in the disclosure of financial information.
Capital allocation
Apart from honesty, capital allocation skills are equally important in assessing
management quality. By capital allocation we mean how the management
chooses to deploy capital in the business or across businesses. Managements that
have in the past destroyed shareholder wealth by diversifying in unrelated,
unviable businesses or make expensive acquisitions would rank low on this
parameter. Further managements that focus on capital intensive growth at the
cost of profitability would also fetch a low rating. The management of Repco
Home Finance has a good track record in terms of capital allocation. The
company is standing on a growth trajectory and is well geared to take up organic
and inorganic route.
Promoter Pledging
Promoters typically pledge their shares to take a loan which is generally infused
in the company. This exercise is generally resorted to when all other sources of
external liquidity dry out. The risk with this strategy arises when share price falls.
This triggers margin calls. If management is unable to provide some sort of a
collateral to the lending party from whom the money is borrowed that party may
sell the shares to recover its money. This accentuates the share price fall. Hence,
higher the promoter pledging higher is the risk.
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NPA ratio in excess of 1.5% are particularly risky. The average net NPA to
advances ratio for Repco Home Finance over the 8 year period (actual history of
past 5 years and forecast for the next 3 years) stands at 0.9%. However given the
high propensity of slippage on account of higher exposure to risky assets.
Comparative Valuations
14
FY13
RHFL
Gruh Finance
Return on assets
2.40%
2.90%
Return on equity
17.10%
33.30%
4.00%
4.40%
Net NPA/Advances
1.00%
0.10%
Cost/income
17.30%
19.00%
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Business per employee (Rs m)
87
47
361
183
2.1
2.8
Valuations (FY14)
Price to adjusted book value
3.2
7.6
Dividend yield
0.40%
1.20%
Valuations
(Rs m)
FY13
FY14E
FY15E
FY16E
FY17E
FY18E
Revenue (Rs m)
1,401
1,695
2,141
2,729
3,403
3,849
PAT (Rs m)
800
901
1,096
1,403
1,753
1,987
EPS (Rs)
12.9
14.5
17.6
22.6
28.2
32
96.8
107
122.3
143.2
169.6
200.2
24.2
21.5
17.7
13.8
11.1
9.8
3.2
2.9
2.6
2.2
1.8
1.6
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Financial at a glance
Consolidated (Rs m)
FY13
FY14E
FY15E
FY16E
FY17E
FY18E
1,401
1,695
2,141
2,729
3,403
3,849
Net Interest Income growth (%) 20.20% 21.00% 26.40% 27.40% 24.70% 13.10%
Net Interest Margins (%)
4.00%
Net profit
Net profit margin (%)
800
4.40%
901
4.20%
1,096
4.20%
1,403
4.20%
1,753
3.90%
1,987
Balance Sheet
Loans and advances
4,638
5,110
5,804
7,001
8,832
11,515
81
81
81
81
81
81
Investments
Total Assets
Current liabilities
5,415
5,956
4,646
4,785
4,799
Net worth
6,345
7,166
8,175
9,491
11,156 13,056
Borrowings
Other liabilities
5,527
Total liabilities
16
6,405
5,140
5,289
5,308
4,799
5,053