14Company January name 2021 Sector update | Sector: HFC hfy Housing Finance

Stagnant real Record estate prices low Govt. interest Incentives/ rates Reforms

A Home Run!

Research Analyst: Alpesh Mehta ([email protected]) | Piran Engineer ([email protected]) Nitin Aggarwal ([email protected]) | Divya Maheshwari ([email protected]) Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital. Housing Finance: A Home Run! Improving Affordability | Supportive regulation| Healthy profitability

01 02 Page #3 Page #7 Summary Revival in the RE space 03 04

Page #14 Page #16 Consolidation in the HFC Minimal Covid-19 impact on space positive for incumbents asset quality

05 06 Page #18 Page #22 Valuation & View Key takeaways from business leaders

COMPANIES

H D F C Well-placed to capture market share ...... Pg24

LIC Housing Finance Business turning around ...... Pg30

AAVAS Financiers Building a foundation for the long term ...... Pg35

Can Fin Homes A balanced player ...... Pg56

PNB Housing Finance Preserving capital; De-risking the balance sheet ... Pg71

Repco Home Finance Prioritizing asset quality over growth ...... Pg75

Aadhar Housing Finance Pan-India affordable housing finance player ...... Pg79

Home First Finance A niche player ...... Pg84 SectorThematic: Update Housing | January Finance 2021 Housing Finance

A Home Run! Improving Affordability | Supportive regulation| Healthy profitability

 After 5 years of stagnant Residential Real Estate (RE) sales, the RE and the Housing Finance sectors have bottomed out. Affordability is the best in the past two decades, with flattish RE prices over FY15-20 and price cuts triggered by the COVID-19 pandemic. In addition, current interest rates (starting at sub-7% for prime customers) are at an all-time low and ~300bp lower than those five years ago. Economic indicators point to an upward trend and the resolve of the government and regulator to solve issues affecting the sector is also encouraging.  Over the past four years, housing sales in India’s top seven cities have exceeded launches, resulting in a meaningful decline in inventory overhang. While sales plummeted ~65% YoY, after the lifting of COVID-19 lockdown restrictions there are early signs of a revival now. Sales in Mumbai have picked up since Sep’20 and even Loan growth to pick up grew on a YoY basis in Nov’20. Over the past four years, we have noted a AUM gr. % FY20 FY21E FY22E consolidation in market share for the top-10 developers in the top-6 cities. HDFC 11.9 11.0 12.5  Over the past two years, the top two Housing Finance companies (HFCs) have LICHF 7.8 8.1 8.3 outperformed on account of strong parentage and access to debt capital. These PNBHF -1.6 -2.5 6.8 players have been able to capture the revival in the RE space, with disbursements CANF 12.6 4.5 8.7 surpassing pre-COVID levels. We expect these players to disproportionately benefit AAVAS 31.2 18.9 19.3 from a pick-up in RE volumes and consolidation in the builder space. Given the sharp Repco 9.1 4.9 7.1 decline in the cost of funds and moderate impact of the lockdown on asset quality,

profitability is likely to remain healthy.

 With the government’s focus of ‘Housing for All’ by 2022, Affordable Housing has seen strong growth over the last six years. Smaller players like Can Fin Homes (CANF), Aavas Financiers (AAVAS), Aadhar Housing Finance, and Repco Home Finance have Credit costs to normalize by FY22E created a niche in this space and are capitalizing on this multi-year opportunity. Credit cost % FY20 FY21E FY22E  HDFC 0.4 0.3 0.3 As credit costs normalize in FY22, we expect HFCs under our coverage to generate 12- LICHF 0.5 0.4 0.4 17% RoE in FY22-23E. Similar to the RE space, we expect further consolidation in the PNBHF 1.8 1.1 1.1 HFC sector to play out, with the top two players gaining market share. While CANF 0.3 0.6 0.3 valuations have re-rated in the past 2-3 months, the risk-reward is favorable in our AAVAS 0.3 0.7 0.4 view. HDFC remains a preferred pick in the sector. We are initiating coverage on Repco 0.5 0.5 0.4 AAVAS/CANF with a Neutral/Buy rating. We maintain our Neutral stance on PNB Housing Finance (PNBHF) due to capitalization challenges.

Multi-year opportunity – Sector tailwinds to accelerate growth… Housing Finance is a strong multi-year growth opportunity given the trend in urbanization, nuclearization, favorable demographics, and low housing penetration. In addition, access to finance has improved considerably over the last decade. Interest rates are at all-time lows (down ~300bp over the past five years), thus enhancing affordability. Other tailwinds include: a) fall in RE prices post-COVID, b) cut in stamp duty in a few large states, c) strong and broad-based economic revival leading to job creation and income growth, and e) focus of the government on resolving the issue of stuck RE projects have further accelerate growth. As a result, affordability has improved to the best ever in the past two decades (refer Exhibit 2).

January 2021 3 Thematic: Housing Finance

AAVAS has the highest RoA… …and focused efforts on Affordable Housing RoA (%) FY20 FY21E FY22E Over the past five years, Affordable Housing has been the key growth driver for the HDFC 1.8 1.8 1.8 industry, led by the huge stimulus from the government, given its target of ‘Housing LICHF 1.2 1.3 1.3 PNBHF 0.8 1.2 1.4 for All’ by 2022. The government tackled the demand side with its flagship Credit CANF 1.9 2.0 2.0 Linked Subsidy Scheme (CLSS). Till date, over 1.1m families have benefited from AAVAS 3.8 2.8 3.3 the interest subsidy. It even extended CLSS to MIG customers by one-year to Repco 2.4 2.4 2.3 Mar’21. In order to tackle the supply side, the government incentivized house construction under the Pradhan Mantri Awas Yojana (PMAY). Over 3.4m houses

have been constructed and allotted so far. Developers have been offered 100% tax …but CANF the highest RoE deduction on construction of affordable housing units up to 31st March, 2021. RoE (%) FY20 FY21E FY22E HDFC 13.1 12.5 12.6 HFC consolidation underway; top two players to benefit disproportionately LICHF 14.3 15.8 15.1 Over the past two years, large banks like SBIN, ICICIB, and AXSB have been PNBHF 8.3 11.4 12.2 aggressive in home loans. Given the lack of growth in corporate lending, these CANF 19.1 18.7 17.0 banks are likely to remain aggressive in the foreseeable future. However, HFCs with AAVAS 12.7 10.6 12.8 strong parentage are able to compete effectively with banks given the sharp decline Repco 16.9 15.2 14.0 in their incremental cost of funds (three-year borrowing at ~5%). Given the huge

scope of the market, these players have enough opportunity to grow despite the intensifying competition. While HFCs are expected to lose market share to banks on the whole, the top two HFCs should maintain or gain market share.

Best asset quality performance across cycles Retail Housing Finance has demonstrated the best asset quality performance across cycles due to higher equity of the borrower, strong emotive value attached to security, and less speculative activities. With most sectors of the economy reviving close to pre-COVID levels, the fear of job losses or salary cuts has abated. Most companies are confident of restricting the stressed pool to less than 2-3% of loans. Within the developer segment, the fear of delinquencies or restructuring has also abated due to improvement in demand and the ability of larger players to raise funds and service their debt. There has been some consolidation in the RE space, with the share of top-10 developers in housing sales rising to 31% from 23% over CY16-20E in the top six cities.

Valuations attractive; reiterate positive stance on the sector Post COVID-19, valuations for HFCs corrected sharply due to concerns on: a) decline in loan growth, b) pressure on spreads owing to lending rate pressures from banks and tight liquidity, and c) deterioration in asset quality on account of job losses and stressed developers. However, with a sharper than earlier anticipated economic recovery, disbursements for larger players have picked up meaningfully. Abundant system-wide liquidity has led to a sharp decline in the cost of funds. Asset quality concerns are reducing. HDFC and Indiabulls Housing Finance (IHFL) have also raised capital. The stance of the regulator is incrementally more supportive. We believe the excess liquidity and low interest rate environment would sustain in the near-to- medium term, which augurs well for the RE sector, and in turn, for HFCs. With growth and profitability normalizing, the sector is likely to see a re-rating. The risk- reward at this point is favorable. We reiterate HDFC as our top pick. We are also initiating coverage on AAVAS with a Neutral rating and CANF with a Buy rating.

January 2021 4 Thematic: Housing Finance

KEY EXHIBITS

Exhibit 1: Comparison of various HFCs on key parameters HDFC LICHF PNBHF CANF AAVAS REPCO AUM (INR b) 5,403 2,133 812 208 84 121 AUM mix (%) Home Loans 70 77 57 90 74 81 Corporate 25 7 17 0 0 0 LAP, NRP, etc. 5 16 26 10 26 19 Share of off-BS AUM (%) 12 0 18 0 20 0 Customer Mix (%) Salaried 80 87 54 71 35 48 Self-employed 20 13 46 29 65 52 Borrowings (INR b) 4,209 1,903 662 187 60 103 Borrowing mix (%) Banks & FIs 21 23 29 60 48 82 NCD 37 60 21 17 24 3 CP 7 3 3 0 0 0 Deposits 35 9 25 2 0 0 Others 0 5 22 21 28 15 Key Financial Parameters (FY20) PAT (INR b) 96.2 24.0 6.5 3.8 2.5 2.8 RoA (%) 1.8 1.2 0.8 1.9 3.8 2.4 RoE (%) 13.1 14.3 8.3 19.1 12.7 16.9 Loans/Equity (x) 6.5 11.7 9.1 9.9 2.8 6.8

Source: MOFSL, Company

Exhibit 2: Affordability is the best over past two decades

Affordability

5.9 5.3 5.1 5.0 5.1 5.1 4.7 4.7 4.5 4.7 4.8 4.6 4.7 4.6 4.3 4.4 4.1 3.8 3.7 3.5 3.3

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Source: MOFSL, HDFC; Note: Affordability = Property Value/Annual Income

Exhibit 3: Slow growth in housing prices Exhibit 4: Top-7 cities have witnessed stagnant prices Housing Price Index Price (INR/sqft) Growth (%) 4 113 112 3 2 106 107 2 99 97 101 1 112 1 109 103 104 107 -1 100 98

6,605 6,869 6,993 7,157 7,254 7,294 7,207 Jun-17 Jun-18 Jun-19 Sep-17 Sep-18 Sep-19 CY14 CY15 CY16 CY17 CY18 CY19 CY20 Dec-17 Dec-18 Dec-19 Dec-16 Mar-18 Mar-19 Mar-20 Mar-17 Source: NHB Source: PropEquity; Note: CY20 data as of Oct ‘20

January 2021 5 Thematic: Housing Finance

Exhibit 5: Sales have exceeded launches in the prior 3 years leading to lower inventory

Sales (Mn sqft) New Launches (Mn sqft) 599 567 474 412 358 294 367 446 246 425 211 376 381 354 352 309 295 184 CY12 CY13 CY14 CY15 CY16 CY17 CY18 CY19 CY20* Source: MOFSL, PropEquity; Note: CY20 data as of Oct ‘20

Exhibit 6: Market share of the Top-2 HFCs in NBFCs improving since FY18; Expected to continue (%)

HDFC LICHF PNBHF Others

26 32 31 31 30 31 32 33 34 31 25

26 23 27 28 27 27 26 25 23 21 21

48 42 41 40 41 40 40 39 40 41 45 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

Source: MOFSL, Company

Exhibit 7: Sharp decline in NCD issuance cost for HDFC… Exhibit 8: …and LICHF to keep spreads stable Interest Rate (%) Date of Issue Tenure (yr) Interest Rate (%) Date of Issue Tenure 7.35 10-Feb-20 5.0 7.45 10-Jan-20 3.1 6.99 13-Feb-20 3.0 7.97 28-Jan-20 10.0 6.95 27-Apr-20 3.0 7.33 12-Feb-20 5.0 7.25 17-Jun-20 10.0 6.57 12-Feb-20 1.4 5.40 11-Aug-20 3.0 5.45 26-Aug-20 3.0 4.95 09-Sep-20 2.0 6.19 25-Sep-20 4.2 5.78 25-Nov-20 5.0 5.53 01-Dec-20 4.1 Source: NSE Source: NSE

January 2021 6 Thematic: Housing Finance

Revival in the RE space Record low interest rates, economic revival, government impetus key drivers

 After a sustained downcycle, the residential real estate sector has bottomed out, in our view. Affordability has been the best over the past two decades, driven by wage inflation exceeding real estate price inflation, record low interest rates and reduction in stamp duty by some state governments. Interest rates currently are ~300bp lower than levels five years ago.  More importantly, we note that the government and the regulator are firm on resolving issues that have been plaguing the sector in the past 4-5 years. We expect the regulator to favor high liquidity and low interest rates at the system level to revive growth, which augurs well for the RE sector.  The AIF set-up by the government has seen some early traction. In addition, the government has taken several steps to reduce inventory by announcing GST cuts on under-construction and affordable housing projects. Lastly, the flagship PMAY project of the government is witnessing improved traction.  The Reserve Bank of India (RBI) is also being supportive. It has reduced RWA for housing loans, allowed extension of DCCO and one-time restructuring without downgrading accounts to NPAs.  Over the past three years, housing sales in the top-7 cities exceeded launches, resulting in a meaningful decline in inventory overhang. While sales plummeted ~65% YoY immediately post the lockdown, there are early signs of revival. Moreover, we note of a consolidation in market share of the top-10 developers in the top-6 cities over the past four years.

Why are we incrementally bullish on the real estate sector? Record low interest  Affordability has improved to its best over the past two decades, driven by a rates, increased combination of largely stagnant real estate prices over the past five years affordability and continued government (significant time correction), wage inflation and multi-year low interest rates. support make us positive Post-COVID, developers have reduced prices (directly/indirectly) by 10-15%, on the RE sector. which has led prices back to 2014-15 levels.  Firm resolve on the part of the government and regulator to solve issues plaguing the real estate sector and to boost affordable housing as a sector remains the key for economic revival.  Post the demand shock immediately after the lockdown, demand has been on an uptrend and is likely to revert to pre-COVID levels soon. Additionally, demand has outpaced supply over the past few years, leading to a reduction in inventory overhang during the same period.

January 2021 7 Thematic: Housing Finance

REAL ESTATE SECTOR ON THE CUSP OF RECOVERY

Improved affordability, 1 Low interest rates

3 REASONS TO TURN 2 Sales have exceeded launches in POSITIVE ON last 3 years REAL ESTATE

Firm resolve of GoI and regulator 3 to solve real estate sector issues

Source: MOFSL

Affordability best now Affordability better than ever now in the past two decades over the past two  Over the past few years, property prices in most metros have been largely decades. stagnant, driven by a large supply-demand mismatch. On the other hand, wages have grown in line with or above inflation.  According to HDFC, affordability (property price/annual income) has declined from 4.7x in 2010 and 4.4x in 2015 to 3.3x in 2020.  In addition, the cost of borrowing has declined to multi-year lows. Interest rates on home loans at ~7% (for Prime category borrowers) are 150-200bp lower than those three years ago. As a result, EMI has reduced by ~10% for a 20-year loan (refer Exhibit 10).

Exhibit 9: Affordability is the best over past two decades

Affordability

5.9 5.3 5.1 5.0 5.1 5.1 4.8 4.7 4.3 4.7 4.5 4.7 4.6 4.7 4.6 4.4 4.1 3.8 3.7 3.5 3.3

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Source: MOFSL, HDFC; Note: Affordability = Property Prices/Annual Income

January 2021 8 Thematic: Housing Finance

Exhibit 10: Sensitivity of EMI to change in interest rate and ticket size Interest Rate/Loan Amount (INR '000) 6.5% 7.0% 7.5% 8.0% 8.5% 150bp reduction in 100 746 775 806 836 868 interest rates reduces 110 820 853 886 920 955 EMI by ~10%. 120 895 931 967 1,004 1,042 130 969 1,008 1,047 1,087 1,129 140 1,044 1,085 1,128 1,171 1,215

Source: MOFSL, Company; Note: 20 year loan

 According to NHB’s Residex, housing prices for the top-50 cities has increased 12% cumulatively over the past 3-4 years. Our interactions with managements suggest that this is largely due to non-metro locations rather than the top 7 cities, wherein prices have been flattish/modestly growing over the past 3-4 years. Post the lockdown, developers have been proactive in giving discounts, freebies and innovative payment schemes to lure buyers.

Exhibit 11: Slow growth in housing prices Exhibit 12: Top-7 cities have witnessed stagnant prices Housing Price Index Price (INR/sqft) Growth (%) 4 109 113 112 112 103 104 106 107 107 100 99 98 97 101 3 2 2 1 1 7,207

-1 6,605 6,869 6,993 7,157 7,254 7,294 Jun-19 Jun-18 Jun-17 Sep-19 Sep-18 Sep-17 CY14 CY15 CY16 CY17 CY18 CY19 CY20 Dec-19 Dec-18 Dec-17 Dec-16 Mar-20 Mar-19 Mar-18 Mar-17 Source: NHB Source: PropEquity; Note: CY20 data as of Oct ‘20

Reduction in GST, set-up Firm resolve of GoI and regulator to tackle RE sector issues of AIF, improved traction  Over the past few years, the government has taken several steps to boost the in PMAY – key support housing sector, especially affordable housing. The most prominent scheme, measures of the PMAY (Pradhan Mantri Aawas Yojna), has witnessed fair success over the past government. three years.  Other initiatives include  tax breaks for affordable housing,  GST reduction on under-construction housing projects from 12% (with Input Tax Credit (ITC)) to 5% (without ITC), and on affordable housing projects from 8% (with ITC) to 1% (without ITC) from 1st Apr’19,  extension of deadline for CLSS-MIG scheme under PMAY by one year up to Mar ’21, and  additional tax deduction of up to INR0.15m for interest paid on housing loans sanctioned in current fiscal for homes priced is below INR4.5m  In order to resolve stuck projects across the country (estimated at 458k units), the government has introduced a fund called SWAMIH (Special Window for Affordable and Mid-Income Housing) with a corpus of INR105b in 2019. In addition to the government, the fund has received investments from institutional investors too. The objective of this fund is to provide last-mile

January 2021 9 Thematic: Housing Finance

financing to stuck projects. So far, SWAMIH has approved INR120b to 123 stuck projects comprising 80k+ housing units  Recent stamp duty cuts announced by the Maharashtra, MP and Karnataka governments have also helped improve demand  Cut in construction premiums by 50% by the Maharashtra government  Allowance of one-time restructuring of real estate projects as well as extension of DCCO for commercial projects by one year without change in classification, and  Reduction in risk weights on housing loans based on the LTV v/s ticket size earlier should also lead to higher push from financiers.

Real estate inventory overhang declining over past few years Inventory overhang is  In the prior four calendar years, sales in the top-7 cities of India exceeded new down from record 43 launches, leading to a decline in the inventory overhang (calculated as unsold months in 2017 to 31 months in 2019. inventory/prior 4-quarter sales) from a record 43 months in 2017 to 31 months in 2019.  Post the outbreak of COVID-19, home sales plummeted, falling 65% YoY in 1QFY21 to 8m sqft in the top-7 cities.  However, with increased discounts offered by developers, reduction in stamp duty in some states and reduction in home loan rates by lenders, sales have started picking up again. For example, housing sales in Mumbai reached 86% of pre-COVID 19 levels in Sep’20, as per a report by CRE Matrix. This trend sustained in Oct ’20 and Nov ’20 too, with Nov ’20 sales up 17% MoM and 67% YoY. In other cities, home sales have seen a sharp recovery in the past six months and are slightly below YoY levels.

Exhibit 13: Sales have exceeded launches in the prior 4 years…

Sales (Mn sqft) New Launches (Mn sqft)

599 567 474 412 358 352 367 295 446 425 376 381 354 211 294 309 246 184 CY12 CY13 CY14 CY15 CY16 CY17 CY18 CY19 CY20* Source: MOFSL, PropEquity; Note: CY20 data as of Oct ‘20

January 2021 10 Thematic: Housing Finance

Exhibit 14: …leading to a decline in inventory Inventory (Mn sqft) Inventory overhang (months) 43 40 37 34 34 34 31 27 22 18 14

554 671 823 965 1,063 1,094 1,098 1,048 990 933 921 CY10 CY11 CY12 CY13 CY14 CY15 CY16 CY17 CY18 CY19 CY20* Source: MOFSL, PropEquity; Note: CY20* number as of Oct ‘20

Consolidation underway in the real estate sector – long-term positive Market share of top-10  Post the implementation of demonetization, RERA and GST, the RE sector faced developers in the top-6 cities is up from 22% to several headwinds. This was more pronounced for smaller players. As a result, 32% over the past four there has been consolidation in the industry ever since. years.  Analysis of the top-6 cities reveals that the market share in housing sales of the top-10 developers has increased from 23% in 2016 to 31% in 2020.

Exhibit 15: Consistent increase in sales market share of Top-10 developers Sales (Mn sqft) Market share (%) 31 26 26 23 23

64 52 70 72 35

CY16 CY17 CY18 CY19 CY20*

Source: MOFSL, PropEquity; Note: CY20 data as of Oct ‘20

INR55t opportunity in affordable housing  A study by KPMG on the housing sector estimated urban/rural housing shortage in India to be 37m/53m units.  Assuming that even half of this shortage is met, it would create ~INR55t financing opportunity in affordable housing.

Exhibit 16: Total housing shortage amounts to 90m units Exhibit 17: INR55t opportunity even if 50% of shortage is met Million Units Urban Rural Total Total funding Shortage % shortage Avg. ticket opportunity Current Shortage 19 40 59 (Mn) met size (INR m) (INR t) Additional 28 23 51 Urban 37 50% 1.8 33 Vacant Houses 9 10 20 Rural 53 50% 0.8 21 Total 90 55 Core demand 37 53 90

Source: MOFSL, Company Source: MOFSL, Company

January 2021 11 Thematic: Housing Finance

Recent steps by GoI and regulator to boost affordable housing  Additional tax deduction up to INR150k for interest paid on loans to purchase homes priced below INR4.5m extended till 31 March, 2021.  Scope of affordable housing expanded to those costing up to INR4.5m with a Gujarat and Maharashtra carpet area of 60sqm in metros and 90sqm in non-metros. lead the pack in terms of  Increased budgetary support - Allocation to PMAY increased from INR253b in number of PMAY FY20 to INR275b in FY21. Extra-budgetary allocation of INR100b for PMAY- beneficiaries urban & PMAY-Rural each.

Exhibit 18: Number of beneficiaries under PMAY (U) – top-10 states (‘000)

EWS/LIG MIG 248

193

92 55 45 44 40 43 40 28 28 33 14 19 21 16 18 13 18 13

GJ MH MP RJ UP TN WB Kar. AP Tel. Source: MOFSL, Lok Sabha

Exhibit 19: Sharp growth in Central Assistance utilized under PMAY (U)

Central Assistance Utilized (INR b) 264

190

46 15

FY17 FY18 FY19 FY20

Source: MOFSL, Lok Sabha

Consumers waiting on the sidelines making a comeback  As per consumer research conducted by NAREDCO and Housing Research in Apr-May’20, 47% of respondents were either uncertain or not confident of their income outlook stability. However, as business has recovered close to pre- COVID levels for most sectors, many of these 47% respondents would now have greater clarity on income stability as compared to Apr-May’20, in our view.  35% of respondents preferred real estate as an asset class and 60% preferred ready-to-move-in properties.  ~80% of respondents who were looking to buy a home have put it on hold for up to the next 12 months, i.e. Apr-May ’21.

January 2021 12 Thematic: Housing Finance

Exhibit 20: 47% customers were unsure of income stability Exhibit 21: RE remains the most preferred investment class Income Stability Outlook Preferred Investment Class 53% 35% 28% 22% 29% 15% 18%

Can't Say Not Confident Confident Fixed Deposit Gold Real Estate Stock Market

Source: MOFSL, NAREDCO; Note: As of Apr/May ‘20 Source: MOFSL, NAREDCO; Note: As of Apr/May ‘20

Exhibit 22: Overwhelming preference for ready properties Exhibit 23: 81% of respondents paused for up to a year only Pause to look for a home 60% Preferred Stage of buying 29% 28% 24% 19% 21% 10% 9%

Ready-to-move- 6-12M delivery 1-2Y delivery New launch in < 3 months 3-6 months 6-12 months Indefinitely

Source: MOFSL, NAREDCO; Note: As of Apr/May ‘20 Source: MOFSL, NAREDCO; Note: As of Apr/May ‘20

January 2021 13 Thematic: Housing Finance

Consolidation in the HFC space positive for incumbents Top-2 players have gained 700bp market share within HFCs

 While on the whole, the HFC sector lost market share in retail home loans to banks post the IL&FS crisis, the top-2 HFCs clearly outperformed its peers with 700bp market share gain within the space. These players enjoy strong parentage and comfortable access to liquidity at attractive prices.  Concerns on the trajectory of spreads post the sharp home loan rate cuts by banks in Mar-Apr’20 have abated. This is due to the fact that HFCs have witnessed anywhere between 75-200bp reduction in incremental cost of funds over the past nine months.  Banks have reduced their lending rates by 75-100bp, thus, benefiting HFCs directly. Further, few HFCs have moved to repo linked borrowings from Banks. At the same time, the cost of funds from capital markets has declined ~200bp since the start of the crisis. Hence, we believe HFCs will be able to keep spreads stable despite intense competition.  Asset quality has deteriorated over the past three years for most players led by the non-retail segment. Stage 2 loan ratio has increased by up to 230bp over FY17-20 with Stage 3 ratio increasing by up to 250bp over the same time period.

Banks have gained market share since the IL&FS crisis… Banks have gained 500bp  From the start of this decade till the IL&FS crisis, HFCs consistently gained market share in home market share in home loans as compared to banks – their market share loans over past two increased from 30% to 40% over FY10-18. years.  However, post the IL&FS crisis, growth for some HFCs took a backseat. In addition, some players are focused on running down their loan books to generate liquidity. As a result, HFCs lost nearly half the market share gained over FY10-18 in FY19-20.

Exhibit 24: Banks gained nearly 500bp market share in home loans over FY18-20 (%) Banks HFCs

30.0 33.7 35.2 37.8 37.9 38.1 37.7 37.7 39.6 37.9 34.9

70.0 66.3 64.8 62.2 62.1 61.9 62.3 62.3 60.4 62.1 65.1

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: MOFSL, Company

The Top 2 HFCs have …led by decline in the loan books of some HFCs gained 700bp market  However, after analyzing market share trends of HFCs, we note that market share within the HFC share of the top-2 HFCs is largely steady despite severe competition from space in the past two banks. years.  Within the HFC space, these players have gained 700bp market share cumulatively over the past two years.

January 2021 14 Thematic: Housing Finance

Exhibit 25: While HDFC’s market share was largely stable over FY12-18, it improved over FY18-20 (%) HDFC LICHF PNBHF Others

26 32 31 31 30 31 32 33 34 31 25 0 0 7 0 2 2 3 4 4 5 7 26 23 27 28 27 27 26 25 23 21 21

48 42 41 40 41 40 40 39 40 41 45

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: MOFSL, Company

Sharp decline in cost of funds over past six months to protect spreads ~75-200bp decline in cost  After the sharp MCLR cuts by banks in Mar-Apr’20, one of the biggest concerns of funds across various for HFCs was the sustainability of spreads. This is because loans reprice instruments. immediately (given their floating rate nature), while borrowings, especially market borrowings, reprice only on maturity of the borrowing.  However, in this phase, the repo rate cuts by the RBI have witnessed effective transmission. The incremental cost of funds for HFCs from capital markets has declined by ~200bp since the start of the crisis.  HDFC and LICHF are able to raise 3-year NCDs at ~5% and 90-day CPs at <4%.  Banks have also reduced MCLR by 75-100bp since the start of the lockdown. Typically, the interest rate reset happens on the anniversary date of the loan – for example, if an HFC borrowed from a bank at 1-year MCLR on 1st Jan’20 and the bank cuts its MCLR on 1st Jun’20, the HFC would get the re-pricing benefit on 1st Jan’21. Large HFCs typically have 20-30% of their borrowings from banks while smaller HFCs have 50-85% of borrowings from the banking system.

Exhibit 26: NCD issuance - HDFC Exhibit 27: NCD issuance - LICHF Interest Rate (%) Date of Issue Tenure (yr) Interest Rate (%) Date of Issue Tenure 6.99 13-Feb-20 3.0 7.97 28-Jan-20 10.0 6.95 27-Apr-20 3.0 7.33 12-Feb-20 5.0 7.25 17-Jun-20 10.0 6.57 12-Feb-20 1.4 5.40 11-Aug-20 3.0 5.45 26-Aug-20 3.0 4.95 09-Sep-20 2.0 6.19 25-Sep-20 4.2 5.78 25-Nov-20 5.0 5.53 01-Dec-20 4.1 4.23 23-Dec-20 2.0 4.96 01-Jan-21 2.8 Source: NSE Source: NSE

Exhibit 28: 80-90bp reduction in 1-year MCLR by leading banks since Jan’20 (%) 8.20 8.20 SBI ICICIB 8.15 8.00 7.75 7.70 7.55 7.45 7.40 7.35 7.35 7.35 7.90 7.85 7.75 7.40 7.25 7.00 7.00 7.00 7.00 7.00 7.00 7.00 Jul '20 Jul Jan '20 Jun '20 Oct '20 Apr'20 Sep '20 Feb '20 Dec'20 Aug'20 Nov '20 Mar '20 May '20 May Source: MOFSL, Company

January 2021 15 Thematic: Housing Finance

Minimal Covid-19 impact on asset quality Economic revival better than expected

 With most sectors of the economy reviving close to pre-COVID levels, the fear of job losses or salary cuts has abated. Most companies are confident of restricting the stress pool in retail loans to less than 2-3% of the overall book.  Over the last three years, the non-retail segment has led to sharp rise in NPAs for HFCs. Post the lockdown, the fear of NPAs in this segment increased manifold. However, with the permission of one-time restructuring and the pick-up in sales velocity for large developers, this is now abating.

Asset quality deterioration over the last two years – a key concern Stage 2 and Stage 3 loans  Over the past few years, asset quality stress has built up in the system. Barring for most HFCs have AAVAS and to an extent Repco, we have observed worsening asset quality increased over the past three years. across players.  Stage 2 loans for most players have increased 80-230bp over the past three years. However, REPCO/AAVAS have witnessed sharp declines of ~1,300/220bp over the same time period.  At the same time, Stage 3 loans ratio for all HFCs, barring AAVAS, increased 140-250bp over FY17-20. AAVAS witnessed modest reduction of 40bp in this ratio over the same time period.

Exhibit 29: Stage 2 loans increased up to 230bp over FY17-20… Exhibit 30: …while Stage 3 loans increased up to 250bp Stage 2 (%) FY17 FY18 FY19 FY20 Stage 3 (%) FY17 FY18 FY19 FY20 HDFC 3.6 4.5 4.3 5.5 HDFC 0.9 1.3 1.4 2.3 LICHF 3.7 3.8 4.4 4.6 LICHF 0.4 0.8 1.5 3.0 PNBHF 1.3 1.7 3.3 3.7 PNBHF 0.2 0.3 0.5 2.7 CANF 4.4 4.8 6.0 CANF 0.4 0.6 1.8 REPCO 15.6 15.5 12.2 2.3 REPCO 2.9 3.1 3.2 4.8 AAVAS 3.3 2.3 1.6 1.0 AAVAS 0.9 0.4 0.5 0.4

Source: MOFSL, Company Source: MOFSL, Company

Non-retail segment led to rise in NPAs  Continued stagnation in RE segment, inability of developers to raise money through few HFCs (struggling with capitalization, liquidity and corporate governance issues) and change in repayment schedule (which were tagged as NPAs) have led to a rise in NPAs for the non-retail segment at industry level.  Considering aggressive lending by a few NBFCs dealing in the RE segment, regulators also adopted a tougher stance for the sector. We entered the COVID situation with an already gloomy background and fear of NPAs in this segment increasing sharply at the beginning of the year.

January 2021 16 Thematic: Housing Finance

Exhibit 31: Segment wise GNPL ratio – HDFC (%) Exhibit 32: Segment wise GNPL ratio – LICHF (%)

Retail Corporate 4.7 Retail GNPL Non-retail GNPL 17.6 4.1 4.2 14.2 13.7 2.9 2.9 11.7 2.5 2.7 2.3 2.2 2.3 8.8 7.8 7.1 6.1 6.9 1.0 0.9 0.7 0.7 0.7 0.7 0.7 0.7 0.8 0.8 1.5 1.9 1.8 0.4 0.8 0.8 0.9 1.1 1.3 FY20 FY19 1HFY21 1HFY20 1HFY19 1QFY21 1QFY20 1QFY19 9MFY20 9MFY19 4QFY18 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 Source: MOFSL, Company Source: MOFSL, Company

Share of sales of the top- Incremental events point toward relatively better outcome 10 developers in the top-  With most sectors of the economy reviving close to pre-COVID levels, the fear 6 cities up from 23% to of job losses or salary cuts has abated. Most companies are confident of 31% over the past four restricting the stress pool in retail loans to less than 2-3% of the overall book. years  Further, improvement in demand and ability of larger developers to raise money and service their debts points toward better asset quality outcome.  Even regulators’ favorable stance toward RE is positive. Over the last six months, the RBI allowed (a) an extension of DCCO for the RE space without classifying it as NPA, (b) one-time restructuring in RE projects, and (c) reduction in risk weights for housing loans.  Over the past four years, there has been a trend in consolidation of the large developers in the top-6 cities while the share of the top-10 developers in total housing sales has increased from 23% to 31% over 2016-20. We expect this consolidation trend to pick up further, which augurs well for asset quality and growth of HFCs.

January 2021 17 Thematic: Housing Finance

Valuation and view On the brink of a turnaround; Valuations attractive

 Over the past five years, the real estate sector has faced several headwinds including slowing sales, rising inventory levels and price stagnation. The implementation of RERA and GST also hit the sector, especially the smaller players. Post IL&FS, some NBFCs faced continued headwinds in accessing debt capital from markets. As a result, large players with strong balance sheets gained market share.  Over the past few years, housing sales exceeded new home launches, resulting in a decline in inventory overhang. Following the lockdown, sales suddenly plunged, but have now started recovering.  The housing finance sector has witnessed two turbulent years post the IL&FS crisis, resulting in loss of market share to banks. However, in these two years, we note of a sharp gain in market share by the top-2 HFCs. Also, while disbursements were muted in 1QFY21, they have largely normalized in 2QFY21. These players expect to deliver YoY disbursement growth in 2HFY21.  Post the sharp cut in home loan rates by banks in Mar-Apr’20, investors were skeptical of the trajectory in spreads. However, the incremental cost of funds has declined sharply (between 75-200bp) for players with strong parentage. As a result, we do not foresee any impact on spreads.  While there had been some asset quality deterioration pre-COVID, concerns on significant deterioration post-COVID too have abated. The retail lending portfolios would not see any meaningful asset quality issues as very few customers have lost jobs or witnessed permanent cash flow disruption. At the same time, HFCs got some relief on the corporate side post the allowance of one-time restructuring by the RBI.  We expect HFCs under our coverage to generate 12-17% RoE once the situation normalizes in FY22. We believe the current risk-reward is favorable. HDFC remains our top idea in the sector. In this report, we are also initiating coverage of AAVAS with a Neutral rating and CANF with a Buy rating. We remain Neutral on PNBHF due to concerns over its capitalization.

Exhibit 33: DuPont Analysis – HDFC (%) (%) FY15 FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E Interest Income 10.83 10.32 9.87 9.03 9.16 8.90 8.02 7.41 7.28 Interest Expended 7.50 7.13 6.69 6.40 6.49 6.31 5.35 4.67 4.60 Net Interest Income 3.33 3.20 3.19 2.63 2.67 2.59 2.66 2.74 2.69 Other core operating income 0.12 0.14 0.11 0.06 0.07 0.06 0.05 0.06 0.06 Core Income 3.46 3.34 3.30 2.69 2.74 2.65 2.72 2.80 2.74 Operating Expenses 0.29 0.28 0.27 0.52 0.35 0.30 0.33 0.32 0.28 Cost to Income Ratio (%) 8.53 8.37 8.12 19.32 12.65 11.48 12.12 11.27 10.19 Employee Expenses 0.14 0.13 0.12 0.37 0.17 0.12 0.17 0.15 0.11 Other Expenses 0.16 0.15 0.14 0.15 0.18 0.18 0.16 0.17 0.17 Core Operating Profits 3.16 3.06 3.03 2.17 2.39 2.35 2.39 2.48 2.46 Provisions/write offs 0.07 0.10 0.14 0.13 0.12 0.32 0.28 0.29 0.29 Core PBT 3.09 2.96 2.89 2.04 2.27 2.03 2.11 2.19 2.17 Dividend Income 0.29 0.30 0.29 0.29 0.26 0.22 0.17 0.22 0.23 Treasury and Other Income 0.22 0.63 0.34 1.56 0.42 2.58 0.37 0.08 0.08 One off provisions/Expenses 0.00 -0.17 -0.09 -0.45 -0.10 -0.88 -0.16 0.00 0.00 PBT 3.60 3.72 3.43 3.45 2.86 3.94 2.48 2.49 2.48 Tax 1.10 1.11 1.05 0.61 0.81 0.53 0.48 0.56 0.56 Tax Rate (%) 30.54 29.83 30.62 17.62 28.44 13.32 19.56 22.41 22.47 Reported PAT 2.50 2.61 2.38 2.84 2.05 3.42 1.99 1.93 1.92 Leverage (x) 8.01 8.01 7.87 6.75 6.01 6.01 5.84 5.74 6.01 RoE 20.02 20.90 18.74 19.18 12.30 20.55 11.30 11.89 12.41 Core RoE 22.76 20.66 19.74 12.57 12.98 13.13 12.48 12.56 12.88

January 2021 18 Thematic: Housing Finance

Exhibit 34: DuPont Analysis – LICHF (%) FY15 FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E Interest Income 10.88 10.92 10.26 9.12 9.24 9.33 8.72 8.11 7.63 Interest Expenses 8.57 8.29 7.56 6.93 6.94 7.08 6.51 5.85 5.42 Net Interest Income 2.31 2.62 2.69 2.19 2.30 2.24 2.21 2.26 2.20 Non interest Income 0.26 0.21 0.15 0.11 0.11 0.10 0.09 0.09 0.10 Net Income 2.57 2.83 2.85 2.30 2.41 2.34 2.30 2.36 2.30 Operating Expenses 0.39 0.42 0.45 0.27 0.26 0.30 0.29 0.29 0.29 Cost to income (%) 15.24 14.74 15.89 11.89 10.63 12.62 12.53 12.39 12.82 Employees 0.13 0.13 0.18 0.14 0.13 0.14 0.14 0.15 0.16 Others 0.26 0.28 0.27 0.13 0.12 0.15 0.15 0.14 0.14 Operating Profits 2.18 2.42 2.39 2.03 2.15 2.05 2.02 2.06 2.00 Provisions/write offs 0.01 0.13 0.21 0.31 0.33 0.48 0.34 0.38 0.38 PBT 2.17 2.28 2.18 1.72 1.82 1.57 1.68 1.68 1.62 Tax 0.74 0.80 0.76 0.47 0.51 0.42 0.35 0.34 0.33 Tax Rate (%) 34.05 35.22 34.67 27.59 28.07 26.53 20.70 20.50 20.50 PAT 1.43 1.48 1.43 1.25 1.31 1.15 1.33 1.34 1.29 Leverage (x) 12.63 13.23 12.65 12.33 12.53 12.42 11.87 11.32 10.93

RoE 17.54 19.58 18.06 15.36 16.40 14.30 15.82 15.14 14.10 Source: MOFSL, Company

Exhibit 35: DuPont Analysis – PNBHF (%) 2015 2016 2017 2018 2019 2020 2021E 2022E 2023E Interest Income 10.93 10.46 10.08 9.56 9.25 9.45 9.35 9.08 8.92 Interest Expended 8.28 7.64 7.32 6.70 7.03 7.22 6.80 6.45 6.34 Net Interest Income 2.66 2.82 2.76 2.86 2.21 2.23 2.56 2.63 2.59 Other Income 0.72 0.63 0.74 0.84 1.21 0.98 0.56 0.79 0.87 Fees 0.32 0.35 0.46 0.55 0.61 0.37 0.16 0.27 0.33 Others 0.40 0.28 0.28 0.28 0.60 0.62 0.41 0.52 0.54 Net Income 3.37 3.45 3.50 3.70 3.43 3.21 3.12 3.42 3.46 Operating Expenses 1.20 1.04 0.99 0.84 0.81 0.68 0.62 0.68 0.70 Cost to Income Ratio (%) 35.5 30.0 28.3 22.6 23.6 21.1 19.9 20.0 20.2 Employee Expenses 0.44 0.31 0.28 0.27 0.41 0.29 0.30 0.34 0.35 Other Expenses 0.76 0.73 0.71 0.56 0.39 0.39 0.32 0.35 0.35 Operating Profit 2.18 2.41 2.51 2.86 2.62 2.53 2.50 2.74 2.76 Provisions/write offs 0.25 0.34 0.28 0.52 0.26 1.54 0.93 0.93 0.51 PBT 1.93 2.07 2.23 2.34 2.36 1.00 1.57 1.81 2.24 Tax 0.66 0.73 0.78 0.74 0.74 0.20 0.35 0.40 0.49 Tax Rate (%) 34.09 35.05 34.86 31.87 31.30 20.32 22.00 22.00 22.00 Reported PAT 1.27 1.35 1.45 1.59 1.62 0.79 1.23 1.41 1.75 Leverage 12.16 13.07 9.09 8.54 10.41 10.47 9.34 8.65 8.41

RoE 15.45 17.58 13.18 13.60 16.89 8.32 11.45 12.19 14.71 Source: MOFSL, Company

January 2021 19 Thematic: Housing Finance

Exhibit 36: DuPont Analysis – CANF (%) 2015 2016 2017 2018 2019 2020 2021E 2022E 2023E Interest Income 11.06 10.94 10.86 10.27 9.94 10.15 9.71 9.31 9.22 Interest Expended 8.57 7.79 7.35 6.76 6.79 6.76 6.01 5.83 5.77 Net Interest Income 2.49 3.15 3.51 3.51 3.16 3.39 3.70 3.47 3.44 Other Income 0.41 0.41 0.39 0.22 0.10 0.06 0.04 0.05 0.05 Net Income 2.90 3.56 3.90 3.73 3.26 3.45 3.74 3.52 3.49 Operating Expenses 0.77 0.70 0.67 0.60 0.53 0.54 0.49 0.51 0.52 Cost to Income Ratio (%) 26.62 19.64 17.21 16.23 16.27 15.69 13.03 14.58 14.77 Employee Expenses 0.35 0.35 0.33 0.31 0.24 0.27 0.27 0.28 0.28 Other Expenses 0.43 0.35 0.34 0.30 0.29 0.27 0.22 0.24 0.24 Operating Profit 2.13 2.86 3.23 3.12 2.73 2.91 3.25 3.01 2.98 Provisions/write offs 0.20 0.20 0.16 0.15 0.01 0.30 0.53 0.28 0.18 PBT 1.93 2.66 3.07 2.97 2.73 2.61 2.72 2.73 2.79 Tax 0.72 1.01 1.12 1.00 1.00 0.71 0.68 0.68 0.70 Tax Rate (%) 37.26 38.11 36.50 33.61 36.80 27.43 25.00 25.00 25.00 PAT 1.21 1.65 1.95 1.97 1.72 1.89 2.04 2.05 2.09 Leverage 11.64 11.57 11.55 10.78 10.54 10.11 9.19 8.30 7.80 14.09 19.05 22.55 21.27 18.15 19.13 18.74 16.98 16.34 RoE Source: MOFSL, Company

Exhibit 37: DuPont Analysis – REPCO (%) 2015 2016 2017 2018 2019 2020 2021E 2022E 2023E Interest Income 12.38 12.31 12.07 11.56 11.25 11.48 11.14 10.55 10.56 Interest Expended 7.99 7.92 7.69 6.91 6.96 7.19 6.77 6.35 6.30 Net Interest Income 4.40 4.39 4.38 4.65 4.29 4.29 4.37 4.20 4.26 Other Income 0.43 0.43 0.38 0.27 0.31 0.29 0.16 0.21 0.22 Net Income 4.83 4.82 4.76 4.91 4.59 4.58 4.53 4.41 4.48 Operating Expenses 1.01 0.93 0.80 0.84 0.95 0.93 0.86 0.88 0.88 Cost to Income Ratio (%) 20.95 19.28 16.91 17.12 20.71 20.24 19.04 19.95 19.74 Employee Expenses 0.62 0.59 0.51 0.53 0.57 0.58 0.57 0.59 0.59 Other Expenses 0.39 0.34 0.29 0.31 0.39 0.35 0.29 0.29 0.29 Operating Profit 3.82 3.89 3.95 4.07 3.64 3.66 3.67 3.53 3.60 Provisions/write offs 0.38 0.57 0.62 0.80 0.16 0.52 0.52 0.42 0.44 PBT 3.44 3.33 3.33 3.27 3.48 3.14 3.14 3.11 3.16 Tax 1.17 1.16 1.17 1.13 1.21 0.70 0.79 0.78 0.80 Tax Rate (%) 33.89 34.77 34.95 34.60 34.79 22.17 25.20 25.20 25.20 PAT 2.28 2.17 2.17 2.14 2.27 2.44 2.35 2.33 2.36 Leverage 6.97 7.83 8.03 7.68 7.30 6.92 6.44 6.03 5.78

RoE 15.88 16.99 17.42 16.44 16.55 16.92 15.15 14.03 13.67 Source: MOFSL, Company

January 2021 20 Thematic: Housing Finance

Exhibit 38: DuPont Analysis – AAVAS (%) % 2015 2016 2017 2018 2019 2020 2021E 2022E 2023E Interest Income 14.93 13.41 13.01 12.10 12.28 11.84 11.63 11.56 11.80 Interest Expended 8.23 7.53 6.86 5.95 5.28 5.36 5.61 5.53 5.55 Net Interest Income 6.70 5.88 6.15 6.15 7.00 6.48 6.02 6.03 6.24 Other Income 1.68 1.90 1.67 3.14 2.43 1.76 1.18 1.52 1.65 Net Income 8.38 7.78 7.82 9.29 9.43 8.24 7.19 7.54 7.90 Operating Expenses 3.49 3.62 3.24 5.07 3.91 3.46 3.06 3.06 2.99 Cost to Income Ratio (%) 41.7 46.5 41.4 54.6 41.5 42.0 42.5 40.6 37.9 Employee Expenses 2.73 2.64 2.07 3.44 2.43 2.21 2.06 2.08 2.06 Other Expenses 0.77 0.98 1.17 1.63 1.49 1.24 1.00 0.97 0.93 Operating Profit 4.89 4.16 4.58 4.22 5.52 4.78 4.13 4.48 4.91 Provisions 0.37 0.36 0.32 0.08 0.18 0.23 0.55 0.31 0.27 PBT 4.52 3.80 4.26 4.14 5.33 4.55 3.58 4.18 4.64 Tax 1.54 1.30 1.48 1.27 1.69 0.80 0.79 0.92 1.02 Tax Rate (%) 34.1 34.4 34.7 30.7 31.7 17.5 22.0 22.0 22.0 PAT 2.98 2.49 2.78 2.87 3.64 3.75 2.79 3.26 3.62 Leverage 8.12 8.45 5.41 3.70 3.19 3.38 3.80 3.94 4.00 RoE 24.20 21.06 15.04 10.60 11.62 12.66 10.61 12.84 14.47

Source: MOFSL, Company

January 2021 21 Thematic: Housing Finance

Key takeaways from business leaders

Mr. Deepak Parekh – Chairman, HDFC  “Property developers should be prepared for up to 20% fall in housing prices and must create liquidity by selling their inventory at whatever prices they get.” (Apr’20)  “Look at any number, whether it is e-bills, tolls and even housing sector (things have recovered). We never expected that September and October would be such fantastic new inflows of application compared to previous September- October, which was pre-pandemic.” (Dec’20)

Mr. Keki Mistry – Vice-Chairman and CEO, HDFC  “Strong AAA rated-NBFCs have no dearth of liquidity. Lower rated NBFCs/HFCs have not been getting funding from banks due to risk aversion. Guarantee should help these lenders. Expect the CLSS to be helpful for the housing finance industry.” (May’20)  “This is the best time to buy a house. Interest rates of sub-7% on housing loans are the lowest in my career and the likelihood of a further rate cuts by RBI seems relatively limited” (Jan’21)

Mr. Siddhartha Mohanty – MD, LIC Housing Finance  “Recently launched home loans at 7.5% interest for customers with 800+ CIBIL score. Taking advantage of reducing cost of funds. Expect demand revival for the affordable housing segment after 2-3 quarters.” (May’20)  “As far as realty sector is concerned, after September, we realized that a lot of growth is happening in this sector, especially in every segment. Earlier, it was restricted just to the affordable segment but in the last two months, we realized the mid-segment, upper mid-segment and premium segment are also growing significantly.” (Jan’21)

Mr. Niranjan Hiranandani – President, Naredco  “Real estate developers are unlikely to sell their inventory at a discount in a hurry. Developers are likely to face high ready-reckoner rates/the minimum price to calculate taxes, as an inability to sell at a discount.” (Jun’20).  “Governments are taking a proactive view in terms of intervention into real estate. The Maharashtra government has brought down stamp duty rates by 60%, which is unprecedented. Stamp duty rates are just 2%, which many people thought would never happen” (Dec’20).

Mr. Pirojsha Godrej – Executive Chairman, Godrej Properties  “We are starting the year (2021) on a positive note. There were a lot of concerns last year with COVID and the lockdown; those concerns passed us. We had a good first half of the financial year from sales volume perspective. We expect the second half to be much better and especially the Q4 where we have large number of launches planned. We have four markets that are of prime focus for us – Mumbai, Pune, National Capital Region (NCR) and Bengaluru and we are seeing good traction here, reasonably equal sales across these 4 markets.” (Jan’21).

January 2021 22 HFC: A Home Run! Thematic: Housing Finance

Well-placed to capture market share Well diversified liability profile; Provisions > GNPLs; Improving ROAs

Business turning around Strong parentage aids debt capital at competitive rates

Building a foundation for the long term Rights Systems, Right Processes | RoA, asset quality best-in-class Pg24

A balanced player Pg30 Healthy asset quality | Low CoF | 100% retail loans Pg35

Preserving capital; Focus on retail loans Pg56 Asset quality a key monitorable

Pg71

Pg75 Prioritizing asset quality over growth RoA/RoE to be healthy at 2.4%/14% Pg79

Pg84 Pan-India affordable housing finance player ~50% CRAR; Healthy return ratios

A niche player Focus on analytics | Healthy asset quality | Strong growth

January 2021 23 UpdateThe | Sector:matic: Financials Housing Finance – NBFC HDFC BSE Sensex S&P CNX 49,584 14,596 CMP: INR2,684 TP: INR3,250 (+21%) Buy

Well-placed to capture market share Well diversified liability profile; Provisions > GNPLs; Improving ROAs Stock info Bloomberg HDFC IN Equity Shares (m) 1,721 Sharp fall in cost of funds M.Cap.(INRb)/(USDb) 4832.3 / 65.8 HDFC is the key beneficiary of continued excess liquidity at the system level and 52-Week Range (INR) 2778 / 1473 the resultant plunge in borrowing cost (partially led by flight to safety). It is 1, 6, 12 Rel. Per (%) 9/12/-11 borrowing 3- to 5-year money at 5–5.5% and one-year CPs at less than 4.5%. Even deposit rates have been down by 150bp+ since the start of the year. The

Financial Snapshot (INR b) 75–100bp cut in MCLR by banks is also likely to help the company. Overall, Y/E March 2020 2021E 2022E incremental cost of funds has declined 150–200bp to 5–5.5%, whereas Core PPoP 140.3 164.2 184.9 incremental lending rates in the retail portfolio stand at 7%+ – providing Adj. PAT 96.2 107.4 128.3 significant comfort on spreads in a hyper-competitive environment. Reduction Adj. EPS (INR) 49.2 54.4 63.8 EPS Gr. (%) 10.8 10.6 17.3 in excess liquidity and the benefit of a capital raise are likely to aid margins. BV/Sh. (INR) 537.9 619.8 665.3 ABV/Sh. (INR) 399.0 485.2 530.7 Growth to remain healthy, led by consolidation in the sector Core RoA (%) 1.8 1.8 1.9 We are constructive on the Indian RE space, and HDFC being a leader with Core RoE (%) 13.1 12.5 12.6 ~16% market share, is likely to be a key beneficiary of the same. HDFC is Payout (%) 23.7 43.5 43.5 expected to be a beneficiary of balance transfer cases at the system level as Valuation AP/E (x) 33.6 28.5 21.6 some of the large HFCs face their own sets of issues. Overall, we estimate a 12- P/BV (x) 5.0 4.3 4.0 13% AUM CAGR in the individual and corporate segments over FY20–23E. AP/ABV (x) 4.1 3.2 2.6 Div. Yield (%) 0.8 0.9 1.0 Asset quality best in class; Non-Individual segment to be a drag HDFC has managed asset quality well across cycles, with the individual GNPA % Shareholding pattern (%) remaining below 1%. With stability returning at the economy level, the fear of As On Sep-20 Jun-20 Sep-19 Promoter 0.0 0.0 0.0 job loss or sharp salary cuts has reduced sharply. We expect the Individual DII 18.7 18.5 16.7 segment to remain resilient in the ensuing years. On the other hand, the Non- FII 70.0 70.2 72.5 Individual segment is likely to remain under pressure, in our view. The GNPA % Others 11.3 11.3 10.8 increased to 4%+ v/s sub 2% earlier. However, we draw our comfort with As On adequate ECL provisioning of 2.6% v/s sub 1% three years ago. We expect Stock Performance (1-year) HDFC to continue to utilize any one-off gains to build provisions for potential stress in the future; hence, higher provisioning may not impact core earnings.

Healthy core ROA of 1.8%; Valuations attractive Stable-to-improving margins, a lean cost structure, and a well-provided balance sheet would keep core RoA healthy at 1.8% over the medium term. Decline in leverage (6–7x, v/s 9–10x earlier) due to the recent capital raise would restrict ROE to ~13% in the near-to-medium term. Over the last 3–5 years, HDFC’s core business (assuming a constant 20% Holdco discount) has seen de-rating, with multiples contracting from 3x+ to 2x core BV due to headwinds faced by the sector and falling ROA. RE sector tailwinds, coupled with improving profitability, should now see multiple re-ratings. We use SOTP to arrive at a TP of INR3,250 (FY23E based).

January 2021 24 Thematic: Housing Finance

Story in charts

Exhibit 39: In last three quarters borrowing rates down by ~250bp across tenure Instrument Month of issue Tenure of instrument Interest rate (%) NCD Apr 3YR 7.20 NCD Apr 3YR 6.95 NCD May 1.5YR 7.06 NCD May 2YR 7.00 NCD Jun 10YR 7.25 NCD Aug 2YR 5.40 NCD Sep 1YR 4.95 NCD Sep 5YR 6.43 NCD Nov 5YR 5.78 NCD Dec 2YR 4.50 NCD Dec 2YR 4.23

Source: MOFSL, NSE

Exhibit 40: Stable spreads (%) Exhibit 41: NII growth largely in-line with AUM growth Individual Loans Non Individual Loans AUM growth NII growth

22.1 3.44

3.26 19.3

3.14 3.14 3.14 3.16 3.08 3.07 3.09 17.8

3.02

15.8 14.7

13.6 12.7 13.2 12.8 12.1

11.9 11.0 11.7 10.9

9.7 10.2

1.91 1.91 1.85 1.97 1.91 1.95 1.93 1.89 1.92 1.90 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21

Q1FY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Source: MOFSL, Company Source: MOFSL, Company; 2QFY21 NII growth strong due to equity raise

Exhibit 42: Individual loan growth remains healthy at ~15% YoY Individual Loan Growth Non-Individual Loan Growth 17.8 17.1 16.8 16.7 16.2 15.2 13.9 13.9 10.4 10.5 9.1 8.1 6.2 6.1 3.5 2.2

9MFY19 FY19 Q1FY20 1HFY20 9MFY20 FY20 Q1FY21 1HFY21

Source: MOFSL, Company

January 2021 25 Thematic: Housing Finance

Exhibit 43: Non individual segment NPA% rising Exhibit 44: HDFC prudently increasing provisioning Individual GNPA Non-Individual GNPA 4.7 ECL Provisions (%) 4.2 2.64 4.1 2.44 2.60 2.25 2.9 2.9 2.5 2.7 1.55 1.72 2.2 2.3 1.31 1.33 1.44

1.0 0.7 0.7 0.7 0.7 0.7 0.8 0.9 0.8 FY20 FY19 1HFY21 1HFY20 1HFY19 Q1FY21 Q1FY20 9MFY20 9MFY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 45: Consistently gaining share despite high Exhibit 46: Sharp improvement in MS within HFCs in last competition from banks three years (MS, %) HDFC LICHF PNBHF Others HDFC Overall MS (%) 15.9 15.7 15.5 15.2 15.4 15.3 26 25 15.0 14.8 32 31 31 30 31 32 33 34 31 14.5 14.3 14.1 0 7 0 0 2 2 3 4 7 26 4 5 27 28 23 27 27 26 25 23 21 21

48 42 41 40 41 40 40 39 40 41 45 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: MOFSL, Company, RBI Source: MOFSL, Company

Exhibit 47: Share of key ventures in SOTP on the rise (%)

59 55 51 54 51 54 49 50 48 49 48 47 43 44 43 44 46 46 FY20 FY19 FY18 FY17 1HFY21 1HFY20 1HFY19 1HFY18 1HFY17 Q1FY21 Q1FY20 Q1FY19 Q1FY18 Q1FY17 9MFY20 9MFY19 9MFY18 9MFY17

Source: MOFSL, Company

January 2021 26 Thematic: Housing Finance

Exhibit 48: DuPont Analysis (%) FY15 FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E Interest Income 10.83 10.32 9.87 9.03 9.16 8.90 8.02 7.41 7.28 Interest Expended 7.50 7.13 6.69 6.40 6.49 6.31 5.35 4.67 4.60 Net Interest Income 3.33 3.20 3.19 2.63 2.67 2.59 2.66 2.74 2.69 Other core operating income 0.12 0.14 0.11 0.06 0.07 0.06 0.05 0.06 0.06 Core Income 3.46 3.34 3.30 2.69 2.74 2.65 2.72 2.80 2.74 Operating Expenses 0.29 0.28 0.27 0.52 0.35 0.30 0.33 0.32 0.28 Cost to Income Ratio (%) 8.53 8.37 8.12 19.32 12.65 11.48 12.12 11.27 10.19 Employee Expenses 0.14 0.13 0.12 0.37 0.17 0.12 0.17 0.15 0.11 Other Expenses 0.16 0.15 0.14 0.15 0.18 0.18 0.16 0.17 0.17 Core Operating Profits 3.16 3.06 3.03 2.17 2.39 2.35 2.39 2.48 2.46 Provisions/write offs 0.07 0.10 0.14 0.13 0.12 0.32 0.28 0.29 0.29 Core PBT 3.09 2.96 2.89 2.04 2.27 2.03 2.11 2.19 2.17 Dividend Income 0.29 0.30 0.29 0.29 0.26 0.22 0.17 0.22 0.23 Treasury and Other Income 0.22 0.63 0.34 1.56 0.42 2.58 0.37 0.08 0.08 One off provisions/Expenses 0.00 -0.17 -0.09 -0.45 -0.10 -0.88 -0.16 0.00 0.00 PBT 3.60 3.72 3.43 3.45 2.86 3.94 2.48 2.49 2.48 Tax 1.10 1.11 1.05 0.61 0.81 0.53 0.48 0.56 0.56 Tax Rate (%) 30.54 29.83 30.62 17.62 28.44 13.32 19.56 22.41 22.47 Reported PAT 2.50 2.61 2.38 2.84 2.05 3.42 1.99 1.93 1.92 Leverage (x) 8.01 8.01 7.87 6.75 6.01 6.01 5.84 5.74 6.01 RoE 20.02 20.90 18.74 19.18 12.30 20.55 11.30 11.89 12.41

Core RoE 22.76 20.66 19.74 12.57 12.98 13.13 12.48 12.56 12.88 Source: MOFSL, Company

Exhibit 49: SOTP (FY23E based) Value Value Value/Sh. Target Particular Stake (INR b) (USD b) (INR) % of total Multiple (x) Rationale Core business 3,114 41.2 1,741 53.6 3.0 PBV Key Ventures HDFC Bank 21.1 1,968 26.0 1,102 33.9 3.6 PBV HDFC Standard Life 50.0 681 9.0 381 11.7 4.0 PEV HDFC AMC 52.7 422 5.6 236 7.3 45.0 PE HDFC ERGO GIC 49.9 120 1.6 67 2.1 7.0 PBV Bandhan Bank 10.0 81 1.1 45 1.4 3.0 PBV Credila 100.0 82 1.1 46 1.4 Last deal Other Invt 17 0.2 10 0.3 1.0 Invested Capital Total Value of Ventures 3,372 44.6 1,887 58.1 Less: 20% holding discount 674 8.9 377 11.6 Value of Key Ventures 2,697 35.7 1,510 46.4 SOTP 5,811 76.9 3,250 100.0 CMP 2,684 Upside - % 21.0

Source: MOFSL, Company

January 2021 27 Thematic: Housing Finance

Financials and valuation

Income statement (INR b) Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Interest Income 281 309 331 393 437 445 459 510 Interest Expended 194 209 235 278 310 297 289 322 Net Interest Income 87 100 96 114 127 148 170 188 Change (%) 8.8 14.5 -3.2 18.7 11.4 15.8 15 10.9 Assignment income 0 0 5 9 10 8 10 12 NII (including assignment income) 87 100 102 123 137 156 180 200 Change (%) 8.8 14.5 2.2 21 11.5 13.4 15.9 11.2 Other core operating income 4 3 2 3 3 3 4 4 Core Income 91 103 104 126 140 159 184 204 Change (%) 9.5 13.5 0.9 21.4 11.1 13.1 15.9 11.3 Operating Expenses 8 8 19 15 15 18 20 20 Change (%) 7.4 10.3 127.6 -22 0.8 21.9 6.9 0.3 % of core income 8.4 8.1 18.3 11.8 10.7 11.5 10.6 9.6 Core operating profits 83 95 85 111 125 140 164 185 Change (%) 9.7 13.8 -10.3 31.1 12.5 12.1 17 12.6 Provisions/write offs 7 7 21 9 59 25 18 21 Core PBT 76 88 64 102 66 116 146 164 Change (%) 2.5 15.3 -27.3 59.9 -35.2 75.2 26.4 12.3 Profit on sale/MTM on Invt. 16 10 57 18 126 20 5 5 Dividend Income 8 9 11 11 11 9 14 16 One off exp/prov -5 -3 -17 -4 -43 -9 0 0 Miscellanous Income 1 1 0 0 0 0 0 0 PBT 97 105 115 127 160 136 165 186 Tax 30 33 22 35 26 27 35 39 Tax Rate (%) 31.2 31.4 19.3 27.4 16.1 19.7 21 21 Reported PAT 66 72 93 92 135 109 130 147 Change (%) 10.9 7.9 29.8 -1 46 -18.7 19.2 12.8 PAT adjusted for EO* 66 74 68 87 96 107 128 145 Change (%) 8.9 12.2 -8.7 29 10.5 11.6 19.5 12.8 Proposed Dividend 31 29 41 43 44 44 49 55 Other liabilities 142 124 139 152 188 207 228 251 Total Liabilities 2,879 3,352 3,989 4,588 5,241 5,852 6,544 7,471 Loans 2,592 2,989 3,628 4,066 4,509 5,062 5,679 6,531 Change (%) 13.6 15.3 21.4 12.1 10.9 12.3 12.2 15 Investments 153 202 307 462 649 682 750 825 Change (%) 7.4 31.5 52.2 50.5 40.4 5 10 10 Net Fixed Assets 7 10 10 10 22 25 27 30 Other assets 144 150 43 50 60 84 88 85 Total Assets 2,897 3,352 3,989 4,588 5,241 5,852 6,544 7,471 E: MOFSL Estimates

January 2021 28 Thematic: Housing Finance

Financials and valuation

Y/E March 2016 2017 2018 2019 2020E 2021E 2022E 2023E AUM (INR B) 2,915 3,385 4,029 4,619 5,168 5,736 6,453 7,421 Change (%) 15.1 16.1 19.0 14.7 11.9 11.0 12.5 15.0 Individual loans (%) 72.8 72.6 72.9 74.5 75.8 74.8 74.5 74.5 Non Individual loans (%) 27.2 27.4 27.1 25.5 24.2 25.2 25.5 25.5

On Balance Sheet (%) 88.9 88.3 90.1 88.0 87.3 88.3 88.0 88.0 Assignment/Securitisation (%) 11.1 11.7 9.9 12.0 12.7 11.8 12.0 12.0 E: MOFSL Estimates

Ratios Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Spreads Analysis (%) Avg Yield on Hsg Loans 11.0 10.5 9.6 9.7 9.7 8.9 8.2 8.0 Avg. Yield on Funds 11.0 10.5 9.4 9.5 9.4 8.5 7.8 7.6 Avg. Cost of funds 8.7 8.1 7.8 8.1 7.9 6.8 5.9 5.8 Interest Spread on loans 2.3 2.5 1.7 1.6 1.8 2.1 2.3 2.3 Net Interest Margin 3.4 3.4 2.7 2.8 2.7 2.8 2.9 2.8

Profitability Ratios (%) RoAE 20.9 18.7 20.2 13.5 21.7 12.5 12.1 12.6 Core ROE 20.7 19.7 12.6 13.0 13.1 12.5 12.6 12.9 RoA 2.42 2.37 1.84 2.03 1.96 1.94 2.07 2.06 Core ROA 2.02 2.04 1.61 1.84 1.80 1.82 1.90 1.88

Efficiency Ratios (%) Int. Expended/Int.Earned 69.0 67.7 70.9 70.9 70.9 66.8 63.0 63.1 Op. Exps./Net Income 6.6 6.8 11.1 9.6 5.4 9.7 9.7 8.7 Empl. Cost/Op. Exps. 46.0 46.5 72.0 48.2 39.6 50.3 47.1 39.9

Asset Quality (INR m) Gross NPAs 19 24 41 48 89 141.0 170.7 201.8 Gross NPAs to Adv. (%) 0.7 0.8 1.1 1.2 2.0 2.8 3.0 3.1 Net NPAs 13 16 29 34 66 98.7 119.5 141.2 Net NPAs to Adv. (%) 0.5 0.6 0.8 0.8 1.5 2.0 2.1 2.2

VALUATION 2016 2017 2018 2019 2020 2021E 2022E 2023E Book Value (INR) 227.7 274.7 391.1 451.7 537.9 619.8 665.3 716.7 Price-BV (x) 6.0 5.0 4.3 4.0 3.7 Adjusted BV* (INR) 176.6 220.1 340.2 352.4 399.0 485.2 530.7 582.1 Adj Price-ABV (x) 5.3 4.2 3.2 2.6 2.0 Adjusted EPS (INR)# 33.7 39.1 34.5 44.4 49.2 54.4 63.8 71.6 Adjusted EPS Growth YoY 8.2 15.9 -11.7 28.7 10.8 10.6 17.3 12.3 Adj Price-Adj EPS (x) 41.7 34.0 28.5 21.6 16.4 Dividend per share (INR) 17.0 18.0 20.0 21.0 21.0 24.8 27.3 30.8 Dividend yield (%) 0.8 0.8 0.9 1.0 1.1 E: MOFSL Estimates; * BV is adj. by ded. invt in Subs/Asso. from NW # Adjusted EPS is adjusting for dividend from key ventures and one offs

January 2021 29 UpdateThe | Sectormatic:: Financials Housing Finance – NBFC LIC Housing Finance BSE Sensex S&P CNX 49,584 14,596 CMP: INR433 TP: INR510 (+18%) Buy

Business turning around Strong parentage aids debt capital at competitive rates

Stock info Focused approach on growth Bloomberg LICHF IN Over FY17–1HFY21, amid a hyper-competitive environment, LICHF moderated Equity Shares (m) 505 growth in core retail housing to ~10% CAGR. During this period, it focused on M.Cap.(INRb)/(USDb) 218.6 / 3 cross-selling high-yielding LAP products with ticket sizes lower than INR1.5m to 52-Week Range (INR) 486 / 186 manage spreads (30%+ CAGR). With the comfort emerging on cost of funds and 1, 6, 12 Rel. Per (%) 12/27/-23 reducing competitive intensity, LICHF is likely to see healthy growth in core

Financial Snapshot (INR b) retail housing. Overall, we factor an 8–9% CAGR over FY20–23E.

Y/E March 2020 2021E 2022E Comfort emerging on spreads NII 46.8 49.9 55.4 PPP 42.7 45.5 50.6 Historically, LICHF has seen margin expansion in periods of excess liquidity, PAT 24.0 30.1 32.7 aided by sharp decline in cost of funds. In 2QFY21, it reported a fall in EPS (INR) 47.6 59.6 64.8 incremental cost of funds to 5.8% v/s ~8% earlier. We expect this to moderate EPS Gr. (%) -1.2 25.3 8.8 further in 2HFY21. With ~68% of liabilities coming from the capital markets (v/s BV/Sh (INR) 352 401 455 43% for HDFC), LICHF is likely to see bigger benefit than HDFC in terms of Ratios improvement in spreads. NIM (%) 2.3 2.3 2.4 C/I ratio (%) 12.6 12.5 12.4 Asset quality a key monitorable RoAA (%) 1.2 1.3 1.3 Asset quality in the core Housing segment (77% of loans) remains manageable, RoE (%) 14.3 15.8 15.1 Payout (%) 16.8 17.5 17.5 with GNPA % at less than 1.5%. However, LAP (16% of loans, post hyper- Valuations growth) has started seeing some deterioration, with GNPA % rising to >3%. P/E (x) 9.1 7.3 6.7 LICHF has consolidated its Developer Loan segment at 6–7% of the portfolio P/BV (x) 1.2 1.1 1.0 over the last two years; however, the book has seen massive deterioration with Div. Yield (%) 1.8 2.1 2.2 GNPA % rising to 17%. While tailwinds in the RE sector point to improvement, Shareholding pattern (%) we believe LAP and the Developer segment remain key monitorables. ECL As On Sep-20 Jun-20 Sep-19 provisions on BS stand at 1.3% v/s 2.6% for HDFC. Promoter 40.3 40.3 40.3 DII 12.6 10.6 14.6 Leverage level of 12–13x poses concern FII 34.4 34.3 32.9 LICHF’s leverage (assets/equity) is at a higher level of 12.5x. While this is lower Others 12.6 14.8 12.2 than the regulatory permissible level, the expectation of lower leverage by FII Includes depository receipts rating agencies at the sector level would enable capital raise in the ensuing

Stock Performance (1-year) quarters. Stock trades below BV and hence any potential capital raise at current price is likely to be BVPS-dilutive.

Valuations factor in negatives We are constructive on the RE space and LICHF with its strong parentage is likely to be a key beneficiary of the same. We expect spreads and core Retail Housing segment growth to improve in the ensuing quarters. However, asset quality remains a key monitorable. In our view, valuations at 0.8x PBV FY22 largely factor in concerns over capitalization and asset quality. We maintain Buy, with target price of INR510 (1x FY23E BVPS).

January 2021 30 Thematic: Housing Finance

Story in charts

Exhibit 50: NIM to remain stable Exhibit 51: Product mix going forward (%)

Individual loans Builder loans 2.7 3.9 4.1 5.9 5.6 6.2 6.9 7.0

2.70 2.52 2.27 2.38 2.33 2.31 2.37 2.30 97.3 96.1 95.9 94.1 94.4 93.8 93.1 93.0

FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 52: Declining cost of funds provides comfort Exhibit 53: Spreads have now stabilized

Yield on loans CoF 1.5 1.5 1.5 1.5 10.5 10.3 1.4 1.4 9.7 1.3 1.3 9.4 9.6 9.1 1.3 1.3 9.0 8.6 8.5 8.2 8.2 8.2 8.0 7.4 6.7 6.3

FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 2QFY21

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 54: Asset quality under pressure 2.8 2.8 2.8 GNPA NNPA 2.7 2.4 2.0 1.6 1.6 1.6 1.5 1.5 1.4 1.3 1.3 1.2 1.1 0.9 0.8 0.8 0.8 0.9 0.6 0.4 0.4 0.4 0.3 FY20 FY19 FY18 1HFY21 1HFY20 1HFY19 1HFY18 1QFY21 1QFY20 1QFY19 9MFY20 9MFY19 9MFY18 Source: MOFSL, Company

January 2021 31 Thematic: Housing Finance

Exhibit 55: DuPont Analysis (%) DuPont Analysis (%) FY15 FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E Interest Income 10.88 10.92 10.26 9.12 9.24 9.33 8.72 8.11 7.63 Interest Expenses 8.57 8.29 7.56 6.93 6.94 7.08 6.51 5.85 5.42 Net Interest Income 2.31 2.62 2.69 2.19 2.30 2.24 2.21 2.26 2.20 Non interest Income 0.26 0.21 0.15 0.11 0.11 0.10 0.09 0.09 0.10 Net Income 2.57 2.83 2.85 2.30 2.41 2.34 2.30 2.36 2.30 Operating Expenses 0.39 0.42 0.45 0.27 0.26 0.30 0.29 0.29 0.29 Cost to income (%) 15.24 14.74 15.89 11.89 10.63 12.62 12.53 12.39 12.82 Employees 0.13 0.13 0.18 0.14 0.13 0.14 0.14 0.15 0.16 Others 0.26 0.28 0.27 0.13 0.12 0.15 0.15 0.14 0.14 Operating Profits 2.18 2.42 2.39 2.03 2.15 2.05 2.02 2.06 2.00 Provisions/write offs 0.01 0.13 0.21 0.31 0.33 0.48 0.34 0.38 0.38 PBT 2.17 2.28 2.18 1.72 1.82 1.57 1.68 1.68 1.62 Tax 0.74 0.80 0.76 0.47 0.51 0.42 0.35 0.34 0.33 Tax Rate (%) 34.05 35.22 34.67 27.59 28.07 26.53 20.70 20.50 20.50 PAT 1.43 1.48 1.43 1.25 1.31 1.15 1.33 1.34 1.29 Leverage (x) 12.63 13.23 12.65 12.33 12.53 12.42 11.87 11.32 10.93

RoE 17.54 19.58 18.06 15.36 16.40 14.30 15.82 15.14 14.10 Source: MOFSL, Company

Exhibit 56: One-year forward P/B chart Exhibit 57: One-year forward P/E chart P/B (x) Avg (x) Max (x) P/E (x) Avg (x) Max (x) 3.6 Min (x) +1SD -1SD 21.0 Min (x) +1SD -1SD 17.8 2.7 2.7 16.0 13.9 2.2 1.7 1.8 11.0 10.9 1.2 7.8 0.9 0.6 0.8 6.0 3.9 6.0

0.0 1.0 Jun-18 Jun-13 Jun-18 Jun-13 Sep-19 Sep-14 Sep-19 Sep-14 Dec-20 Dec-15 Dec-10 Dec-20 Dec-15 Dec-10 Mar-17 Mar-12 Mar-17 Mar-12 Source: MOFSL, Company Source: MOFSL, Company

January 2021 32 Thematic: Housing Finance

Financials and valuation

Income Statement (INR M) Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Interest Income 1,22,509 1,38,767 1,46,662 1,71,628 1,94,620 1,96,837 1,98,592 2,03,392 Interest Expense 93,068 1,02,315 1,11,439 1,28,915 1,47,839 1,46,920 1,43,184 1,44,623 Net Interest Income 29,441 36,452 35,223 42,713 46,781 49,917 55,408 58,769 Change (%) 31.6 23.8 -3.4 21.3 9.5 6.7 11.0 6.1 Fee Income 1,453 1,102 356 348 394 536 541 625 Other Income 893 934 1,388 1,669 1,684 1,600 1,760 1,936 Net Income 31,787 38,489 36,968 44,730 48,859 52,053 57,709 61,330 Change (%) 27.7 21.1 -4.0 21.0 9.2 6.5 10.9 6.3 Operating Expenses 4,687 6,118 4,396 4,754 6,167 6,521 7,153 7,863 Operating Profits 27,100 32,371 32,572 39,976 42,692 45,532 50,557 53,467 Change (%) 28.5 19.4 0.6 22.7 6.8 6.7 11.0 5.8 Provisions/write offs 1,465 2,813 4,917 6,181 10,002 7,575 9,369 10,201 PBT 25,636 29,558 27,655 33,796 32,690 37,957 41,188 43,266 Tax 9,028 10,247 7,630 9,486 8,672 7,857 8,443 8,870 Tax Rate (%) 35.2 34.7 27.6 28.1 26.5 20.7 20.5 20.5 PAT 16,608 19,311 20,025 24,310 24,018 30,100 32,744 34,397 Change (%) 19.8 16.3 3.7 21.4 -1.2 25.3 8.8 5.0 Proposed Dividend 3,333 3,759 3,998 4,471 4,040 5,260 5,722 6,011

Balance Sheet (INR M) Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Capital 1,010 1,010 1,010 1,010 1,010 1,010 1,010 1,010 Reserves & Surplus 90,450 1,21,351 1,37,404 1,57,112 1,76,881 2,01,721 2,28,743 2,57,129 Net Worth 91,460 1,22,361 1,38,413 1,58,122 1,77,891 2,02,731 2,29,753 2,58,139 Borrowings 11,09,310 12,63,170 14,53,099 17,06,670 19,13,317 20,57,497 22,16,656 24,11,275 Change (%) 14.9 13.9 15.0 17.5 12.1 7.5 7.7 8.8 Other liabilties 0 1,19,285 1,19,385 1,41,043 76,848 88,375 1,01,631 1,16,876 Total Liabilities 12,00,769 15,04,816 17,10,898 20,05,835 21,68,056 23,48,603 25,48,040 27,86,290 Investments 2,768 33,694 19,722 35,951 54,964 60,460 66,506 73,157 Change (%) 16.7 1,117.1 -41.5 82.3 52.9 10.0 10.0 10.0 Loans 12,51,730 14,47,167 16,61,623 19,29,927 20,79,880 22,48,631 24,35,886 26,64,392 Change (%) 15.5 15.6 14.8 16.1 7.8 8.1 8.3 9.4 Net Fixed Assets 920 965 971 1,359 2,544 2,925 3,364 3,869 Other assets -54,649 22,990 28,582 38,598 30,669 36,587 42,284 44,872 Total Assets 12,00,769 15,04,816 17,10,898 20,05,835 21,68,056 23,48,603 25,48,040 27,86,290 E: MOFSL Estimates

January 2021 33 Thematic: Housing Finance

Financials and valuation

Ratios (%) Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Spreads Analysis (%) Yield on loans 10.5 10.3 9.4 9.6 9.7 9.1 8.5 8.0 Cost of funds 9.0 8.6 8.2 8.2 8.2 7.4 6.7 6.3 Spreads Analysis (%) 1.52 1.7 1.2 1.4 1.5 1.7 1.8 1.7 Margins 2.5 2.7 2.3 2.4 2.3 2.3 2.4 2.3 Profitability Ratios (%) Adj RoAE 19.6 18.1 15.4 16.4 14.3 15.8 15.1 14.1 Adj RoAA 1.5 1.4 1.2 1.3 1.2 1.3 1.3 1.3 Int. Expended/Int.Earned 76.0 73.7 76.0 75.1 76.0 74.6 72.1 71.1 Other Inc./Net Income 2.8 2.4 3.8 3.7 3.4 3.1 3.0 3.2 Efficiency Ratios (%) Fees/Operating income 1.2 0.8 0.2 0.2 0.2 0.3 0.3 0.3 Op. Exps./Net Income 14.7 15.9 11.9 10.6 12.6 12.5 12.4 12.8 Empl. Cost/Op. Exps. 32.1 40.2 50.8 52.1 48.5 49.1 51.5 53.8 Asset-Liability Profile (%) Loans/Borrowings Ratio 112.8 114.6 114.4 113.1 108.7 109.3 109.9 110.5 Debt/Equity (x) 12.1 10.3 10.5 10.8 10.8 10.1 9.6 9.3 Gross NPAs (Rs m) 5,678 6,271 13,036 30,754 59,594 82,080 94,259 1,07,581 Gross NPAs to Adv. 0.5 0.4 0.8 1.6 2.8 3.6 3.8 4.0 Net NPAs (Rs m) 2,705 2,053 7,117 21,000 41,000 57,456 65,982 75,307 Net NPAs to Adv. 0.2 0.1 0.4 1.1 2.0 2.6 2.7 2.8 Valuation 2016 2017 2018 2019 2020 2021E 2022E 2023E Book Value (INR) 181.1 242.3 274.1 313.1 352.3 401.5 455.0 511.2 Growth (%) 17.0 33.8 13.1 14.2 12.5 14.0 13.3 12.4 Price-BV (x) 1.1 1.1 1.0 0.8 EPS (INR) 32.9 38.2 39.7 48.1 47.6 59.6 64.8 68.1 Growth (%) 19.8 16.3 3.7 21.4 -1.2 25.3 8.8 5.0 Price-Earnings (x) 7.8 7.3 6.7 6.4 Dividend Per Share 5.5 6.2 6.8 7.6 8.0 8.9 9.7 10.2 Dividend Yield (%) 2.2 2.1 2.2 2.4 E: MOFSL Estimates

January 2021 34 Initiating CoverageThe | Sectormatic:: Financials Housing Finance – NBFC AAVAS Financiers BSE Sensex S&P CNX 49,269 14,485 CMP: INR1,930 TP: INR2,000 (+4%) Neutral

Building a foundation for the long term

Rights Systems, Right Processes | RoA, asset quality best-in-class

Stock info Bloomberg AAVAS IN  Incorporated as a subsidiary of erstwhile AU Financiers in 2011, Aavas Financiers Equity Shares (m) - (AAVAS) has come a long way over the past decade. It is now one of the fastest M.Cap.(INRb)/(USDb) 151.3 / 2.1 growing, most profitable affordable housing finance companies in India. 52-Week Range (INR) 2113 / 846  Backed by two PE players (Kedara Capital and Partners Group), AAVAS has 1, 6, 12 Rel. Per (%) 9/14/-22 12M Avg Val (INR M) 207 focused on the right systems and processes from day one. Asset quality was and Free float (%) 49.8 is its top priority. It segregated its sales, credit and collections functions to

facilitate independent underwriting. Around 60-70% of files sourced are rejected. Financial Snapshot (INR b) With a credit team of 600+ members and a collections team of ~200 (MOFSL est.), INR b 2020 2021E 2022E NII 4.3 5.1 5.9 we believe no other company of the size of AAVAS has such a large underwriting PPP 3.2 3.5 4.4 and collections teams. The focus on underwriting reflects in its pristine asset PAT 2.5 2.4 3.2 quality – 2.4% 1dpd+ ratio and 0.5% GS3 ratio (FY20) – which is superior to peers. EPS (INR) 31.8 30.0 40.9  AAVAS also has the largest branch network among affordable housing financiers EPS Gr. (%) 35.3 67.3 41.2 BV/Sh. (INR) 268 298 339 in India. Over FY17-20, the network by over 2.5x to 250 branches and AAVAS’ Ratios (%) employee base by nearly 4x to 3,500+ employees. Hence, its expense ratio of

NIM 7.9 7.5 7.3 3.3% is far higher than peers. However, with scale-up of these new branches, the C/I ratio 42.0 42.5 40.6 company should benefit from operating leverage. We forecast 50bp reduction in Credit cost 0.28 0.69 0.37 RoA 3.8 2.8 3.3 the expense ratio to 2.8% over FY20-23E. RoE 12.7 10.6 12.8  At the core of its performance is its technology. AAVAS has a team of ~100 Payout (%) 0.0 0.0 0.0 people just working in technology and data analytics. Its predictive analytics Valuation model on customer bounce has accuracy of 75-80% (as per management). The P/E (x) 60.7 64.3 47.2 model is also able to predict which customers are likely to do a balance transfer P/BV (x) 7.2 6.5 5.7 (BT) out of AAVAS – this has helped AAVAS curtail BT by ~50%. Div. Yield (%) 0.0 0.0 0.0  At 7.5-8%, AAVAS’ NIM is far superior to peers (~4% typically) due to (a) higher

Shareholding pattern (%) share of self-employed customers and of LAP, and (b) high Tier I ratio of 50%+. As On Sep-20 Jun-20 Sep-19  We believe AAVAS has built a sustainable business model to deliver healthy Promoter 50.2 53.5 58.3 growth along with strong profitability over the long term. The company’s DII 12.4 13.0 8.7 management team is young and well-incentivized. While AAVAS has best-in-class FII 28.0 24.5 18.1 RoA of 3.5%+, its RoE is modest at 12-14% due to low leverage. While this is Others 9.5 9.1 15.0 unlikely to meaningfully improve over the next two years, we believe it can FII Includes depository receipts improve to 16-18% structurally over the long term. There is no risk of dilution Stock Performance (1-year) over the next five years, in our opinion. However, given its rich valuations, we initiate coverage with Neutral and a TP of INR2,000 (5.0x FY23E BVPS).

Niche affordable housing finance player operating in 10 states Headquartered in Jaipur, AAVAS primarily focuses on the low and middle- income category of borrowers in semi-urban and rural areas. More than half of its borrowers are part of the EWS and LIG categories (

the past four years, the company has grown its LAP book considerably – it now

January 2021 35 Thematic: Housing Finance

accounts for 27% of overall AUM. While AAVAS is present across 10 states, ~80% of its branches are in Rajasthan, Maharashtra, Gujarat and MP.

What makes AAVAS’ asset quality stand out vs peers? Across all asset quality parameters, AAVAS is either in line with or better than peers. Its GS3 ratio is only 0.5% despite catering to the low-ticket, self- employed segment. Its 1dpd+ ratio of 2.4% (FY20) is also significantly better than peers. Also, contrary to other HFCs, its GNPL ratio improved over the past three years. We attribute this to its heavy investment in people, systems and processes. AAVAS has a credit team of 600+ people and a collections team of ~200 people (MOFSL est.). ~50% of its underwriters are Chartered Accountants. None of its peers of a similar size have such a large credit or underwriting team. AAVAS also has a 30-member fraud risk team. It has templates of 60+ customer profiles compiled throughout the years. Borrowers with 100% agricultural income are rejected. In addition, not only does AAVAS monitor the progress of its customers on a regular basis, but also keeps track of the progress of applicants that were rejected in the past and have taken a loan elsewhere. Also, for overdue customers, there are multiple collections teams involved depending on the delinquency bucket. In addition, the credit manager has to visit every 90dpd+ customer to understand what went wrong.

Largest branch network among affordable housing financiers The company has been in a rapid expansion mode over the past three years. Its branch network increased from 97 in FY17 to 250 in FY20. This is a key differentiator v/s other affordable housing finance companies like REPCO, CANF and erstwhile GRHF that opened only 10-21 branches over FY17-20. As a result, AAVAS delivered AUM CAGR of 40%+ over FY17-20 to INR78b. While AUM growth is likely to slow down meaningfully in FY21 due to the pandemic, we believe it is only a temporary blip. Beyond FY21, AAVAS plans to continue to open 30-40 branches every year. In addition, branches opened over the past 1-2 years would continue to scale up. Hence, we expect AAVAS to deliver 20% AUM CAGR over FY20-23E, higher than other HFCs in our coverage.

Profitability susceptible to up-fronting of assignment income At 22% of AUM as of FY20, AAVAS’ share of off-balance sheet loans is the highest in our coverage universe. Under Ind-AS, companies are required to upfront the future estimated spreads from loan assignments. As a result, over the past two years, assignment income has been meaningful .i.e. ~20% of NII and 25-30% of PBT. This makes overall profitability of the company susceptible to the quantum of sell-downs done during the year. Any reduction in assignments could significantly impact profits.

Margins to moderate; Operating leverage to drive expense ratio lower AAVAS generates an average yield of 13.5%, ~200bp above peers like REPCO. This is due to its lower ticket size customer segment, higher share of self- employed customers and higher share of LAP. However, yields have declined 130bp over the past three years despite rising share of LAP. This is owing to (a) reduction in interest rates for customers looking to switch to other lenders, and (b) in order to grow the loan book beyond a certain point, yields would have to

January 2021 36 Thematic: Housing Finance

decline to be competitive with peers. We expect this trend to play out over the next 2-3 years, albeit at lower pace. Hence, we forecast 50bp moderation in margins over FY20-23E to 7.4%. Over the past three years, AAVAS has expanded its branch network by over 2.5x to 250 and its employee base by nearly 4x to 3,500+. Hence, its expense ratio of 3.3% is far higher than peers. With gradual scale-up of recently-opened branches, it should benefit from operating leverage, resulting in 50bp expense ratio reduction over FY20-23E.

Best-in-class RoA and asset quality; Initiate with Neutral due to rich valuations Being a niche product, only a few companies have been able to scale up in low- ticket affordable housing finance. This business is very geography specific – there is no large pan-India player in this segment yet. We believe AAVAS has built a sustainable business model to scale up profitably across geographies over the long term. Its technology adoption and relentless focus on asset quality has made it stand out vs peers. The management team is young and well-incentivized. While the company has best-in-class RoA of 3.5%+, its RoE is modest at 12-14% due to low leverage. While this is unlikely to meaningfully improve over the next two years, one can expect 16-18% RoE structurally over the long term. AAVAS could deliver 20-25% EPS CAGR over the medium-to-long term without any dilution. However, as valuations are rich, we initiate coverage on AAVAS with a Neutral rating and a TP of INR2,000 (5.0x FY23E BVPS).

January 2021 37 Thematic: Housing Finance

WHAT MAKES AAVAS DIFFERENT?

No month-end concept: Around 70% of the High rejection rate: On an average, the sales business is done in the first three weeks of team sources ~10k files per month. Of these, 60- 70% are rejected. Note that customers with the month (sub-50% for peers). Hence, 01 100% agricultural income are rejected. In 05 there is no unnecessary pressure on the sales and credit teams to disburse files at addition, AAVAS continually tracks the month-end. performance of customers that it rejects.

Separate teams for sales, credit and collections: The credit manager in the branch does not report to the branch manager. Instead, he reports to the area credit manager. This ensures unbiased underwriting. Hiring policy: AAVAS prefers to recruit 02 The credit manager is empowered to sanction loans executives not previously exposed to the 06 only up to a particular limit depending on the vintage mortgage finance sector. As per of the branch and other parameters. The company management, their inexperience is an has a 600+ member underwriting team which is the largest among peers of its size (MOFSL est.).

Large collections team: AAVAS has a Others: (a) AAVAS also takes an employer collections team of ~200+ people (MOFSL guarantee for salaried customers who receive 03 est.). In addition, there are two collections their salary in cash. (b) The sales team 07 heads – one for 1dpd+ and the other for incentive is linked to 1dpd performance. (c) higher buckets. The credit manager has to visit every case that turns 90dpd.

Technology: 80 people tech team and 15 people data analytics team. All data is geotagged. The portfolio is now plotted on a heat map wherein just pointing to any location, you can know 04 details of loans, arrears, collections, demographic, etc. Have predictive model for balance transfers which has helped reduce balance transfers by 50%.

January 2021 38 Thematic: Housing Finance

Low-ticket affordable housing player 65% self-employed customers; High margins; Strong asset quality

 Incorporated in 2011 in Rajasthan, AAVAS delivered AUM CAGR of 42% over FY17-20 to INR78b. This, the company achieved by deepening penetration in its home state and expansion into new states. It has a network of 251 branches across 10 states with the key states being Rajasthan, Maharashtra, Gujarat and Madhya Pradesh.  The company focuses on the low-income, affordable housing segment with an average ticket size of sub-INR1m. ~65% of its loans are to the self-employed segment. Unlike peers, the company has a 100% insourcing model. In addition, it has separate teams for sales, credit and collections.  In FY15, AAVAS started loans against property. This book has grown rapidly and comprises 26% of total AUM. In addition, unlike most peers, the company regularly assigns loans to banks – the share of assigned loans stands at 20% of total AUM.

Incorporated as a subsidiary of AU SFB; Key states are RJ, MH, GJ and MP Incorporated in 2011;  AAVAS Financiers was incorporated in 2011 as AU Housing Finance, a subsidiary Based out of Jaipur. of AU Financiers (AUSFB).  However, after AUSFB received a small finance bank license in 2013, it divested 90% stake in the business to various private equity funds managed by Kedaara Capital and Partners Group.

Exhibit 58: Company Snapshot What? Description Key segments  Home Loans (74% of AUM), LAP (26% of AUM) Customer profile  Self-employed (65%), Salaried (35%) Property  Self-construction (80-85% of cases) Key states  Rajasthan, Maharashtra, Gujarat and MP Average ticket size  INR0.9m for home loans, INR0.6m for LAP Sourcing mix  100% own-sourced Average yield  ~13% for home loans, 15% for LAP Average LTV  50%  Loan assignment 20% of the AUM is assigned to banks Source: MOFSL, Company

Exhibit 59: State-wise mix of AAVAS’ 259 branches (%)

UK, 3% UP, 6% CH, 2% HY, 6% RJ, 34% NCR, 2% HP, 2%

MP , 14%

GJ, 14% MH, 17%

Source: MOFSL, Company

January 2021 39 Thematic: Housing Finance

Catering primarily to the self-employed segment; Ticket size sub-INR1m  AAVAS primarily caters to the informal customer segment of the economy, with Separate teams for sales, credit and collections. particular focus on self-employed customers. Credit underwriting of such customers is done on the basis of several templates developed by the company over the years. The company has a database of over 60+ templates, which helps it in underwriting home loans for the self-employed.  There is clear segmentation of the sales and credit teams – the sales team is not authorized to sanction a loan. Also, the credit manager at the branch has the authority to sanction a loan only up to a particular limit depending on the vintage of the branch and other parameters. One of the differentiating aspects of AAVAS is that it has an underwriting team of over 600 people (MOFSL est.) – the largest among any of its similarly sized peers.

Exhibit 60: Average ticket size steady over past few years Exhibit 61: Average ticket size lower than peers (INR m) Average ticket size (INR m) 1.8

1.2 1.0 0.8

0.64 0.76 0.85 0.86 0.86 0.86 0.84

FY14 FY15 FY16 FY17 FY18 FY19 FY20 CANF REPCO BANDHAN AAVAS

Source: MOFSL, Company; Note: Blended average of HL and LAP Source: MOFSL, Company; Note: Affordable housing finance segment of BANDHAN

Exhibit 62: Share of self-employed customers (%) Share of self-employed FY17 FY18 FY19 FY20 customers 65% higher 64 64 65 65 than that of peers. 60 58 55 52 44 40 40 40 29 29 25 27

AAVAS REPCO BANDHAN CANF Source: MOFSL, Company

40%+ AUM CAGR over the past three years AUM up 3x over FY17-20  Over the past few years, the company has scaled up its loan book rapidly, to INR78b. driven by increased business from vintage branches as well as new branch expansions.  Disbursements grew 2x to INR29b while total AUM grew 3x to INR78b over FY17-20.

January 2021 40 Thematic: Housing Finance

Exhibit 63: Disbursements up 2x… Exhibit 64: …while AUM up 3x over FY17-20

Disbursements (INR b) Growth (%) AUM (INR b) Growth (%) 96 60 51 46

47 31 32 30 24 10

5.4 10.5 13.9 20.5 26.7 29.3 8 17 27 41 59 78 84 21 FY15 FY16 FY17 FY18 FY19 FY20 1HFY FY15 FY16 FY17 FY18 FY19 FY20 Source: MOFSL, Company Source: MOFSL, Company

Rapid scale-up of the LAP book; LAP now 26% of total AUM LAP now comprises 26%  In FY15, AAVAS started ‘Loans against Property’ (LAP), catering to the same of total AUM. segment of customers, with an average ticket size of INR0.6-0.7m. This business has grown quite swiftly and now accounts for 26% of total AUM.  Around one-fourth of these loans are top-up loans. Note that top-up loans are not given to overdue customers. Apart from LAP, there are no other non-core loans such as builder loans and LRD.  Among peers, AAVAS has the highest share of AUM coming from non-core loans. It is also the only player that has increased its share of non-core loans over FY17-20.

Exhibit 65: Share of LAP in total AUM continually rising (%)

LAP AUM (INR b) Share of total AUM (%) 26.5 24.5 22.4 18.1

12.0

6.1

0.5 2.0 4.9 9.1 14.5 20.7

FY15 FY16 FY17 FY18 FY19 FY20

Source: MOFSL, Company

Exhibit 66: Non-home loans share on a rising trend and highest amongst peers (%)

FY17 FY18 FY19 FY20 27 24 22 20 19 19 18 18 17 19 18 14 12 10 11 10

AAVAS BANDHAN CANF REPCO Source: Company, MOFSL

January 2021 41 Thematic: Housing Finance

Pristine asset quality a key differentiator Only HFC to report improvement in Stage 2 and Stage 3 loans over FY17-20

 AAVAS has a GS3 ratio of 0.5%. Its average credit cost over the past 5 years is 0.3%. Superior asset quality performance despite a high share of self-employed customers is on back of (a) large credit team (600+) as well as collections team (~200), (b) strong underwriting model with 60+ templates of various professions and (c) 100% in- sourcing with focus on customer referrals.  The company also has multiple collections teams depending on the delinquency bucket. It has one team for early delinquencies and one for higher bucket delinquencies. In addition, there is a specialized team focusing only on SARFAESI cases. Given its strong focus on collections, AAVAS’ 1dpd has improved from 9% to 2.4% over the past three years.  Interestingly, LAP has lower NPLs compared to home loans (30bp v/s 50bp).

Rigid underwriting process; Strong focus on collections… AAVAS has 600+ employees in credit team  AAVAS has segregated its sales and credit teams. While the credit manager and ~200 employees in works out of the branch, he does not report to the branch manager, and thus, collections team (MOFSL is independent from the sales team. The company has over 60 templates for est.). different professions, which assists the credit team in underwriting. Typically, 65-70% of loan applications are rejected.  Moreover, the company uses two valuers – internal and external for property valuation. Also, it sanctions loans based on the documented transaction price and not on the market value.  The company also has multiple collections teams with a total workforce of ~200 employees. Moreover, the credit manager has to visit every 90dpd case to understand what went wrong.

Exhibit 67: Number of employees – Large investments in the team across functions FY17 FY18 FY19 FY20 3,564

2,384 1,862

994 940 785 929 792 838 670 578 648

AAVAS REPCO CANF

Source: MOFSL, Company; Note: On-roll employees

…resulting in strong asset quality 1dpd+ loans ratio  This has resulted in strong asset quality. The 1dpd+ ratio has improved from improved from 9% to 9% to 2.4% over FY17-20, while the GNPL ratio stands at ~0.3%. 2.4% over the past three  Interestingly, the LAP book has lower GNPLs than the home loan book (0.3% v/s years. 0.5% as of FY19).  Moreover, the highest credit cost over the past five years is only ~40bp.

January 2021 42 Thematic: Housing Finance

Exhibit 68: Asset quality trend (%) Exhibit 69: GNPL ratio much better than peers (%) Gross NPL (INR m) GNPL ratio (%) 3.8 FY18 FY19 FY20 0.8 2.9 3.0

0.5 0.5 0.3 0.3 0.3 1.3

0.7 0.6 0.8 0.5 43 80 169 107 158 210 0.3 0.3 0.3 0.4

FY15 FY16 FY17 FY18 FY19 FY20 AAVAS BANDHAN CANF Repco Source: MOFSL, Company Source: MOFSL, Company

Exhibit 70: Significant improvement in 1dpd+ loans (%) Exhibit 71: Slippage ratio and credit costs benign

1dpd+ % Slippage ratio (%) Credit cost (%) 8.9 7.3 0.8 6.7

4.8 4.9 0.6 4.1 3.9 4.3 3.9 3.4 3.4 0.5 2.4 0.4 0.3 0.3 0.3 0.4 0.3 0.4 0.4 0.1 0.3 0.2 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: MOFSL, Company Source: MOFSL, Company

Strong collection efficiency during the moratorium period Collection efficiency of  Even during the moratorium period, AAVAS delivered collection efficiency (CE) 97% post the higher than peers. CE improved from 76% in Apr’20 to ~90% in Jun’20. moratorium period in  Once the moratorium was lifted in September, the company collected money Sep ‘20. from 97% of its customers.  Less than 0.5% of its customers had not paid a single instalment during the moratorium period.

January 2021 43 Thematic: Housing Finance

Margins best-in-class Long-term borrowings ensure no ALM mismatch

 Given the high-share of self-employed customers as well as of LAP, AAVAS earns an average yield of 13.5% (~200bp higher than that of peers like REPCO). Nevertheless, yields compressed 130bp over the past three years. This has been partly offset by 90bp decline in cost of funds over the same time period.  One key differentiator of AAVAS’ liability profile is the average duration of the borrowings. AAVAS borrows money at an average duration of 10-11 years. In addition, the company has 20%+ liquidity on the balance sheet. Therefore, the company does not face any ALM issues despite the long duration of its assets.  Another key differentiator between AAVAS and other affordable housing players is that it has ~20% of its AUM off-balance sheet. It has been selling down loans since FY16, which has helped it not only generate liquidity but also to forge strong relationships with its lenders.

Yields down 130bp over FY17-20, yet significantly higher than peers  AAVAS’ yield is ~200bp higher than competitors. This is on account of (a) Yield of 13.5% is ~200bp higher share of self-employed customers (100-150bp higher interest rate v/s higher than peers due to higher share of self- salaried customers), (b) higher share of LAP, and (c) lower ticket size (implying employed customers and a ‘riskier’ category of borrowers). higher share of LAP.  However, in order to tap a larger customer base and retain good-quality existing customers, it has had to cut its home loan rates over the past three years. This has led to 130bp reduction in total yields over FY17-20, as compared to only 50bp reduction for peers like REPCO and CANF.

Exhibit 72: Yield on loans (%)

FY17 FY18 FY19 FY20 14.8 14.2 13.9 13.5 12.2 11.7 11.7 10.9 11.4 10.3 10.1 10.4

AAVAS CANF REPCO Source: MOFSL, Company

Low dependence on capital markets for borrowings ~80% of total borrowings  AAVAS’ key sources of borrowings include banks, NHB and foreign multi-lateral (incl. off-BS borrowings) institutions. Around 60% of its total borrowings come from banks and loan come from banks and assignments to banks while ~20% comes from NHB. NHB.  The share of NCDs has historically been low. However, in FY20, AAVAS raised long-term money from ADB and CDC Group, largely via NCDs. Unlike raising money from mutual funds, which are of 3-year tenure, these borrowings come with tenure of 5-8 years. Also, AAVAS does not have any commercial paper outstanding.

January 2021 44 Thematic: Housing Finance

Exhibit 73: Borrowing mix trend (%) Exhibit 74: Credit rating Term Loans Assignment NHB NCDs ICRA CARE

Credit Rating AA- AA- 13 11 11 16 15 18 19 18 10 Source: MOFSL, Company 19 18 15 13 14 21 22 27 28 28 28 28 25 24 24

50 42 43 42 44 43 36 36 FY20 FY19 1HFY21 1HFY20 1QFY21 1QFY20 9MFY20 9MFY19 Source: MOFSL, Company

Exhibit 75: Share of off-BS as % of AUM higher than that of peers

FY16 FY17 FY18 FY19 FY20 22 23 22 21 20

13 12 12 13 12 11 10 8 7

1

AAVAS HDFC PNBHF Source: MOFSL, Company

Healthy ALM position due to long borrowing tenure; 20%+ liquidity on BS  AAVAS has no CPs outstanding. In addition, it typically does not borrow much Average borrowing tenure of 11 years helps from mutual funds due to the relatively short tenure of the money offered. The maintain positive ALM. company prefers long-term borrowings from banks, NHB and multi-lateral institutions. The average tenure of borrowings for the company is 11 years.  The company has INR15b liquidity on the balance sheet (25% of borrowings). This helps it maintain positive ALM across buckets.

Exhibit 76: ALM pattern as of 1HFY21 (INR b)

Assets Liabilities 31.5

16.8 16.8 17.3 12.8 8.2 8.7 9.4 6.1 4.2 5.4 2.7 2.6 1.2

< 3 months 3-6 months 6-12 months 1-3 years 3-5 years 5-7 years 7+ years

Source: MOFSL, Company

January 2021 45 Thematic: Housing Finance

Exhibit 77: Average tenure of borrowings (years) Exhibit 78: Liquidity at 20%+ of borrowings Liquidity (INR b) % of borrowings 11.9 11.9 25.0 11.6 22.3 11.4 20.6 11.2 18.6 11.0 10.8 16.1 15.4 10.6

2.3 2.8 5.6 6.8 11.9 15.1 FY16 FY17 FY18 FY19 FY20 3QFY19 4QFY19 1QFY20 2QFY20 3QFY20 4QFY20 1QFY21 2QFY21

1HFY21 Source: MOFSL, Company Source: MOFSL, Company

Strong fundamentals lead to competitive cost of funds Cost of funds (calc.)  Over the past five years, AAVAS’ cost of funds (calc.) has declined by 200bp to declined 200bp over past ~8%. Its cost of funds is competitive with some of the largest HFCs. five years to ~8%.

Exhibit 79: Cost of funds (calc., %) Cost of funds (%) 12.0 9.9 8.9 8.8 8.5 8.0 7.9

FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Company, MOFSL

January 2021 46 Thematic: Housing Finance

Expect 18% PAT CAGR over FY20-23E Spread pressure to be offset by lower expense ratio

 In our view, FY21 will be a temporary blip in the long-term growth trajectory of AAVAS. AUM growth is likely to slow from ~30% in FY20 to ~20% in FY21, Going forward, the company should be able to grow at 20-25% CAGR sustainably with ramping up of existing branches as well as new branch openings. The share of LAP should be largely stable incrementally.  We expect modest 20bp spread compression over the next three years, driven by 40bp yield decline. Nevertheless, the company should deliver 18% NII CAGR over FY20-23E. Assignment income is a meaningful contributor to the top line – while it is difficult to forecast assignment income, we forecast 20% CAGR over FY20-23E.  Asset quality would witness some deterioration given the impact of the lockdown. We expect GNPL ratio to increase to ~2.5% in FY22 and remain stable thereafter. Likewise, credit costs would increase from 30bp in FY20 to 70bp in FY21 and normalize thereafter.  These factors should drive 18% PAT CAGR over FY20-23E. RoA is expected to moderate 20bp to 3.6% while RoE should improve ~200bp to 15% over the same period.

Expect 20% AUM CAGR over FY20-23E Disbursements per  Over the past two years, AAVAS has opened 85 branches. Typically, an HFC branch should recover to FY20 levels of ~INR120m branch reaches its optimum disbursements level in 3-4 years. Many of these by FY23E. new branches are likely to witness an improving disbursement trajectory over the next 1-3 years.  In addition, the company expects to open 30-40 branches per year on a run- rate basis in foreseeable future. These new branches should provide more impetus to overall growth.  Hence, post the estimated 15% YoY in disbursement decline in FY21E, we expect 32% disbursement CAGR over FY21-23E, resulting in an average 20% AUM CAGR over FY20-23E.

Exhibit 80: Expect gradual recovery in disbursements per Exhibit 81: …resulting in 6% CAGR in AUM per branch over branch over FY21-23E (INR m)… FY20-23E (INR m) Disb/branch AUM/branch 148 372 127 346 124 117 122 312 331 110 287 283 89 247 FY17 FY18 FY19 FY20 FY17 FY18 FY19 FY20 FY21E FY22E FY23E FY21E FY22E FY23E Source: MOFSL, Company Source: MOFSL, Company

January 2021 47 Thematic: Housing Finance

Exhibit 82: Expect 14% disbursement CAGR over FY20-23E… Exhibit 83: …resulting in 20% AUM CAGR

Disbursements (INR b) Growth (%) AUM (INR b) Growth (%) 47 60 40 32 51 30 25 46 10 31 -14 19 19 21

10.5 13.9 20.5 26.7 29.3 25.1 35.1 43.9 17 27 41 59 78 93 111 134 FY16 FY17 FY18 FY19 FY20 FY16 FY17 FY18 FY19 FY20

FY21E FY22E FY23E FY21E FY22E FY23E Source: MOFSL, Company Source: MOFSL, Company

Expect 40bp yield Spreads to contract 20bp driven by lower yields compression to 13.1%  Over the past three years, AAVAS’ yields declined 130bp, sharper than the 50bp over FY20-23E. yield decline reported by peers like REPCO and CANF. In our view, AAVAS could experience further yield pressure over the next 2-3 years, albeit at a lower intensity.  AAVAS’ calculated cost of funds in FY20 was 8%. Given the long-term nature of its borrowings, we do not foresee any major decline in the cost of funds. Moreover, due to higher liquidity on its balance sheet, the impact on margins would be slightly more (50bp) than that on spreads.

Exhibit 84: Expect 30bp compression in yields (%) Exhibit 85: NIM contraction sharper than that in spreads (%) Yield on loans Cost of funds Spreads NIM 15.0 14.8 8.4 14.2 7.9 13.9 13.5 13.5 13.1 13.1 7.5 7.3 7.4 7.0 7.3 6.6

8.9 8.8 8.5 8.0 7.9 7.9 7.7 7.7 6.0 6.1 5.7 5.9 5.6 5.6 5.4 5.4 FY16 FY17 FY18 FY19 FY20 FY16 FY17 FY18 FY19 FY20

FY21E FY22E FY23E FY21E FY22E FY23E Source: MOFSL, Company Source: MOFSL, Company

Share of assigned Share of assigned portfolio to stabilize portfolio stable at ~20%  Over FY15-18, AAVAS had an aggressive sell-down strategy resulting in the for the past two years. share of assigned loans increasing from nil to 22% of total AUM. Under Ind-AS, companies upfront the future spread income. Over the past two years, this income was INR750-800m i.e. ~20% of NII and 25-30% of PBT.  Currently, AAVAS’ share of off-balance sheet book is significantly higher than most peers. However, we expect it to stabilize going forward. While it is difficult to predict upfront assignment income, we expect it to decline 20% YoY in FY21E and bounce back in FY22E.

January 2021 48 Thematic: Housing Finance

Exhibit 86: Share of sell-downs to remain stable Exhibit 87: Trend in assignment income Sell-down portfolio (INR b) % of AUM Assignment income (INR m) % of avg. AUM 1.8 23 22 22 22 1.6 21 20 21 1.1 1.1 13 1.0 0.7

2.3 5.6 9.0 13.6 17.4 18.5 23.2 29.5 602 783 766 613 1,042 1,354 FY16 FY17 FY18 FY19 FY20 FY18 FY19 FY20 FY21E FY22E FY23E FY21E FY22E FY23E Source: MOFSL, Company Source: MOFSL, Company

25% of PBT came from  The impact of upfronting of assignment income on profitability is much higher assignment income in for AAVAS compared to other HFCs. Note that assignment income comprised FY20. 30% of the company’s PBT in FY19 v/s 8-18% for others (note that we have not taken FY20 numbers as PBT was suppressed due to Covid-19 provisions).

Exhibit 88: Assignment income (INR m) Exhibit 89: Contribution of assignment income to PBT (%) FY19 FY20 % of PBT FY19 FY20

HDFC 8,600 9,679 HDFC 8% 9% PNBHF 3,081 3,362 PNBHF 18% 41% IHFL 6,731 4,530 IHFL 12% 18% AAVAS 783 766 AAVAS 30% 25%

Source: MOFSL, Company Source: MOFSL, Company; Note: Core PBT for HDFC

Operating leverage to result in 50bp expense ratio reduction over FY20-23E Expense ratio should  AAVAS opened 85 new branches over the past two years. These branches are reduce to 2.8% by FY23E. yet to scale up to their full potential in terms of disbursements. As and when these branches do scale up over the medium-to-long term, there would be a meaningful impact on operating leverage.  We have built in opex growth of 12% YoY for FY21, as business activity has resumed full-fledged in 2HFY21. Beyond FY21, opex should grow at ~15% CAGR, resulting in 50bp reduction in the expense ratio to 2.8% over FY20-23E.

Exhibit 90: 400bp reduction in C/I ratio over FY20-23E (%)

C/I ratio Opex/Avg AUM 4.9

3.7 3.8 3.6 3.3 3.1 3.0 3.0 2.8

41.7 46.5 41.4 54.6 41.5 42.0 42.5 40.6 37.9 FY15 FY16 FY17 FY18 FY19 FY20

FY21E FY22E FY23E Source: MOFSL, Company

January 2021 49 Thematic: Housing Finance

GNPL ratio to rise due to Covid-19 impact, should stabilize thereafter Expect GNPL ratio to rise  While AAVAS had healthy collection efficiency during the moratorium period, to 2.6% by FY22. there is a tail risk. Compared to an average slippage ratio of 0.4% over the past three years, we are forecasting a cumulative 5% slippage ratio over FY21-22.  This would result in the GNPL ratio increasing from 0.3% to 2.1% in FY21. Credit costs should increase from 0.3% in FY20 to 0.7% in FY21 and then normalize.

Exhibit 91: Slippage ratio to spike to 3% in FY21E… Exhibit 92: …resulting in 2.1% GNPL ratio by FY21E

Slippage ratio Net Slippage ratio GNPL ratio (%) PCR (%) 3.0 30 25 25 25 2.2 2.0 23 19 1.0 0.8 1.0 1.0 0.4 0.4 0.4 -0.2 0.2 0.2 0.3

0.3 0.3 0.3 2.1 2.6 2.4 FY17 FY18 FY19 FY20 FY18 FY19 FY20 FY21E FY22E FY23E FY21E FY22E FY23E Source: MOFSL, Company Source: MOFSL, Company

Exhibit 93: Improvement in Stage 2 loans over FY17-20 only Exhibit 94: Credit costs to spike in FY21 and then moderate for AAVAS Provisions (INR m) Credit cost (%) Stage 2 (%) FY17 FY18 FY19 FY20 0.7 HDFC 3.6 4.5 4.3 5.5 LICHF 3.7 3.8 4.4 4.6 0.4 0.3 0.3 PNBHF 1.3 1.7 3.3 3.7 0.2 CANFIN 4.4 4.8 6.0 0.1 89 153 467 302 304 REPCO 15.6 15.5 12.2 2.3 26 AAVAS 3.3 2.3 1.6 1.0 FY18 FY19 FY20 Source: MOFSL, Company FY21E FY22E FY23E Source: MOFSL, Company

3.6% RoA, 15% RoE in FY23E Increase in leverage from  Over FY20-23E, margins are likely to compress 50bp given the yield decline and 2.9x to 3.4x over FY20- 23E to drive RoE to ~15% higher BS liquidity. Assignment income would moderate in FY21 but normalize by FY23E in FY22. Lower NIM would be offset by a lower expense ratio.  This would result in a modest 20bp compression in RoA over FY20-23E to 3.5%, which is yet significantly higher than peers. However, as leverage is still low, RoE would be 13-15% over FY22-23.

Exhibit 95: Trend in RoA and RoE (%) Exhibit 96: Expect 18% PAT CAGR over FY20-23E RoA RoE PAT (INR b) Growth (%) 21.1 80 89 15.0 14.5 61 12.7 12.8 42 10.6 11.6 10.6 36 29 -6 2.4 2.5 2.8 2.9 3.6 3.8 2.8 3.3 3.6 0.6 0.9 1.8 2.5 3.2 4.1 FY17 FY18 FY19 FY20 FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E FY21E FY22E FY23E Source: MOFSL, Company Source: MOFSL, Company

January 2021 50 Thematic: Housing Finance

Key risks

Asset quality risks on account of large share of self-employed customers The company operates in the low-ticket affordable housing segment, predominantly in rural areas. Around 65% of its borrowers are self-employed while majority of the remaining are salaried people in the informal sector. Such customers are more prone to cyclical swings in the economy. This could result in asset quality shocks in an economic downturn.

Liquidating collateral in rural areas could be difficult Properties in rural areas are more illiquid compared to those in urban areas. If the company were to invoke SARFAESI and repossess a property, it could be difficult to liquidate.

Risk of balance transfers as the book matures While balance transfers out of AAVAS’ book are currently low, there is a risk of an increase when the book matures. This is because their borrowers would have a few years of credit history to back them, leading to balance transfers by banks.

High contribution of upfront assignment income to PBT Over the past two years, AAVAS derived 25-30% of its PBT from assignment income. If the quantum of loan assignments were to decline, it would impact profitability meaningfully.

January 2021 51 Thematic: Housing Finance

Initiate coverage with a Neutral rating Sturdy fundamentals, but rich valuations limit upside

 Only a few companies have been able to scale up in low-ticket affordable housing finance. This business is geography-specific – there is no large pan-India player in this segment. While the company has grown fast over the past three years, it has done so by expanding into new locations. It network grew from 94 branches in FY17 to 250 in FY20. It now has more branches than peers like REPCO and CANF. We believe AAVAS has the ingredients in place to deliver ~20% AUM CAGR over the next decade.  The company has done an excellent job of maintaining healthy asset quality despite fast loan growth and rising share of LAP. Its GNPL ratio as well as credit costs are best- in-class as compared to peers. While there would be a temporary disruption due to the lockdown, we expect normalization in FY22.  Over the next three years, we expect investments in people and branches to bear fruit, resulting in 50bp reduction in the expense ratio to 2.8%, driven by operating leverage. Over the long term, we believe the expense ratio would decline further.  However, on account of low leverage, AAVAS generates RoE of 13-14% despite 3.5%+ RoA. It does not pay a dividend, thus reinvesting all profits in the business itself.  Valuations at ~5x FY23E BVPS are rich and leave little room for error. We believe the risk-reward is unfavourable at these valuations. Hence, we initiate with a Neutral rating and a target price of INR2,000 (5.0x FY23E BVPS).

Exhibit 97: DuPont Analysis % 2015 2016 2017 2018 2019 2020 2021E 2022E 2023E Interest Income 14.93 13.41 13.01 12.10 12.28 11.84 11.63 11.56 11.80 Interest Expended 8.23 7.53 6.86 5.95 5.28 5.36 5.61 5.53 5.55 Net Interest Income 6.70 5.88 6.15 6.15 7.00 6.48 6.02 6.03 6.24 Non-Interest Income 1.68 1.90 1.67 3.14 2.43 1.76 1.18 1.52 1.65 Total Income 8.38 7.78 7.82 9.29 9.43 8.24 7.19 7.54 7.90 Operating Expenses 3.49 3.62 3.24 5.07 3.91 3.46 3.06 3.06 2.99 Operating Profit 4.89 4.16 4.58 4.22 5.52 4.78 4.13 4.48 4.91 Provisions 0.37 0.36 0.32 0.08 0.18 0.23 0.55 0.31 0.27 PBT 4.52 3.80 4.26 4.14 5.33 4.55 3.58 4.18 4.64 Tax 1.54 1.30 1.48 1.27 1.69 0.80 0.79 0.92 1.02 Tax Rate (%) 34.1 34.4 34.7 30.7 31.7 17.5 22.0 22.0 22.0 PAT 2.98 2.49 2.78 2.87 3.64 3.75 2.79 3.26 3.62 Leverage 8.12 8.45 5.41 3.70 3.19 3.38 3.80 3.94 4.00

RoE 24.20 21.06 15.04 10.60 11.62 12.66 10.61 12.84 14.47 Source: MOFSL, Company

Exhibit 98: PB chart – 1 year forward Exhibit 99: PE chart – 1 year forward P/B (x) Avg (x) Max (x) P/E (x) Avg (x) Max (x) 8.0 Min (x) +1SD -1SD 90 Min (x) +1SD -1SD 6.8 6.5 70 67.7 5.8 5.9 55.3 5.0 4.7 50 43.7 45.7 3.6 32.1 3.5 2.6 30 23.6 2.0 10 Jul-19 Jul-20 Jul-19 Jul-20 Oct-18 Oct-19 Oct-20 Apr-19 Apr-20 Feb-19 Sep-19 Feb-20 Sep-20 Dec-18 Dec-19 Dec-20 Oct-18 Oct-19 Oct-20 Apr-19 Apr-20 Feb-19 Sep-19 Feb-20 Sep-20 Dec-18 Dec-19 Dec-20 May-19 May-20 May-19 May-20 Source: MOFSL, Company Source: MOFSL, Company

January 2021 52 Thematic: Housing Finance

Company overview Shareholding pattern – Sep ’20 (%) Promoter 50.2 AAVAS Financiers was incorporated in 2011 as AU Housing Finance, a subsidiary of - Lake District Holdings 29.5 erstwhile AU Financiers (AU SFB). After AUSFB received a small finance bank license -Partners group 20.6 in 2013, it divested 90% stake in the business to various private equity funds Smallcap World Fund 6.2 managed by Kedaara Capital and Partners Group. In Sep’18, AAVAS listed on the AU Small Finance Bank 4.6 stock exchanges – the listing was a mix of OFS by existing shareholders (INR15b) SBI Mutual Fund 2.4 and fresh equity raise (INR4b). The company has 259 branches across ten states in Kotak Mutual Fund 2.1 the country. Others 34.5 Total 100.0 Key management personnel

Mr. Sushil Kumar Agarwal, MD & CEO Mr. Sushil Kumar Agarwal is the whole-time Director and CEO of the company. He has been associated with the AAVAS since incorporation in 2011. He is a qualified Chartered Accountant and a qualified Company Secretary. He was previously associated with AU SFB as its Business Head – SME & Mortgages. Mr. Agarwal has also worked with ICICI Bank Limited as its Chief Manager and with Kotak Mahindra Primus Limited as an Assistant Manager. He has more than 19 years of experience in the field of retail financial services.

Mr. Ghanshyam Rawat, Chief Financial Officer Mr. Ghanshyam Rawat is the Chief Financial Officer (finance and treasury) of the company. He is associated with AAVAS since 2013. He presently heads finance and treasury, accounts, internal audit, compliance, budget and analytics departments. He holds a Bachelor’s degree in Commerce from Rajasthan University and is a fellow member of the Institute of Chartered Accountants of India. He has been previously associated with First Blue Home Finance Limited, Accenture India Private Limited and Deutsche Postbank Home Finance Limited. Further, he has also worked with Pan Asia Industries Limited and Indo Rama Synthetics (I) Limited.

Mr. Sunku Ram Naresh, Chief Business Officer Mr. Sunku Ram Naresh joined AAVAS in 2016 and has been instrumental in setting up the rural distribution model for the company. His last assignment was with Bajaj Finance Ltd. He has also worked with other companies like GE Money, ICICI Bank and Nestle India. He is an MBA and B.Sc. from Sri Krishnadevaraya University, A.P.

Mr. Ashutosh Atre, Chief Risk Officer Mr. Ashutosh Atre is the Chief Risk Officer and was previously the Chief Credit Officer of the company. He has over three decades of experience in sales, credit and risk across retail and SME products. Prior to joining AAVAS, he worked with leading institutions including Equitas, ICICI Bank and Cholamandalam Investment & Finance. He holds a Diploma in Finance and Engineering from NMIMS and MP Board of Technical Education, respectively.

January 2021 53 Thematic: Housing Finance

Financials and Valuation

Income statement INR m Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Interest Income 1,725 2,707 3,926 5,935 7,864 9,788 11,354 13,497 Interest Expended 969 1,428 1,931 2,554 3,561 4,721 5,433 6,353 Net Interest Income 757 1,279 1,995 3,382 4,304 5,068 5,920 7,144 Change (%) 76.3 69.0 56.0 69.5 27.3 17.8 16.8 20.7 Gain on Securitisation 0 5 602 783 766 613 1,042 1,354 Other Operating Income 244 343 417 391 401 377 448 536 Total Income 1,001 1,627 3,014 4,556 5,470 6,058 7,410 9,034 Change (%) 86.5 62.5 85.3 51.2 20.1 10.7 22.3 21.9 Operating Expenses 466 673 1,645 1,890 2,296 2,577 3,005 3,422 Operating Income 535 953 1,369 2,666 3,174 3,481 4,405 5,612 Change (%) 71.0 78.1 43.6 94.7 19.1 9.7 26.5 27.4 Provisions 47 67 26 89 153 467 302 304 PBT 489 887 1,343 2,577 3,020 3,014 4,103 5,308 Tax 168 308 412 818 529 663 903 1,168 Tax Rate (%) 34.4 34.7 30.7 31.7 17.5 22.0 22.0 22.0 PAT 321 579 931 1,759 2,491 2,351 3,201 4,140 Change (%) 68.0 80.4 60.9 89.0 41.6 -5.6 36.1 29.3 Proposed Dividend 0 0 0 0 0 0 0 0

Balance sheet Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Capital 384 582 692 781 783 783 783 783 Reserves & Surplus 1,647 5,082 11,207 17,589 20,196 22,547 25,748 29,888 Net Worth 2,031 5,663 11,899 18,370 20,979 23,331 26,531 30,671 Borrowings 14,572 17,935 27,376 36,533 53,520 65,987 75,137 89,865 Change (%) 104.2 23.1 52.6 33.4 46.5 23.3 13.9 19.6 Other liabilities 505 908 1,126 1,366 2,081 2,497 2,996 3,595 Total Liabilities 17,108 24,507 40,401 56,268 76,580 91,815 1,04,664 1,24,131 Loans 14,702 21,638 33,334 47,245 61,808 74,143 87,368 1,04,494 Change (%) 75.9 47.2 54.1 41.7 30.8 20.0 17.8 19.6 Investments 0 8 45 45 45 45 45 45 Change (%) NM NM NM 0.0 0.0 0.0 0.0 0.0 Other assets 2,405 2,861 7,022 8,978 14,727 17,627 17,251 19,593 Total Assets 17,108 24,507 40,401 56,268 76,580 91,815 1,04,664 1,24,131 E: MOFSL Estimates

January 2021 54 Thematic: Housing Finance

Financials and Valuation

Ratios (%)

Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Spreads Analysis (%)

Avg Yield on Housing Loans 15.0 14.8 14.2 13.9 13.5 13.5 13.1 13.1 Avg. Cost-Int. Bear. Liab. 8.9 8.8 8.5 8.0 7.9 7.9 7.7 7.7 Interest Spread 6.0 6.1 5.7 5.9 5.6 5.6 5.4 5.4 Net Interest Margin 6.6 7.0 7.3 8.4 7.9 7.5 7.3 7.4 Profitability Ratios (%)

RoE 21.1 15.0 10.6 11.6 12.7 10.6 12.8 14.5 RoA 2.5 2.8 2.9 3.6 3.8 2.8 3.3 3.6 Loans/Equity (x) 7.2 3.8 2.8 2.6 2.9 3.2 3.3 3.4 Cost/Income 46.5 41.4 54.6 41.5 42.0 42.5 40.6 37.9 Asset Quality (%) Gross NPAs 80 169 107 158 210 1,548 2,273 2,517 Gross NPAs to Adv. 0.6 0.8 0.3 0.3 0.3 2.1 2.6 2.4 Net NPAs 62 129 83 112 171 1,161 1,705 1,888 Net NPAs to Adv. 0.4 0.6 0.2 0.2 0.3 1.6 2.0 1.8 VALUATION 2016 2017 2018 2019 2020 2021E 2022E 2023E Book Value (INR) 52.9 97.4 172.0 235.2 267.9 297.9 338.7 391.6 Price-BV (x) 6.3 6.5 5.7 4.9 EPS (INR) 8.4 9.9 13.5 22.5 31.8 30.0 40.9 52.9 EPS Growth YoY 44.1 19.1 35.3 67.3 41.2 -5.6 36.1 29.3 Price-Earnings (x) 53.4 64.3 47.2 36.5 Dividend per share (INR) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Dividend yield (%) 0.0 0.0 0.0 0.0 E: MOFSL Estimates

January 2021 55 Initiating CoverageThe | Sectormatic:: Financials Housing Finance – NBFC Can Fin Homes BSE Sensex S&P CNX 48,584 14,596 CMP: INR500 TP: INR650 (+30%) Buy

A balanced player Healthy asset quality | Low CoF | 100% retail loans

 Can Fin Homes (CANF) is a leading player in the low-to-middle income housing

finance segment. The company has strong parentage of Canara Bank and a track Stock info record of superior asset quality and profitability. CANF is amongst the lowest- Bloomberg CANF IN cost borrowers in the HFC market (in line with the top-2 HFCs). As a result, it has Equity Shares (m) 133 maintained healthy spreads of 2.5-2.8% over the past few years (compared to M.Cap.(INRb)/(USDb) 66.6 / 0.9 1.5% for LICHF, 2.2% for HDFC and 3.2% for REPCO) despite catering primarily to 52-Week Range (INR) 519 / 253 the salaried customer segment. 1, 6, 12 Rel. Per (%) -5/6/11  CANF’s key differentiator is its pristine asset quality. With 90% share of home

loans and nil corporate loans, its GNPL ratio has been sub-1% and average credit Financial Snapshot (INR b) cost over the past five years is 0.2%. While we expect some spike in FY21 due to Y/E March 2020 2021E 2022E NII 6.7 8.0 8.0 the impact of COVID-19, asset quality should normalize thereafter. PPP 5.8 7.0 7.0  While the company has targeted primarily salaried customers over the past five PAT 3.8 4.4 4.7 years, it has also grown its self-employed customer book rapidly. The self- EPS (INR) 28.2 33.2 35.6 employed book grew at 36% CAGR to INR61b (v/s 16% CAGR for the salaried EPS Growth (%) 26.8 17.5 7.2 customer book) and its share in the total book has increased from 15% to 29% BVPS (INR) 161 193 226 Ratios (%) over FY15-20. While this would help maintain margins, it could impact asset NIM 3.5 3.8 3.6 quality negatively, especially post COVID-19. C/I ratio 15.7 13.0 14.6  With healthy NIMs of 3.2-3.5%, low expense ratio and benign credit costs, CANF RoAA 1.9 2.0 2.0 generated an average ~19% RoE over the past three years, the highest in our HFC RoE 19.1 18.7 17.0 Payout 8.5 6.0 5.6 coverage universe. The company offers balanced loan growth (in line with peers), Valuation high RoE and low balance sheet risk. While it has received the Board’s approval P/E (x) 17.7 15.1 14.1 to raise up to INR10b equity capital, the exact quantum and timelines are yet to P/BV (x) 3.1 2.6 2.2 be finalized. Hence, we have not included it in our estimates. Initiate coverage Div. Yield (%) 0.4 0.4 0.4 with a Buy rating and TP of INR650 (2.5x FY23E BVPS).

Shareholding pattern (%) As On Dec-20 Sep-20 Jun-20 Low cost of funds due to strong parentage and robust track record Promoter 30.0 30.0 30.0 With strong parentage (Canara Bank), 100% retail loans and a history of healthy FII 10.1 11.5 13.6 asset quality, CANF has been able to raise money at rates competitive with DII 15.3 13.4 11.8 even the top-2 HFCs. The company borrows from banks at sub-MCLR rates by Others 44.6 45.1 44.6 linking to external benchmarks. Moreover, given that most of its loans assume FII Includes depository receipts PSL status, banks are willing to lend to CANF at lower rates. In addition, 20% of its borrowings are from NHB, which are at low rates too. Stock Performance (1-year) Its cost of funds at 7.6% in FY20 was the lowest in our HFC coverage universe. As a result, CANF has maintained healthy spreads of 2.5-2.8% over the past few years (compared to 1.5% for LICHF, 2.2% for HDFC and 3.2% for REPCO) despite catering primarily to the salaried customer segment.

100% retail lending ensures healthy asset quality Unlike some other HFCs that aggressively disbursed corporate/builder loans over 2015-18, CANF stuck to its principle of doing only retail loans. Also, within retail, the company has consistently maintained a mix of 90% home loans and 10% non-housing loans (LAP, etc.). As a result, historically its asset quality has

January 2021 56 Thematic: Housing Finance

remained pristine – GNPL ratio has been sub-1% and average credit cost over the past five years is 0.2%. Post lifting of the moratorium in September, collection efficiency was 93%, excluding pre-payments. As a result, we do not foresee any significant asset quality disruptions. We forecast GNPL ratio to rise from 0.8% to 1.9% YoY in FY21 and stabilize thereafter. Likewise, credit costs should inch up to 0.6% this fiscal but normalize in FY22.

Rising share of self-employed customers a risk Historically, CANF has targeted salaried customer on the outskirts of large cities. Given this profile, it has not faced any problems in asset quality. However, over the past five years, it has focused on growing its self-employed customer book. Over FY15-20, the self-employed book has delivered 36% CAGR to INR61b and its share in the total book has increased from 15% to 29%. Management plans to further increase this to 35% over the near-to- medium term. This could pose some risk to asset quality going forward.

Highest RoE in our coverage universe Given the healthy margins (3.2-3.5%), low expense ratio (0.5% for CANF v/s 0.9% for REPCO) and benign credit costs, CANF generates healthy return ratios. Over the past five years, it has delivered RoA in the range of 1.6-2.0%. In addition, it has maintained high leverage of ~10x. As a result, its historical RoE of 18-22% is the best in our coverage universe. Beyond the temporary disruption in FY21, we believe CANF would continue to generate healthy RoE of 16-17% in the medium term. However, in the event of a capital raise (not factored in our estimates), RoE could moderate.

Valuation and view Over the past five years, CANF has been prudent in balancing growth, profitability and asset quality. On the growth front, we expect a modest 8% loan book CAGR over FY20-23E given a slowdown in disbursement growth and higher levels of balance transfers out of the book. Spreads would remain healthy at 2.8% as the competitive pressure on yields is offset by lower cost of funds. While trajectory of GNPLs is uncertain at the moment, our conversations with management and industry participants suggest that retail loan portfolios are unlikely to cause any meaningful stress for the industry. Hence, credit costs would remain benign, post the temporary spike in FY21. Leverage, though, at ~9x is quite high. While the company has Board approval for up to INR10b equity capital raise, the timeline and exact quantum is not clear. Hence, we have not included it in our estimates. We forecast an average 2% RoA and 16- 17% RoE over the medium term. Its RoE is 200-400bp higher than that of the top-2 HFCs. We expect strong RoE to drive re-rating in the stock. Initiate coverage with a Buy rating and TP of INR650 (2.5x FY23E BVPS).

January 2021 57 Thematic: Housing Finance

Retail-focused player Catering to salaried players on the outskirts of cities

 While CANF was incorporated over three decades ago, bulk of its scale-up happened during the past 7-8 years. Its loan book grew nearly 8x to INR205b since FY12, driven by steady branch expansion.  Unlike many peers, the company does not cater to corporate/builder loans. It has largely maintained its share of home loans at ~90% over the past few years. However, the new management intends to increase the share of non-housing loans over the medium-to-long term.  The company targets primarily the salaried customer segment with an average ticket size of INR1.8m. However, over the past five years, the company has pushed the pedal on self-employed home loans, the share of which has increased from 15% in FY15 to 29% in FY20.  While the company delivered above-average loan growth in the past, we believe growth is likely to slow as the company does not want to sacrifice profitability for growth. We forecast 8% loan book CAGR over FY20-23E.

Retail lending book; 70% in South India 16% loan book CAGR  While CANF was incorporated over three decades ago, most of the business over FY17-20. scale-up occurred during the past 7-8 years. From a loan book of INR27b in FY12, it grew nearly 8x to INR205b, driven by steady branch count expansion (up ~4x to 200 over the same time period).  In addition, unlike many other HFCs, its growth has been driven by retail lending. The company does not do builder loans. In addition, 90% of the loan book is home loans (with an average ticket size of INR1.8m) and the rest is non-housing (i.e. LAP, top-ups, etc.). While the share of non-housing loans is significantly lower than that of peers like REPCO and AAVAS, management intends to grow this share over the medium-to-long term.  The company is predominantly in South India, the share of which in total loans stands at ~70%. Karnataka accounts for 25-30% of CANF’s total loan book.

Exhibit 100: Rapid scale up, though growth decelerating Exhibit 101: Loan mix largely steady (%) Loans (INR b) Growth (%) Housing Non-housing 50.8 45.8 8.8 11.3 11.9 11.5 10.1 10.7 9.9 41.3

29.1 21.2 23.4 18.3 16.6 91.2 88.7 87.9 88.4 89.9 89.3 90.1 12.6

27 40 59 83 107 132 156 182 205 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: MOFSL, Company Source: MOFSL, Company

Share of self-employed Primarily a salaried player, but growing fast in self-employed segment loans nearly doubled to  While CANF typically caters to the salaried customer segment, it has grown fast 29% over FY15-20. in the self-employed segment over the past five years.

January 2021 58 Thematic: Housing Finance

 Over the past five years, the share of self-employed customers has nearly doubled to 29%. Management’s intention is to increase this to 35% over the near-to-medium term. While this would support margins, we acknowledge an asset quality risk associated with the same, especially in the post-pandemic era.

Exhibit 102: Rise in share of self-employed customers over the past five years (%) Salaried Self-employed

14.0 14.0 15.5 19.4 24.5 26.7 28.8 29.0

86.0 86.0 84.5 80.6 75.5 73.3 71.2 71.0 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

Source: MOFSL, Company

Loan growth slowing down; Expect 8% loan book CAGR over FY20-23E Expect 8% disbursement  While the company enjoyed a phase of robust growth till FY17, growth CAGR over FY20-23E. slowed from 25% YoY in FY17 to 13% YoY in FY20. This was due to slowdown in branch expansion as well as reluctance to compromise margins for growth.  In the near term, growth is likely to remain subdued given the impact of the lockdown on its customer base. While we expect disbursements to bounce back in FY22, overall loan book CAGR is likely to remain modest at 8% over FY20-23E.

Exhibit 103: 8% disbursement CAGR over FY20-23E… Exhibit 104: …to lead to 8% loan book CAGR

Disbursements (INR b) Growth (%) Loans (INR b) Growth (%) 40.0 29.1 22.2 17.2 20.0 23.4 8.7 5.2 18.3 0.0 16.6 -26.0 12.6 11.3 8.7 4.5 39.2 47.9 52.1 54.8 54.8 40.6 56.8 68.1 107 132 156 182 205 215 233 260 FY16 FY17 FY18 FY19 FY20 FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E FY21E FY22E FY23E Source: MOFSL, Company Source: MOFSL, Company

January 2021 59 Thematic: Housing Finance

Low cost of funds – A sustainable advantage Expense ratio lower than peers

 One of CANF’s biggest competitive advantages is its low cost of funds. Over the past three years, its average cost of funds stood at 7.6% – 30-40bp lower than that of LICHF and HDFC. The low cost of funds, in turn, helps the company deliver healthy spreads (2.5%+) without taking any major asset quality risks.  An interesting feature is that most of CANF’s bank borrowings are at sub-MCLR rates. This has been achieved by linking to external benchmarks. Note that banks account for 60% of total borrowings for the company.  Roughly half of sourcing by CANF comes from external partners. This minimizes the fixed cost in P&L. With an expense ratio of 0.5-0.6%, CANF has been able to deliver an expense ratio superior to peers, REPCO (0.9-1%) and AAVAS (3%+).

Strong parentage and track record results in low cost of funds Cost of funds was 30-  One of the biggest advantages that CANF has over its peers is access to low cost 40bp lower than that of of funds (in line with that of the top-2 HFCs). In our view, this comes from its the top-2 HFCs in FY20. strong PSU Bank parentage (Canara Bank) as well as robust track record over the past decade.  The company is able to borrow from banks at sub-MCLR rates by linking its borrowings to external benchmarks.  Over the past 5-6 years, CANF’s borrowing mix has changed in line with the overall macro environment. Prior to the IL&FS crisis, it rapidly moved from bank borrowings to market borrowings (share up from 22% in FY15 to 50% in FY18), post which there was a reversal in trend (share down from 50% in FY18 to 20% currently).

Exhibit 105: Cost of funds lower than top-2 HFCs (%) Exhibit 106: Trend in borrowing mix (%)

FY18 FY19 FY20 Banks NHB Market borrowings Deposits 3 2 2 2 2 2 8.2 8.2 8.2 8.1 22 22 34 34 7.8 7.9 51 50 19 7.6 7.6 12 7.6 44 37 15 28 52 57 31 33 27 19

CANF HDFC LICHF FY15 FY16 FY17 FY18 FY19 FY20

Source: MOFSL, Company Source: MOFSL, Company

January 2021 60 Thematic: Housing Finance

Exhibit 107: Able to borrow at sub-MCLR rates from banks (FY20 data) Lender Amount (INR b) Interest Rate Canara Bank 5.0 7.65% Canara Bank 5.0 7.65% Canara Bank 15.0 7.65% State Bank of India 5.0 7.70% State Bank of India 10.0 7.80% State Bank of India 5.0 7.80% State Bank of India 1.8 7.70% State Bank of India 10.0 7.70% State Bank of India 10.0 7.80% HDFC Bank 3.0 5.65% HDFC Bank 2.6 6.88% HDFC Bank 5.0 7.85% HDFC Bank 10.0 7.70% Corporation Bank 2.5 8.00% Federal Bank 2.5 7.65% Federal Bank 2.5 7.65% Federal Bank 2.5 7.65% Federal Bank 0.9 7.95% Federal Bank 1.0 7.65% Syndicate Bank 10.0 7.60% Axis Bank 2.0 7.80% Bank of India 10.0 7.50% Allahabad Bank 5.0 8.10% Bank of Maharashtra 4.0 7.75% Total 130.2

Source: MOFSL, Company

Expect spreads to remain largely stable at 2.8% Spreads should remain  Over FY15-18, CANF’s spreads improved meaningfully from 1.4% to 2.7%, led stable at 2.8%. by the sharp reduction in cost of funds, partially offset by lower yields. Post FY18, spreads have been largely range-bound at those levels.  While cost of funds is likely to improve 80bp in FY21 due to excess liquidity in the system, we also expect a similar decline in yields due to the competitive pressure. Hence, we do not foresee further improvement in spreads hereon.

Exhibit 108: Decline in CoF to be offset by lower yields (%)… Exhibit 109: …leading to largely stable NIMs (%) Yield on loans Cost of funds NIM

11.1 11.0 10.9 10.3 10.1 10.4 10.0 9.6 9.5

9.7 9.0 8.4 7.6 7.6 7.6 6.8 6.7 6.7 2.5 3.2 3.5 3.5 3.2 3.5 3.8 3.6 3.6 FY15 FY16 FY17 FY18 FY19 FY20 FY15 FY16 FY17 FY18 FY19 FY20

FY21E FY22E FY23E FY21E FY22E FY23E Source: MOFSL, Company Source: MOFSL, Company

January 2021 61 Thematic: Housing Finance

Stringent cost control leads to lower expense ratio v/s peers CANF’s expense ratio of  Roughly half of CANF’s sourcing comes from external partners. This minimizes 50-60bp is much lower than peers. the fixed cost on the P&L. In addition, the company has a low-cost model of operations.  As a result, it has been able to deliver an expense ratio superior to peers. CANF’s expense ratio of 0.5-0.6% is lower than that of REPCO (0.9-1%) and much lower than that of AAVAS (3%+).

Exhibit 110: Low expense ratio v/s peers (%) Exhibit 111: Expect expense ratio to remain stable (%)

FY18 FY19 FY20 Expense ratio C/I ratio 4.86 19.6 17.2 16.2 16.3 15.7 3.77 14.6 14.8 3.34 13.0

0.85 0.96 0.95 0.61 0.54 0.56 0.7 0.7 0.6 0.5 0.6 0.5 0.5 0.5

CANF REPCO AAVAS FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E

Source: MOFSL, Company Source: MOFSL, Company

January 2021 62 Thematic: Housing Finance

Asset quality trends encouraging RoE in high-teens, better than that of listed peers

 Given its product and customer positioning (retail lending primarily to salaried customers), CANF has enjoyed healthy asset quality over time. Its slippage ratio has historically been less than 0.4%. GNPL ratio has been sub-1% while the average credit cost over the past five years is 0.2%.  However, rising share of self-employed customers poses a risk to asset quality, especially post the pandemic. The company has witnessed deterioration in Stage 2 loan ratio – from 4.4% in FY18 to 6.0% in FY20. We believe GNPL ratio will rise from 0.8% to ~2% YoY in FY21 due to the Covid-19 impact, but moderate thereafter.  While the company generates a RoA of ~2%, which is the median in the HFC universe, its RoE of 19% (FY20) is best-in-class. While we forecast ~200bp decline in RoE to 16- 17% over the medium term, we believe it would still be comfortably ahead of peers.

Low GNPL ratio a comforting factor Gross slippage/ net  A key differentiating factor of CANF is its historically low GNPL ratio and credit slippage ratio of 0.4%/0.2% in FY20. costs. This has been driven by its targeted business segments (100% retail lending with majority salaried customers). Its slippage ratio has historically been less than 0.4%. GNPL ratio has been sub-1% while the average credit cost over the past five years is 0.2%.  Even in this pandemic, the company did a decent job on collection efficiency. Post lifting of the moratorium, CANF achieved 93% collection efficiency in September, excluding pre-payments.  However, the rising share of self-employed customers poses a risk to asset quality. In addition, the company witnessed deterioration in Stage 2 loans ratio from 4.4% in FY18 to 6.0% in FY20.  We forecast GNPL ratio to rise from 0.8% to ~2% YoY in FY21 due to the impact of Covid-19, but it should moderate thereafter. Likewise, credit costs should inch up to 0.6% this fiscal but normalize in FY22.

Exhibit 112: Slippage ratio to spike in FY21/22E (%)… Exhibit 113: …resulting in 2% GNPL ratio in FY21E Slippage ratio Net slippage ratio GNPL ratio PCR 100 100 1.8

1.2 1.0 53

30 29 25 30 30 0.4 0.4 0.4 0.4 0.5 0.3 0.2 0.3 0.1 0.1 0.2 0.2 0.4 0.6 0.8 1.9 1.8 1.8 0.1 FY16 FY17 FY18 FY19 FY20 FY17 FY18 FY19 FY20 FY21E FY22E FY23E FY21E FY22E FY23E

Source: MOFSL, Company Source: MOFSL, Company

January 2021 63 Thematic: Housing Finance

Exhibit 114: Trend in credit costs (%) Exhibit 115: Stage 2 loans up 160bp over FY18-20 (%) FY18 FY19 FY20 0.6 6.0 5.5 4.8 4.4 4.5 4.3 4.4 4.6 0.3 3.8 0.2 0.2 0.2 0.2 0.2 0.2 0.0 FY15 FY16 FY17 FY18 FY19 FY20

FY21E FY22E FY23E CANF HDFC LICHF Source: MOFSL, Company Source: MOFSL, Company

Leverage higher than peers Leverage at 9.5x is higher  CANF operates at leverage higher than most peers. Over the past five years, than that of peers. leverage (loans/equity) has been ~10x.  The company has the Board’s approval to raise up to INR10b equity capital to bring down leverage and fuel growth. However, the timeline and exact quantum is not finalized as yet.

Exhibit 116: Loans/Equity – CANF is the second highest after LICHF (FY20, x)

11.7 9.5 8.3 6.5 5.2

2.9

LICHF CANF PNBHF REPCO HDFC AAVAS Source: MOFSL, Company

Highest RoE in our HFC coverage universe 2% RoA/19% RoE over  With healthy margins coupled with low expense ratio and credit costs, CANF the past three years. generates healthy RoA of 1.9-2% (middle of HFC’s RoA range).  However, given the higher leverage, its RoE of 19% is best-in-class. We expect a slight moderation in RoE to 16-17%, driven by lower leverage due to modest loan growth over the medium term. Nevertheless, we expect CANF to deliver 12% PAT CAGR over FY20-23E.

January 2021 64 Thematic: Housing Finance

Exhibit 117: RoA in middle of HFC range (FY20, %)… Exhibit 118: …but RoE best-in-class (FY20, %)

3.8 19.1 16.9 2.4 14.3 13.1 12.7 1.9 1.8 8.3 1.2 0.8

AAVAS REPCO CANF HDFC LICHF PNBHF CANF REPCO LICHF HDFC AAVAS PNBHF

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 119: Moderation in RoE due to lower leverage (%) Exhibit 120: Expect 12% PAT CAGR over FY20-23E

RoA RoE PAT (INR b) Growth (%) 22.5 21.3 49.4 18.2 19.1 18.7 17.0 16.3 4.7 26.8 22.0 3.0 17.5 12.6 7.2 3.7 2.0 2.0 1.7 1.9 2.0 2.0 2.1 2.3 2.9 3.8 4.4 5.3 FY17 FY18 FY19 FY20 FY17 FY18 FY19 FY20 FY21E FY22E FY23E FY21E FY22E FY23E Source: MOFSL, Company Source: MOFSL, Company

January 2021 65 Thematic: Housing Finance

Valuation and view A balanced player

 In our view, CANF is a well-balanced player. Its loan growth is in line with large HFCs. It has maintained spreads higher than that of large HFCs, driven by competitive cost of funds. Also, asset quality is superior to peers due to product and customer segmentation (i.e. no builder loans and primarily salaried customers).  Having said that, the company is facing a few challenges. CANF’s ability to kick-start growth in FY22, post the pandemic, will be keenly watched. Additionally, the company would have to focus on collections to minimize the asset quality impact of the lockdown. Moreover, it needs to raise equity capital due to leverage being higher than that of peers. Note that we haven’t built in any capital raise in our estimates.  In our view, its loan growth, in high-single digits, is likely to be in line with larger HFCs like LICHF. With excess liquidly in the system, margins should remain intact. In our view, the impact of the lockdown, especially on salaried customers, has been benign compared to our initial expectations. Hence, the asset quality impact should be temporary and manageable.  CANF is the only listed HFC to make high-teens RoE on a consistent basis. This, we believe would moderate to ~17% over the medium term, but still be 200-300bp higher than that of the top-2 HFCs. We believe consistent performance on RoE would drive re- rating in the stock. Initiate coverage with Buy and a TP of INR650 (2.5x FY23E BVPS).

Exhibit 121: DuPont analysis (%) 2013 2014 2015 2016 2017 2018 2019 2020 2021E 2022E 2023E Interest Income 11.17 11.16 11.06 10.94 10.86 10.27 9.94 10.15 9.71 9.31 9.22 Interest Expended 8.34 8.47 8.57 7.79 7.35 6.76 6.79 6.76 6.01 5.83 5.77 Net Interest Income 2.82 2.69 2.49 3.15 3.51 3.51 3.16 3.39 3.70 3.47 3.44 Other Income 0.41 0.42 0.41 0.41 0.39 0.22 0.10 0.06 0.04 0.05 0.05 Total Income 3.23 3.11 2.90 3.56 3.90 3.73 3.26 3.45 3.74 3.52 3.49 Operating Expenses 1.06 0.88 0.77 0.70 0.67 0.60 0.53 0.54 0.49 0.51 0.52 Cost to Income Ratio (%) 32.80 28.29 26.62 19.64 17.21 16.23 16.27 15.69 13.03 14.58 14.77 Employee Expenses 0.46 0.36 0.35 0.35 0.33 0.31 0.24 0.27 0.27 0.28 0.28 Other Expenses 0.60 0.52 0.43 0.35 0.34 0.30 0.29 0.27 0.22 0.24 0.24 Operating Profit 2.17 2.23 2.13 2.86 3.23 3.12 2.73 2.91 3.25 3.01 2.98 Provisions/write offs -0.04 0.09 0.20 0.20 0.16 0.15 0.01 0.30 0.53 0.28 0.18 PBT 2.21 2.14 1.93 2.66 3.07 2.97 2.73 2.61 2.72 2.73 2.79 Tax 0.62 0.62 0.72 1.01 1.12 1.00 1.00 0.71 0.68 0.68 0.70 Tax Rate (%) 27.93 29.01 37.26 38.11 36.50 33.61 36.80 27.43 25.00 25.00 25.00 PAT 1.60 1.52 1.21 1.65 1.95 1.97 1.72 1.89 2.04 2.05 2.09 Leverage 9.17 11.82 11.64 11.57 11.55 10.78 10.54 10.11 9.19 8.30 7.80

RoE 14.63 17.93 14.09 19.05 22.55 21.27 18.15 19.13 18.74 16.98 16.34 Source: MOFSL, Company

Exhibit 122: P/E chart (1-year forward) Exhibit 123: P/B chart (1-year forward) P/E (x) Avg (x) Max (x) P/B (x) Avg (x) Max (x) 40.0 Min (x) +1SD -1SD 6.0 Min (x) +1SD 5.5 -1SD 29.7 30.0 4.0 3.1 20.0 17.1 13.4 2.2 10.8 2.0 1.8 10.0 4.4 3.0 0.4 0.6 0.0 0.0 Jun-13 Jun-18 Sep-14 Sep-19 Dec-15 Dec-20 Dec-10 Jun-13 Jun-18 Mar-17 Mar-12 Sep-14 Sep-19 Dec-15 Dec-20 Dec-10 Mar-17 Mar-12 Source: MOFSL, Company Source: MOFSL, Company

January 2021 66 Thematic: Housing Finance

Key Risks

Pressure on margins due to competition Over the past six months, banks and large HFCs have cut home loan rates by 100- 150bp. While CANF should be able to manage spreads due to a similar decline in cost of funds, any further rate cut by competitors would result in meaningful spread compression for CANF.

Exit of Canara Bank as the promoter Canara Bank owns 30% of the company. With strong parentage, CANF has been able to access debt capital at competitive rates, even in times of tight liquidity. If Canara Bank were to sell its stake in the company, it could have an impact on CANF’s credit rating as well as access to debt capital.

Rising share of LAP/self-employed customers could impact asset quality The share of self-employed customers increased from 15% to 29% over the past five years. In the current pandemic, self-employed customers have faced more cash flow problems than salaried customers. In addition, while the company has historically maintained the share of non-housing loan at ~10%, the new management is looking to increase its share over the medium-to-long term. These could pose a risk to asset quality in the future.

January 2021 67 Thematic: Housing Finance

Key management personnel and shareholding

Mr. Girish Kousgi, MD & CEO Mr. Kousgi is a seasoned banking professional with over two decades of work experience. He joined the company in 2019. He has previously worked with several institutions including HDFC, ICICIB, IDFCB and Tata Capital in a variety of products such as home loans, business loans, LAP, personal loans, etc. Mr. Kousgi has worked in several functions including sales, product, underwriting, risk and operations. He holds a Bachelor’s in Commerce degree and is an MBA.

Mr. Shreekant Bhandiwad, Dy. MD Mr. Bhandiwad is the Dy. Managing Director of the company. He joined Canara Bank in 1994 as an officer. He was also the ‘Head’ of Jaipur circle for Canara Bank. He has over 26 years of work experience in banking.

Mr. Prashanth Joishy, CFO Mr. Joishy is the Asst. General Manager and CFO of the company. He joined the company in 1989 and has over three decades of work experience. He has worked in operations in various locations such as Karnataka, Maharashtra and Odisha. He has also worked for 11 years in the finance and accounts department of the company.

January 2021 68 Thematic: Housing Finance

Financials and Valuation

Income statement INR m Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Interest Income 10,444 13,060 14,906 17,134 20,189 21,027 21,539 23,466 Interest Expended 7,435 8,840 9,810 11,693 13,442 13,013 13,498 14,702 Net Interest Income 3,009 4,220 5,096 5,441 6,747 8,014 8,041 8,763 Change (%) 69.4 40.2 20.8 6.8 24.0 18.8 0.3 9.0 Other Income 391 471 314 179 115 91 115 125 Net Income 3,401 4,691 5,410 5,621 6,862 8,104 8,155 8,889 Change (%) 64.5 37.9 15.3 3.9 22.1 18.1 0.6 9.0 Operating Expenses 668 807 878 915 1,076 1,056 1,189 1,313 Operating Income 2,733 3,884 4,532 4,706 5,786 7,048 6,967 7,576 Change (%) 80.1 42.1 16.7 3.8 23.0 21.8 -1.2 8.7 Provisions/write offs 194 188 221 11 603 1,156 652 463 PBT 2,539 3,696 4,311 4,695 5,183 5,892 6,315 7,113 Tax 968 1,349 1,449 1,728 1,422 1,473 1,579 1,778 Tax Rate (%) 38.1 36.5 33.6 36.8 27.4 25.0 25.0 25.0 Reported PAT 1,571 2,347 2,862 2,967 3,761 4,419 4,736 5,335 Change (%) 82.2 49.4 22.0 3.7 26.8 17.5 7.2 12.6 Proposed Dividend (incl. tax) 321 321 321 321 321 266 266 266

Balance sheet INR m Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Capital 266 266 266 266 266 266 266 266 Reserves & Surplus 8,514 11,771 14,604 17,556 21,234 25,387 29,857 34,925 Net Worth 8,780 12,037 14,870 17,822 21,501 25,654 30,123 35,192 Borrowings 90,740 1,18,675 1,39,210 1,67,974 1,87,484 1,95,263 2,07,675 2,31,193 Change (%) 23.0 30.8 17.3 20.7 11.6 4.1 6.4 11.3 Other liabilities 8,040 2,168 3,215 1,500 1,451 1,813 2,267 2,833 Total Liabilities 1,07,560 1,32,880 1,57,295 1,87,295 2,10,436 2,22,730 2,40,065 2,69,218 Loans 1,07,146 1,32,241 1,56,440 1,82,342 2,05,257 2,14,575 2,33,342 2,59,767 Change (%) 29.1 23.4 18.3 16.6 12.6 4.5 8.7 11.3 Investments 149 160 160 163 243 267 294 323 Change (%) 0.0 7.1 0.0 1.9 49.1 10.0 10.0 10.0 Net Fixed Assets 89 102 96 99 379 417 459 504 Other assets 175 377 600 4,692 4,557 7,471 5,970 8,623 Total Assets 1,07,560 1,32,880 1,57,295 1,87,295 2,10,436 2,22,730 2,40,065 2,69,218 E: MOFSL Estimates

January 2021 69 Thematic: Housing Finance

Financials and Valuation

Ratios Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Yield on loans 11.0 10.9 10.3 10.1 10.4 10.0 9.6 9.5 Cost of funds 9.0 8.4 7.6 7.6 7.6 6.8 6.7 6.7 Spread 1.9 2.5 2.7 2.5 2.8 3.2 2.9 2.8 Net Interest Margin 3.2 3.5 3.5 3.2 3.5 3.8 3.6 3.6

Profitability Ratios (%) RoE 19.0 22.5 21.3 18.2 19.1 18.7 17.0 16.3 RoA 1.6 2.0 2.0 1.7 1.9 2.0 2.0 2.1 C/I ratio 19.6 17.2 16.2 16.3 15.7 13.0 14.6 14.8

Asset Quality (%) Gross NPAs 198 279 675 1,135 1,571 4,050 4,245 4,759 Gross NPAs to Adv. 0.2 0.2 0.4 0.6 0.8 1.9 1.8 1.8 Net NPAs 0 0 316 795 1,118 3,038 2,971 3,331 Net NPAs to Adv. 0.0 0.0 0.2 0.4 0.5 1.4 1.3 1.3 PCR 100.0 100.0 53.2 30.0 28.8 25.0 30.0 30.0

VALUATION Book Value (INR) 66.0 90.4 111.7 133.8 161.5 192.6 226.2 264.3 Price-BV (x) 7.4 5.4 4.4 3.6 3.0 2.6 2.2 1.9 EPS (INR) 11.8 17.6 21.5 22.3 28.2 33.2 35.6 40.1 EPS Growth YoY 82.2 49.4 21.9 3.7 26.8 17.5 7.2 12.6 Price-Earnings (x) 17.6 15.1 14.1 12.5 Dividend per share (INR) 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 Dividend yield (%) 0.4 0.4 0.4 0.4 E: MOFSL Estimates

January 2021 70 UpdateThe | Sectormatic:: Financials Housing Finance – NBFC PNB Housing Finance BSE Sensex S&P CNX 49,584 14,596 CMP: INR370 TP: INR400 (+8%) Neutral

Preserving capital; Focus on retail loans Asset quality a key monitorable

Stock info Focus on capital preservation and de-risking the balance sheet Bloomberg PNBHOUSI IN In the past year, PNBHF has focused on capital preservation, increasing balance Equity Shares (m) 167 sheet liquidity, and de-risking the loan book. It has been running down its loan M.Cap.(INRb)/(USDb) 62.2 / 0.9 52-Week Range (INR) 579 / 146 book (especially corporate loans) as well as assigning loans to banks. Total 1, 6, 12 Rel. Per (%) -9/45/-40 AUM declined ~10% over the past four quarters. Additionally, it has assigned INR34b worth of loans during this period. As a result, leverage (loans/equity) Financial Snapshot (INR b) has declined from 9.3x to 7.9x. At the same time, PNBHF increased balance Y/E March 2020 2021E 2022E sheet liquidity to 16% in FY20, from 12% in FY19, well ahead of peers such as NII 18.1 20.0 20.9 HDFC and LICHF. PPP 20.6 19.5 21.8 PAT 6.5 9.6 11.2 Diversifying the borrowing mix; Spreads to remain stable EPS (INR) 38.4 56.9 66.6 On the liability side, PNBHF has lowered its dependence on market borrowings EPS Gr. (%) -46 48 17 and increased the share of bank loans and public deposits. Since FY19, total BV/Sh. (INR) 476 519 573 Ratios market borrowings have halved to ~INR160b, driven by a reduction in the NIM (%) 2.6 3.0 3.1 share of both NCDs and CPs. Over this period, the number of depositors has C/I ratio (%) 21.1 19.9 20.0 gone up 50% to 232k. The cost of these deposits for 1- to 3-year tenure is ~6% RoAA (%) 0.8 1.2 1.4 incrementally. In our opinion, these benefits on cost of funds would offset yield RoE (%) 8.3 11.4 12.2 pressure due to lower home loan rates and a mix shift toward retail lending. Valuations P/E (x) 9.6 6.5 5.6 Hence, spreads should be largely stable at 2.1-2.3% going forward.

P/BV (x) 0.8 0.7 0.6 Asset quality a key monitorable Div. Yield (%) 2.4 3.1 2.7 Over the past six quarters, the company has witnessed asset quality stress in Shareholding pattern (%) five or six large corporate accounts. Its overall GNPL ratio has increased nearly As On Sep-20 Jun-20 Sep-19 200bp to 2.6% over the past four quarters; the corporate GNPL ratio has also Promoter 32.7 32.7 32.7 spiked to ~8%. Additionally, in the second moratorium phase, its retail DII 3.6 4.9 7.1 FII 24.0 21.9 23.4 moratorium book share of 29% was higher v/s larger peers (16–17%). However, Others 39.8 40.6 36.8 despite the moratorium, the company achieved average collection efficiency of FII Includes depository receipts 95% in the retail lending book in 2QFY21. The silver lining is its high provisioning – standard asset provisioning of 1.9% is significantly higher v/s Stock Performance (1-year) peers. While the overall macro environment is improving, we would wait and watch emerging trends in asset quality over the next few quarters.

Capital raise to be key trigger; Maintain Neutral One of the key investor concerns has been the delay by the company in raising equity capital. With leverage of ~8x and corporate loan share of nearly 17%, this is a key priority for the company. PNBHF recently received board approval to raise up to INR18b equity capital. PNB has also approved to invest up to INR6b in the upcoming capital raise. If the capital raise were to go through, this would strengthen the balance sheet and lower leverage to 6.8x (pro-forma).

However, we have not factored any capital raise in our estimates. Maintain Neutral with a TP of INR400 (0.6x FY23E BVPS).

January 2021 71 Thematic: Housing Finance

Story in charts

Exhibit 124: Expect 6% CAGR in AUM over FY20–23E Exhibit 125: Moderation in leverage due to slow growth AUM (INR b) Growth (%) 12.7 Leverage (x) 63 59 10.6 51 50 9.8 8.7 8.3 36 7.5 6.7 7.2 7.2 13 7 (2) (2)

173 276 415 623 847 833 813 868 978

FY15 FY16 FY17 FY18 FY19 FY20E FY21E FY22E FY23E FY15 FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E Source: MOFSL, Company Source: MOFSL, Company

Exhibit 126: Asset quality under some pressure (%)

GNPL ratio NNPL ratio 5.4 5.3 4.8

3.6 3.5 3.2 2.8 1.8

0.3 0.5 0.4 0.2 0.1 0.2 0.1 0.2 0.2 0.3

FY15 FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E

Source: MOFSL, Company

Exhibit 127: Reducing dependence on capital markets (%) Exhibit 128: Improving profitability (%) NCD CP Deposits ECB TL NHB Assignment RoA RoE 12 17.6 5 15 17 20 19 19 18 16.9 7 8 8 14.7 20 8 7 7 10 11 13.2 13.6 17 18 12.2 2 21 22 11.4 6 6 23 24 23 24 18 17 6 6 8.3 17 18 6 7 7 7 12 11 20 19 10 8 20 20 21 5 3 1 1 33 30 28 3 25 22 22 23 20 17 1.3 1.4 1.6 1.6 0.8 1.2 1.4 1.7 FY20 FY19 FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E 1HFY21 1HFY20 1HFY19 1QFY21 1QFY20 9MFY20 9MFY19 Source: MOFSL, Company Source: MOFSL, Company

January 2021 72 Thematic: Housing Finance

Financials and valuation

Income statement (INR M) Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Interest Income 25,461 36,401 50,467 67,929 76,882 73,061 72,146 77,018 Interest Expended 18,603 26,437 35,366 51,664 58,750 53,105 51,241 54,700 Net Interest Income 6,858 9,964 15,101 16,265 18,133 19,956 20,905 22,318 Change (%) 68.9 45.3 51.6 7.7 11.5 10.1 4.8 6.8 Other Operating Income 1,534 2,678 4,426 8,904 8,013 4,396 6,277 7,501 Net Income 8,393 12,642 19,528 25,169 26,146 24,352 27,182 29,819 Change (%) 62.8 50.6 54.5 28.9 3.9 -6.9 11.6 9.7 Operating Expenses 2,521 3,573 4,416 5,935 5,522 4,842 5,428 6,028 Operating Income 5,872 9,069 15,112 19,234 20,624 19,510 21,755 23,791 Change (%) 76.6 54.5 66.6 27.3 7.2 -5.4 11.5 9.4 Provisions/write offs 832 1,029 2,766 1,890 12,514 7,241 7,397 4,431 Reported PBT 5,040 8,040 12,346 17,344 8,110 12,269 14,358 19,360 Tax 1,766 2,803 3,934 5,429 1,648 2,699 3,159 4,259 Tax Rate (%) 35.0 34.9 31.9 31.3 20.3 22.0 22.0 22.0 Reported PAT 3,273 5,237 8,412 11,915 6,462 9,570 11,199 15,101 Change (%) 68.7 60.0 60.6 41.7 -45.8 48.1 17.0 34.8 Proposed Dividend 486 1,196 1,799 1,809 1,816 2,297 2,016 2,718

Balance sheet (INR M) Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Capital 1,269 1,656 1,666 1,675 1,682 1,682 1,682 1,682 Reserves & Surplus 20,190 56,340 64,008 73,764 78,296 85,569 94,752 1,07,135 Net Worth 21,459 57,996 65,673 75,439 79,978 87,251 96,434 1,08,817 Borrowings 2,60,137 3,53,207 5,37,767 7,18,589 6,77,351 6,50,273 6,80,666 7,58,819 Change (%) 57.8 35.8 52.3 33.6 -5.7 -4.0 4.7 11.5 Other liabilities 14,809 14,974 26,704 44,662 31,969 35,165 38,682 42,550 Total Liabilities 2,96,405 4,26,177 6,30,145 8,38,690 7,89,297 7,72,689 8,15,783 9,10,186 Loans 2,71,813 3,87,347 5,71,648 7,42,879 6,66,280 6,50,273 6,94,557 7,82,287 Change (%) 61.8 42.5 47.6 30.0 -10.3 -2.4 6.8 12.6 Investments 16,223 33,236 24,130 45,607 20,757 22,833 25,116 28,884 Change (%) 2.3 104.9 -27.4 89.0 -54.5 10.0 10.0 15.0 Net Fixed Assets 622 604 858 1,083 1,353 1,421 1,492 1,567 Other assets 7,747 4,990 33,509 49,122 1,00,906 98,162 94,617 97,448 Total Assets 2,96,405 4,26,177 6,30,145 8,38,690 7,89,297 7,72,689 8,15,783 9,10,186 E: MOFSL Estimates

January 2021 73 Thematic: Housing Finance

Financials and valuation

Ratios (%) Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Spreads Analysis (%) Avg yield on loans 11.2 10.6 10.2 10.1 10.6 10.7 10.3 10.0 Avg. cost of funds 8.8 8.6 7.9 8.2 8.4 8.0 7.7 7.6 Interest Spread 2.4 2.0 2.3 1.9 2.1 2.7 2.6 2.5 NIM on loans 3.1 3.0 3.1 2.5 2.6 3.0 3.1 3.0

Profitability Ratios (%) RoE 17.6 13.2 13.6 16.9 8.3 11.4 12.2 14.7 RoA 1.3 1.4 1.6 1.6 0.8 1.2 1.4 1.7 Int. Expended/Int.Earned 73.1 72.6 70.1 76.1 76.4 72.7 71.0 71.0 Other Inc./Net Income 18.3 21.2 22.7 35.4 30.6 18.1 23.1 25.2

Efficiency Ratios (%) Op. Exps./Net Income 30.0 28.3 22.6 23.6 21.1 19.9 20.0 20.2 Empl. Cost/Op. Exps. 29.9 28.3 32.6 51.2 42.2 49.1 49.1 49.5

Asset Quality (INR m) Gross NPA 598 858 1,861 3,549 18,562 31,888 38,391 41,863 GNPA ratio 0.2 0.2 0.3 0.5 2.8 4.8 5.4 5.3 Net NPA 381 590 1,438 2,784 11,838 20,727 24,954 27,211 NNPA ratio 0.1 0.2 0.3 0.4 1.8 3.2 3.6 3.5

VALUATION 2016 2017 2018 2019 2020 2021E 2022E 2023E Book Value (INR) 169.1 350.1 394.2 450.5 475.5 518.8 573.4 647.0 BVPS Growth YoY 11.2 107.1 12.6 14.3 5.6 9.1 10.5 12.8 Price-BV (x) 0.8 0.7 0.6 0.6 EPS (INR) 25.8 31.6 50.5 71.1 38.4 56.9 66.6 89.8 EPS Growth YoY 38.0 22.6 59.7 40.9 -46.0 48.1 17.0 34.8 Price-Earnings (x) 9.8 6.5 5.6 4.1 Dividend per share (INR) 3.4 6.0 9.0 9.0 9.0 11.4 10.0 13.5 Dividend yield (%) 2.5 3.1 2.7 3.6 E: MOFSL Estimates

January 2021 74 UpdateThe | Sectormatic:: Financials Housing Finance – NBFC Repco Home Finance BSE Sensex S&P CNX 49,584 14,596 CMP: INR258 TP: INR340 (+32%) Buy

Prioritizing asset quality over growth RoA/RoE to be healthy at 2.4%/14%

Prioritized collections over the past year Stock info Management’s key focus over the past six quarters has been on asset quality. It Bloomberg REPCO IN has set up teams dedicated to doing collections in overdue accounts. While the Equity Shares (m) 63 GNPL ratio has remained flat at ~4% over the past few quarters, REPCO has M.Cap.(INRb)/(USDb) 16.3 / 0.2 seen a huge improvement in its Stage 2 loans. The Stage 2 loan ratio improved 52-Week Range (INR) 366 / 91 to 2.3% in FY20, from 12.2% in FY19, and is now among the lowest in our HFC 1, 6, 12 Rel. Per (%) -5/67/-38 coverage universe. The company has also increased its provision buffer in this

Financial Snapshot (INR b) crisis. Over the past three quarters, Stage 3 PCR has increased to 41% from Y/E March 2020 2021E 2022E 29%, and the total ECL provision to 2.0% from 1.5%. NII 4.9 5.4 5.6 PPP 4.2 4.5 4.7 Expect 10% loan CAGR over FY20–23E; LAP share to be stable PAT 2.8 2.9 3.1 Past issues (sand mining ban and registration issues in Tamil Nadu) continue to EPS (INR) 44.8 46.6 49.4 EPS Gr. (%) 19 4 6 impact company growth. The pandemic has put further pressure on loan BV/Sh. (INR) 286 329 375 growth (down from 10% YoY pre-COVID to 5% YoY currently). Given gradual Ratios opening up of the economy, we expect growth to improve from 5% in FY20 to NIM (%) 4.4 4.5 4.3 11% in FY21. Also, the share of LAP should remain range-bound over the C/I ratio (%) 20.2 19.0 19.9 medium term, in our view. RoAA (%) 2.4 2.4 2.3 RoE (%) 16.9 15.2 14.0 Payout (%) 7.0 7.0 7.0 MCLR cuts by banks to soon translate to lower borrowing cost Valuation Given its low dependence on the capital markets for borrowings, REPCO has P/E (x) 5.8 5.5 5.2 been less impacted by the liquidity crisis. ~95% of its borrowings come from P/BV (x) 0.9 0.8 0.7 banks and NHB. Banks have cut MCLR by 75-100bp over the past 9 months – Div. Yield (%) 1.0 1.1 1.1 this should impact cost of funds relatively quickly. REPCO has done a decent Shareholding pattern (%) job of maintaining yields at ~11.5% over the past 1–2 years despite the increase As On Sep-20 Jun-20 Sep-19 in the share of salaried customers from 43% to 48% over the past two years. Promoter 37.1 37.1 37.1 However, going forward, there would be pressure on yields due to sharp home DII 20.2 18.6 26.1 FII 19.1 26.7 26.8 loan rate reduction by the competition. Given the decline in cost of funds, we Others 23.6 17.6 9.9 believe REPCO would be able to maintain spreads at 3.2–3.3%. FII Includes depository receipts Valuation and view Stock Performance (1-year) Over the past year or so, REPCO has done a commendable job with collections by reducing its Stage 2 loans to ~2%. It has also increased liquidity on the balance sheet from sub-1% to 4%+ of borrowings. However, past issues (sand mining and the registration ban in Tamil Nadu) continue to impact company growth. With the gradual lifting of the lockdown, we expect disbursements to pick up. Nevertheless, loan growth is likely to remain in the 9-10% range in the near-to-medium term. Trends in asset quality over the next 2–3 quarters would be a key monitorable. We expect REPCO to deliver average 2.4% RoA and 14% RoE over the medium term. Maintain Buy, with TP of INR340 (0.8x FY23E BVPS).

January 2021 75 Thematic: Housing Finance

Story in charts

Exhibit 129: Expect loan growth to pick up Exhibit 130: LAP share to remain largely stable Home Loans LAP 28 Loan book (INR b) Loan Growth (%)

19.9 20.4 16.8 16.9 18.7 18.5 18.5 18.5

16 12 11 8 7 7 7 80.1 79.6 83.2 83.1 81.3 81.5 81.5 81.5

77 90 96 108 116 124 133 148 FY16 FY17 FY18 FY19 FY20 FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E FY21E FY22E FY23E

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 131: Collection efforts yielding results – Sharp improvement in Stage 2 loans (%) Exhibit 132: Increasing the provision buffer Stage 2 (%) FY18 FY19 FY20 GNPA PCR 64 HDFC 4.5 4.3 5.5 56 54 55 LICHF 3.8 4.4 4.6 47 48 47 42 PNBHF 1.7 3.3 3.7 CANF 4.4 4.8 6.0 REPCO 15.5 12.2 2.3 AAVAS 2.3 1.6 1.0 1.3 2.6 2.9 3.0 4.3 4.5 5.1 4.6

Source: MOFSL, Company FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E Source: MOFSL, Company

Exhibit 133: Expect cost of funds to come off over FY20–23E Exhibit 134: RoE/RoA at ~14%/2.4% over the medium term

Yields Cost of borrowings RoE RoA 12.4 12.2 2.4 11.6 11.4 11.7 11.5 2.4 2.4 10.9 10.9 2.3 2.3 9.4 9.2 2.2 2.2 8.5 2.1 8.3 8.3 8.1 7.7 7.7

17.0 17.4 16.4 16.5 16.9 15.2 14.0 13.7 FY16 FY17 FY18 FY19 FY20 FY16 FY17 FY18 FY19 FY20 FY21E FY22E FY23E FY21E FY22E FY23E Source: MOFSL, Company Source: MOFSL, Company

January 2021 76 Thematic: Housing Finance

Financials and valuation

Income statement (INR M) Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Interest Income 8,521 10,141 10,851 11,634 13,174 13,795 14,003 15,294 Interest Expended 5,483 6,463 6,489 7,200 8,250 8,389 8,432 9,127 Net Interest Income 3,039 3,678 4,362 4,434 4,924 5,406 5,571 6,168 Change (%) 27.8 21.0 18.6 1.7 11.0 9.8 3.1 10.7 Other Operating Income 297 318 250 318 337 202 283 326 Net Income 3,336 3,996 4,612 4,752 5,261 5,608 5,854 6,494 Change (%) 27.7 19.8 15.4 3.1 10.7 6.6 4.4 10.9 Operating Expenses 643 676 790 984 1,065 1,068 1,168 1,282 Operating Income 2,693 3,320 3,822 3,768 4,196 4,540 4,686 5,212 Change (%) 30.4 23.3 15.1 -1.4 11.4 8.2 3.2 11.2 Provisions/write offs 392 518 748 170 594 647 558 635 PBT 2,301 2,802 3,074 3,598 3,602 3,894 4,128 4,576 Tax 800 979 1,063 1,252 798 981 1,040 1,153 Tax Rate (%) 34.8 34.9 34.6 34.8 22.2 25.2 25.2 25.2 PAT 1,501 1,823 2,010 2,346 2,804 2,913 3,088 3,423 Change (%) 21.9 21.4 10.3 16.7 19.5 3.9 6.0 10.8

Balance sheet (INR M) Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Capital 625 626 626 626 626 626 626 626 Reserves & Surplus 8,923 10,747 12,459 14,648 17,243 19,953 22,826 26,011 Net Worth 9,548 11,372 13,085 15,274 17,869 20,579 23,452 26,636 Borrowings 65,379 75,604 81,343 92,774 101,090 106,049 112,961 124,098 Change (%) 28.1 15.6 7.6 14.1 9.0 4.9 6.5 9.9 Other liabilities 2,705 3,457 2,882 1,522 980 1,098 1,230 1,377 Total Liabilities 77,632 90,433 97,310 109,570 119,939 127,726 137,642 152,112 Loans 77,049 89,578 96,492 108,379 115,877 124,034 132,895 147,736 Change (%) 28.1 16.3 7.7 12.3 6.9 7.0 7.1 11.2 Investments 124 156 239 363 321 369 424 488 Change (%) 0.0 25.8 53.5 51.5 -11.5 15.0 15.0 15.0 Net Fixed Assets 93 91 135 155 372 391 410 431 Other assets 366 609 443 673 3,369 2,931 3,912 3,457 Total Assets 77,632 90,433 97,310 109,570 119,939 127,726 137,642 152,112 E: MOFSL Estimates

January 2021 77 Thematic: Housing Finance

Financials and valuation

Ratios (%) Y/E March 2016 2017 2018 2019 2020 2021E 2022E 2023E Spreads Analysis (%) Avg Yield on Loans 12.4 12.2 11.6 11.4 11.7 11.5 10.9 10.9 Avg. Cost of Borrowings 9.4 9.2 8.3 8.3 8.5 8.1 7.7 7.7 Interest Spread 3.0 3.0 3.4 3.1 3.2 3.4 3.2 3.2 Net Interest Margin 4.4 4.4 4.7 4.3 4.4 4.5 4.3 4.4

Profitability Ratios (%) RoE 17.0 17.4 16.4 16.5 16.9 15.2 14.0 13.7 RoA 2.2 2.2 2.1 2.3 2.4 2.4 2.3 2.4 Int. Expended/Int.Earned 64.3 63.7 59.8 61.9 62.6 60.8 60.2 59.7 Other Inc./Net Income 8.9 8.0 5.4 6.7 6.4 3.6 4.8 5.0

Efficiency Ratios (%) Op. Exps./Net Income 19.3 16.9 17.1 20.7 20.2 19.0 19.9 19.7 Empl. Cost/Op. Exps. 63.7 63.8 62.6 59.5 62.4 66.6 67.0 67.1

Asset Quality (%) Gross NPAs 1,009 2,328 2,827 3,258 5,117 5,696 6,937 6,937 Gross NPAs to Adv. 1.3 2.6 2.9 3.0 4.3 4.5 5.1 4.6 Net NPAs 368 1,227 1,255 1,507 2,988 2,962 3,688 3,127 Net NPAs to Adv. 0.5 1.4 1.3 1.4 2.6 2.4 2.8 2.1

VALUATION 2016 2017 2018 2019 2020 2021E 2022E 2023E Book Value (INR) 152.7 181.8 209.2 244.1 285.6 328.9 374.9 425.8 Price-BV (x) 0.9 0.8 0.7 0.6 EPS (INR) 24.0 29.1 32.1 37.5 44.8 46.6 49.4 54.7 EPS Growth YoY 21.6 21.4 10.3 16.7 19.5 3.9 6.0 10.8 Price-Earnings (x) 5.9 5.5 5.2 4.7 Dividend per share (INR) 1.8 2.0 2.2 2.3 2.7 2.8 3.0 3.3 Dividend yield (%) 1.1 1.1 1.1 1.3 E: MOFSL Estimates

January 2021 78 Initiating CoverageThe | Sectormatic:: Financials Housing Finance – NBFC Aadhar Housing Finance BSE Sensex S&P CNX 49,584 14,596 ,2 Pan-India affordable housing finance player ~50% CRAR; Healthy return ratios

Financial Snapshot (INR b) Aadhar Housing Finance (Aadhar) is a leading affordable housing finance Y/E March 2018 2019 2020 company with presence across 20 states and union territories (UTs) with an NII 2.4 3.6 4.2 AUM of INR114b. PPP 1.9 2.8 3.4 PAT 1.1 1.6 1.9 EPS (INR) 45.6 64.6 48.0 Affordable housing finance player; ATS of INR0.8m EPS Gr. (%) 118 42 -26 Aadhar is among the larger affordable housing finance players in India with a BV/Sh. (INR) 286 342 595 network of 294 branches across 20 states and UTs. The company merged with Ratios (%) DHFL Vysya in FY18 and was bought by Blackstone in FY20. While it caters NIM 5.3 4.8 5.0 C/I ratio 46.8 47.4 42.8 primarily to the salaried customer segment, we note that the share of self- RoA 2.4 1.9 1.7 employed customers has increased from 32% to 35% over FY18-20. Its RoE 26.3 20.6 11.8 average home loan ticket size is INR0.8m, similar to that of peers like AAVAS. The company has ~2,100 on-roll employees.

INR13b equity infusion by Blackstone to provide capital for growth Despite liquidity tightening post the IL&FS crisis, Aadhar managed to grow its loan book commendably. Over FY18-20, Aadhar delivered AUM CAGR of 20% to INR114b and its number of customers increased at 27% CAGR to 160k. Post its acquisition of the company, Blackstone infused INR13b equity into Aadhar, resulting in its CRAR spiking from 18% to 51% YoY in FY20. While we do not have any estimates on loan growth, we believe Aadhar is well-capitalized and would not need to dilute equity over the next 3-5 years.

Spreads improving; Higher liquidity; Asset quality healthy Over the past two years, Aadhar has witnessed 140bp improvement in spreads to 5.4%, driven by a sharp decline in cost of funds. Change in parentage and reduction in leverage (loans/equity down from 10.1x to 3.8x over FY18-20) are key reasons for the same, in our view. The company’s credit rating is CARE AA. Aadhar also increased liquidity on the balance sheet from 13% to 33% YoY in FY20. On the asset quality front, the company has seen low GNPLs despite catering to a low-ticket customer segment. Retail/total GNPL ratio is 0.8%/1.3%. While credit costs stood at ~0.5% over FY18-19, they spiked to 1.3% in FY20 due to provisions for COVID-19 and some legacy builder NPLs. Excluding these one-offs, credit costs stood at 0.2% in FY20.

Core RoA/RoE healthy Aadhar delivered RoA/RoE of 1.7%/12% in FY20, down from 2.4%/26% in FY18. The decline in RoA was due to the drag on NIMs owing to excess liquidity coupled with higher credit costs on account of one-offs. The lesser RoE was due to lower leverage. Excluding the one-off credit costs as mentioned above, RoE/RoE would have been 2.6%/20% in FY20.

January 2021 79 Thematic: Housing Finance

Story in charts

Exhibit 135: Key Parameters FY18 FY19 FY20 ATS (INR m) 0.82 0.83 0.84 Salaried customers AUM share (%) 68.0 66.0 65.0 Retail GNPA (%) 0.58 0.58 0.82 CAR (%) 18.8 18.3 51.4 Branches 275 311 294 Employees 1,742 2,217 2,097 Customers ('000) 100 133 161

Source: MOFSL, Company

Exhibit 136: 20% AUM CAGR over FY18-20 Exhibit 137: 22% off-balance sheet loans

AUM (INR b) Loans/AUM ratio (%)

114 100 80

32 0 18 0.91 0.80 0.78

FY15 FY16 FY17 FY18 FY19 FY20 FY18 FY19 FY20

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 138: Sharp decline in CoF over FY18-20 (%) Exhibit 139: Expense ratio increased post-merger in FY18 (%)

Yield on loans Cost of funds Expense ratio C/I ratio 46.8 47.4 15.5 42.8 14.3 14.3 40.7 13.0 12.6 12.2 31.5 27.5 11.5 10.0 10.0 9.6 9.4 8.9

1.3 1.4 1.7 3.6 3.3 3.0

FY15 FY16 FY17 FY18 FY19 FY20 FY15 FY16 FY17 FY18 FY19 FY20

Source: MOFSL, Company Source: MOFSL, Company

January 2021 80 Thematic: Housing Finance

Exhibit 140: GNPL ratio healthy (%) Exhibit 141: Credit costs spiked in FY20 due to one-offs (%) GNPL ratio PCR

40 37 37 32 33 29

0.7 1.3 1.5 1.2 1.2 1.3 0.2 0.3 0.6 0.4 1.3

FY15 FY16 FY17 FY18 FY19 FY20 FY16 FY17 FY18 FY19 FY20

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 142: Trend in PAT Exhibit 143: Healthy return ratios

PAT (INR b) Growth (%) RoA RoE 394 26.3

21.5 20.6 19.2 15.4 11.8 42 17 -6 -13

0.3 0.2 1.1 1.6 1.9 2.0 1.8 1.3 2.4 1.9 1.7

FY16 FY17 FY18 FY19 FY20 FY15 FY16 FY17 FY18 FY19 FY20

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 144: DuPont Analysis % 2016 2017 2018 2019 2020 Interest Income 12.20 11.43 14.53 12.70 11.13 Interest Expended 8.86 8.33 9.53 8.47 7.27 Net Interest Income 3.34 3.10 5.00 4.23 3.86 Other Income 0.81 0.77 2.28 1.98 1.59 Net Income 4.15 3.86 7.28 6.20 5.45 Operating Expenses 1.31 1.57 3.41 2.94 2.33 Cost to Income Ratio (%) 31.53 40.66 46.82 47.39 42.76 Employee Expenses 0.77 0.99 2.19 2.06 1.54 Other Expenses 0.54 0.58 1.22 0.88 0.80 Operating Profit 2.84 2.29 3.87 3.26 3.12 Provisions/write offs 0.15 0.24 0.54 0.37 1.00 PBT 2.70 2.05 3.33 2.73 2.12 Tax 0.90 0.72 0.97 0.85 0.38 Tax Rate (%) 33.21 35.09 29.02 31.10 17.99 PAT 1.80 1.33 2.37 1.88 1.74 Leverage 10.64 11.61 11.12 10.93 6.81 RoE 19.19 15.45 26.31 20.58 11.81

Source: MOFSL, Company

January 2021 81 Thematic: Housing Finance

Financials and Valuation

Income statement (INR m)

Y/E March 2015 2016 2017 2018 2019 2020 Interest Income 1,660 1,809 1,994 7,047 10,950 12,145 Interest Expended 1,176 1,313 1,454 4,623 7,305 7,935 Net Interest Income 484 496 541 2,425 3,644 4,210 Change (%) 2.4 9.0 348.5 50.3 15.5

Other Operating Income 128 120 134 1,104 1,707 1,739 Net Income 612 616 674 3,529 5,351 5,950 Change (%) 0.6 9.5 423.2 51.7 11.2 Operating Expenses 168 194 274 1,652 2,536 2,544 Operating Income 444 422 400 1,876 2,815 3,406 Change (%) -4.9 -5.1 368.8 50.0 21.0 Provisions/write offs 12 22 43 260 320 1,097 PBT 431 400 358 1,616 2,495 2,309 Extraordianary Items 0 0 0 0 -139 0 PBT after EO 431 400 358 1,616 2,357 2,309 Tax 148 133 126 469 733 415 Tax Rate (%) 34.2 33.2 35.1 29.0 29.4 18.0 PAT 284 267 232 1,147 1,624 1,894 Change (%) -5.8 -13.1 394.1 41.5 16.6

Balance sheet

Y/E March 2015 2016 2017 2018 2019 2020 Capital 111 111 111 252 252 395 Reserves & Surplus 1,207 1,357 1,426 6,931 8,348 23,079 Net Worth 1,318 1,468 1,537 7,183 8,599 23,473 Borrowings 12,257 14,005 16,939 63,793 81,950 96,433 Change (%) 14.3 21.0 276.6 28.5 17.7 Other liabilities 287 318 637 6,895 4,075 3,758 Total Liabilities 13,862 15,791 19,114 77,871 94,624 1,23,664 Loans 13,203 14,692 18,100 72,730 80,256 89,090 Change (%) 11.3 23.2 301.8 10.3 11.0 Investments 71 71 208 2,102 1,497 240 Change (%) 0.4 192.5 910.6 -28.8 -84.0 Net Fixed Assets 8 9 1 191 241 443 Other assets 580 1,018 805 2,848 12,631 33,892 Total Assets 13,862 15,791 19,114 77,871 94,624 1,23,664 E: MOFSL Estimates

January 2021 82 Thematic: Housing Finance

Financials and Valuation

% Ratios Y/E March 2015 2016 2017 2018 2019 2020 Spreads Analysis (%) Avg Yield on Loans 12.6 13.0 12.2 15.5 14.3 14.3 Avg. Cost of Borrowings 9.6 10.0 9.4 11.5 10.0 8.9 Interest Spread - 3.0 2.8 4.1 4.3 5.4 Net Interest Margin 3.7 3.6 3.3 5.3 4.8 5.0

Profitability Ratios (%) RoE 21.5 19.2 15.4 26.3 20.6 11.8 RoA 2.0 1.8 1.3 2.4 1.9 1.7 Int. Expended/Int.Earned 70.8 72.6 72.9 65.6 66.7 65.3 Other Inc./Net Income 20.9 19.5 19.8 31.3 31.9 29.2

Efficiency Ratios (%) Cost-to-Income ratio 27.5 31.5 40.7 46.8 47.4 42.8 Empl. Cost/Op. Exps. 58.6 59.1 63.0 64.2 70.1 65.9

Asset Quality (%) Gross NPAs 98 169 281 863 1,001 1,170 1.3 1.5 1.2 1.2 1.3 Gross NPAs to Adv. Net NPAs 62 114 199 574 628 699 Net NPAs to Adv. 0.5 0.8 1.1 0.8 0.8 0.8

January 2021 83 Initiating CoverageThe | Sectormatic:: Financials Housing Finance – NBFC Home First Finance BSE Sensex S&P CNX 49,584 14,596

A niche player Focus on analytics | Healthy asset quality | Strong growth

Home First Finance (Home First) is an affordable housing finance player with

Financial Snapshot (INR b) over 43k customers operating across 11 states in India. The company was Y/E March 2018 2019 2020 founded by Mr. Jaithirth Rao, Mr. P.S. Jayakumar and Mr. Manoj Viswanathan NII 0.6 1.1 1.6 and commenced operations in Aug’10. The company is owned by a clutch of PE PPP 0.3 0.7 1.2 investors including True North (34.4%), Warburg Pincus (25.6%), Aether PAT 0.2 0.5 0.8 (22.9%), Bessemer (11.5%). EPS (INR) 3.1 7.1 10.2 EPS Gr. (%) 139 130 42 BV/Sh. (INR) 63 83 119 Affordable housing finance player; Focused on digital adoption Ratios Home First is an affordable housing finance player with an average loan ticket NIM (%) 6.1 5.9 6.0 size of INR1.0m. The largest states where it operates are Gujarat (39% of C/I ratio (%) 60.2 49.8 45.2 loans) and Maharashtra (21%). The company has invested deeply in digital and RoAA (%) 1.4 2.4 2.7 RoE (%) 5.1 10.7 10.9 analytical capabilities. It captures over 100 data points of its customers in addition to credit bureau data as well as fraud-related and other data. With its digital architecture, it is able to sanction home loans with a TAT of 48 hours.

Rising share of salaried customers Over FY17-1HFY21, the share of salaried customers increased from 69% to 73%. Its salaried customers are typically employed by small firms or are working in junior positions in large firms. Over the past few years, Home First has focused more on customers with existing credit history – the share of such customers in total AUM increased from 55% to 67% over FY17-1HFY21. The company finances predominantly completed homes (85% of portfolio).

50%+ loan book CAGR over FY17-20; Spreads rising Disbursements almost quadrupled to INR15.7b over FY17-19. However, it was largely stable in FY20. Nevertheless, it delivered loan book CAGR of 56% to reach INR30b over FY17-20. Over this the same period, the share of home loans declined from 97% to 90% while that of LAP increased from 3% to 6%. Given the strong growth, its CRAR ratio declined from 69% to 39% over FY18- 20. The company also improved its spreads from 4.6% in FY18 to 5.0% in FY20, driven by yield improvement to 13.8%.

RoA healthy; Low leverage leads to modest RoE With strong underwriting, the company has experienced healthy asset quality with GNPL ratio at sub-1% and credit costs of 0.3-0.6% over the past three years. As a result, its RoA of 2.7% in FY20 is healthy v/s peers. However, given its low leverage (loans/equity of 3.2x), it delivered modest RoE of 11% in FY20.

January 2021 84 Thematic: Housing Finance

Story in charts

Exhibit 145: Strong disbursement growth… Exhibit 146: …results in ~4x AUM in 3 years AUM (INR b) Growth (%)

80

60 48 15.7 16.2

7.5 4.2 8.5 13.6 24.4 36.2

FY17 FY18 FY19 FY20 FY17 FY18 FY19 FY20

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 147: Loan CAGR of ~60% over FY17-20 Exhibit 148: 90%+ of AUM is in home loans (%)

Loans (INR b) Growth (%) Home loan LAP & others Developer 3.3 1.3 2.8 66 63 2.7 3.4 4.5 5.8

41

96.7 96.0 92.0 91.5

7.9 13.1 21.3 30.1

FY17 FY18 FY19 FY20 FY17 FY18 FY19 FY20

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 149: High share of salaried customers (%)… Exhibit 150: 2/3rd of customers with credit history (%) Salaried Self Employed Corporate New to credit Credit History

1.3 3.4 2.1 1.9 30.6 25.1 23.8 25.0 25.0 55.3 58.2 63.0 65.7 67.2

69.4 73.6 72.8 72.9 73.1 44.7 41.8 37.0 34.3 33

FY17 FY18 FY19 FY20 1HFY21 FY17 FY18 FY19 FY20 1HFY21

Source: MOFSL, Company Source: MOFSL, Company

January 2021 85 Thematic: Housing Finance

Exhibit 151: State-wise AUM mix (%) Exhibit 152: Healthy liquidity on the balance sheet GJ MH TN KN Others Liquidity on BS (INR b) % of borrowings 27 12 11 14 20 20 9 7 9 8 9 9 9 9 10 11 15 36 28 15 37 22 21

33 38 41 40 39 3 1.8 2.9 3.7 0.3 FY17 FY18 FY19 FY20 1HFY21 FY17 FY18 FY19 FY20

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 153: Spread expansion over FY18-20 (%) Exhibit 154: Operating leverage playing out (%)

Yield on loans Cost of funds Expense ratio C/I ratio 67.8 13.5 13.8 60.2 12.4 49.8 45.2

8.6 8.8 7.8 3.2 3.9 4.2 4.0

FY18 FY19 FY20 FY17 FY18 FY19 FY20

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 155: Asset quality has been healthy (%) Exhibit 156: Credit costs minimal (%)

GNPL ratio PCR Credit costs 24.9 25.8 20.5 16.6

0.6 1.0 0.7 0.8 0.4 0.6 0.3

FY17 FY18 FY19 FY20 FY18 FY19 FY20

Source: MOFSL, Company Source: MOFSL, Company

January 2021 86 Thematic: Housing Finance

Exhibit 157: Trend in PAT Exhibit 158: RoE modest due to low leverage (%) PAT (INR m) Growth (%) RoA RoE 10.7 10.9 183

139

5.1 76 4.4

67 160 452 796 1.4 1.4 2.4 2.7

FY17 FY18 FY19 FY20 FY17 FY18 FY19 FY20

Source: MOFSL, Company Source: MOFSL, Company

Exhibit 159: DuPont analysis % 2017 2018 2019 2020 Interest Income 17.80 11.04 12.06 11.90 Interest Expended 10.93 5.60 6.58 6.50 Net Interest Income 6.87 5.44 5.48 5.40 Other Income 0.73 0.36 2.03 2.17 Net Income 7.59 5.80 7.51 7.58 Operating Expenses 5.15 3.49 3.74 3.42 Cost to Income Ratio (%) 67.78 60.24 49.78 45.17 Employee Expenses 3.03 2.12 2.22 2.05 Other Expenses 2.11 1.37 1.52 1.37 Operating Profit 2.45 2.31 3.77 4.15 Provisions/write offs 0.35 0.24 0.38 0.55 PBT 2.09 2.06 3.39 3.60 Tax 0.74 0.70 1.04 0.93 Tax Rate (%) 35.53 34.11 30.66 25.88 PAT 1.35 1.36 2.35 2.67 Leverage 3.23 3.73 4.53 4.09

RoE 4.36 5.06 10.66 10.92 Source: MOFSL, Company

January 2021 87 Thematic: Housing Finance

Financials and Valuation

Income statement (INR m) Y/E March 2017 2018 2019 2020 Interest Income 880 1,300 2,319 3,548 Interest Expended 540 660 1,265 1,938 Net Interest Income 339 640 1,054 1,610 Change (%) 88.5 64.7 52.8

Other Operating Income 36 43 390 648 Net Income 375 683 1,444 2,258 Change (%) 81.9 111.5 56.4 Operating Expenses 254 411 719 1,020 Operating Income 121 271 725 1,238 Change (%) 124.5 167.1 70.8 Provisions/write offs 17 29 73 165 PBT 104 243 652 1,073 Extraordianary Items 0 0 0 0 PBT after EO 104 243 652 1,073 Tax 37 83 200 278 Tax Rate (%) 35.5 34.1 30.7 25.9 PAT 67 160 452 796 Change (%) 139.5 182.7 76.0

Balance sheet

Y/E March 2017 2018 2019 2020 Capital 103 103 127 157 Reserves & Surplus 2,960 3,149 5,105 9,178 Net Worth 3,064 3,252 5,231 9,334 Borrowings 6,630 10,199 19,256 24,938 Change (%) 53.8 88.8 29.5 Other liabilities 196 199 332 530 Total Liabilities 9,890 13,649 24,820 34,802 Loans 7,893 13,087 21,347 30,139 Change (%) 65.8 63.1 41.2 Investments 0 0 1,029 1,456 Change (%) 41.4 Net Fixed Assets 67 112 174 210 Other assets 1,930 450 2,270 2,997 Total Assets 9,890 13,649 24,820 34,802 E: MOFSL Estimates

January 2021 88 Thematic: Housing Finance

Financials and Valuation

% Ratios Y/E March 2017 2018 2019 2020 Spreads Analysis (%) Yield on loans 11.1 12.4 13.5 13.8 Cost of funds 16.3 7.8 8.6 8.8 Spreads 6.0 4.5 4.5 4.4 Net Interest Margin 8.6 6.1 5.9 6.0

Profitability Ratios (%) RoE 4.4 5.1 10.7 10.9 RoA 1.4 1.4 2.4 2.7 Int. Expended/Int.Earned 61.4 50.8 54.6 54.6 Other Inc./Net Income 9.6 6.3 27.0 28.7

Efficiency Ratios (%) Cost-to-income 67.8 60.2 49.8 45.2 Empl. Cost/Op. Exps. 58.9 60.7 59.4 59.9

Asset Quality (%) Gross NPAs 57 81 170 315 Gross NPAs to Adv. 0.7 0.6 0.8 1.0 Net NPAs 48 64 128 234 Net NPAs to Adv. 0.6 0.5 0.6 0.8

January 2021 89

KEY FINANCIAL REPORTS

THEMATIC/STRATEGY RESEARCH GALLERY Thematic: Housing Finance

Explanation of Investment Rating Investment Rating Expected return (over 12-month) BUY >=15% SELL < - 10% NEUTRAL < - 10 % to 15% UNDER REVIEW Rating may undergo a change NOT RATED We have forward looking estimates for the stock but we refrain from assigning recommendation *In case the recommendation given by the Research Analyst is inconsistent with the investment rating legend for a continuous period of 30 days, the Research Analyst shall within following 30 days take appropriate measures to make the recommendation consistent with the investment rating legend. Disclosures The following Disclosures are being made in compliance with the SEBI Research Analyst Regulations 2014 (herein after referred to as the Regulations). Motilal Oswal Financial Services Ltd. (MOFSL) is a SEBI Registered Research Analyst having registration no. INH000000412. MOFSL, the Research Entity (RE) as defined in the Regulations, is engaged in the business of providing Stock broking services, Investment Advisory Services, Depository participant services & distribution of various financial products. MOFSL is a subsidiary company of Passionate Investment Management Pvt. Ltd.. (PIMPL). MOFSL is a listed public company, the details in respect of which are available on www.motilaloswal.com. MOFSL (erstwhile Motilal Oswal Securities Limited - MOSL) is registered with the Securities & Exchange Board of India (SEBI) and is a registered Trading Member with National Stock Exchange of India Ltd. (NSE) and Bombay Stock Exchange Limited (BSE), Multi Commodity Exchange of India Limited (MCX) and National Commodity & Derivatives Exchange Limited (NCDEX) for its stock broking activities & is Depository participant with Central Depository Services Limited (CDSL) National Securities Depository Limited (NSDL),NERL, COMRIS and CCRL and is member of Association of Mutual Funds of India (AMFI) for distribution of financial products and Insurance Regulatory & Development Authority of India (IRDA) as Corporate Agent for insurance products. Details of associate entities of Motilal Oswal Financial Services Limited are available on the website at http://onlinereports.motilaloswal.com/Dormant/documents/List%20of%20Associate%20companies.pdf MOFSL and its associate company(ies), their directors and Research Analyst and their relatives may; (a) from time to time, have a long or short position in, act as principal in, and buy or sell the securities or derivatives thereof of companies mentioned herein. (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as a market maker in the financial instruments of the company(ies) discussed herein or act as an advisor or lender/borrower to such company(ies) or may have any other potential conflict of interests with respect to any recommendation and other related information and opinions.; however the same shall have no bearing whatsoever on the specific recommendations made by the analyst(s), as the recommendations made by the analyst(s) are completely independent of the views of the associates of MOFSL even though there might exist an inherent conflict of interest in some of the stocks mentioned in the research report MOFSL and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, the recipients of this report should be aware that MOFSL may have a potential conflict of interest that may affect the objectivity of this report. Compensation of Research Analysts is not based on any specific merchant banking, investment banking or brokerage service transactions. Details of pending Enquiry Proceedings of Motilal Oswal Financial Services Limited are available on the website at https://galaxy.motilaloswal.com/ResearchAnalyst/PublishViewLitigation.aspx A graph of daily closing prices of securities is available at www.nseindia.com, www.bseindia.com. Research Analyst views on Subject Company may vary based on Fundamental research and Technical Research. Proprietary trading desk of MOFSL or its associates maintains arm’s length distance with Research Team as all the activities are segregated from MOFSL research activity and therefore it can have an independent view with regards to Subject Company for which Research Team have expressed their views. Regional Disclosures (outside India) This report is not directed or intended for distribution to or use by any person or entity resident in a state, country or any jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject MOFSL & its group companies to registration or licensing requirements within such jurisdictions. For Hong Kong: This report is distributed in Hong Kong by Motilal Oswal capital Markets (Hong Kong) Private Limited, a licensed corporation (CE AYY-301) licensed and regulated by the Hong Kong Securities and Futures Commission (SFC) pursuant to the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) “SFO”. As per SEBI (Research Analyst Regulations) 2014 Motilal Oswal Securities (SEBI Reg No. INH000000412) has an agreement with Motilal Oswal capital Markets (Hong Kong) Private Limited for distribution of research report in Hong Kong. This report is intended for distribution only to “Professional Investors” as defined in Part I of Schedule 1 to SFO. Any investment or investment activity to which this document relates is only available to professional investor and will be engaged only with professional investors.” Nothing here is an offer or solicitation of these securities, products and services in any jurisdiction where their offer or sale is not qualified or exempt from registration. The Indian Analyst(s) who compile this report is/are not located in Hong Kong & are not conducting Research Analysis in Hong Kong. For U.S. Motilal Oswal Financial Services Limited (MOFSL) is not a registered broker - dealer under the U.S. Securities Exchange Act of 1934, as amended (the"1934 act") and under applicable state laws in the United States. In addition MOFSL is not a registered investment adviser under the U.S. Investment Advisers Act of 1940, as amended (the "Advisers Act" and together with the 1934 Act, the "Acts), and under applicable state laws in the United States. Accordingly, in the absence of specific exemption under the Acts, any brokerage and investment services provided by MOFSL , including the products and services described herein are not available to or intended for U.S. persons. This report is intended for distribution only to "Major Institutional Investors" as defined by Rule 15a-6(b)(4) of the Exchange Act and interpretations thereof by SEC (henceforth referred to as "major institutional investors"). This document must not be acted on or relied on by persons who are not major institutional investors. Any investment or investment activity to which this document relates is only available to major institutional investors and will be engaged in only with major institutional investors. In reliance on the exemption from registration provided by Rule 15a-6 of the U.S. Securities Exchange Act of 1934, as amended (the "Exchange Act") and interpretations thereof by the U.S. Securities and Exchange Commission ("SEC") in order to conduct business with Institutional Investors based in the U.S., MOFSL has entered into a chaperoning agreement with a U.S. registered broker-dealer, Motilal Oswal Securities International Private Limited. ("MOSIPL"). Any business interaction pursuant to this report will have to be executed within the provisions of this chaperoning agreement. The Research Analysts contributing to the report may not be registered /qualified as research analyst with FINRA. Such research analyst may not be associated persons of the U.S. registered broker-dealer, MOSIPL, and therefore, may not be subject to NASD rule 2711 and NYSE Rule 472 restrictions on communication with a subject company, public appearances and trading securities held by a research analyst account. For Singapore In Singapore, this report is being distributed by Motilal Oswal Capital Markets Singapore Pte Ltd (“MOCMSPL”) (Co.Reg. NO. 201129401Z) which is a holder of a capital markets services license and an exempt financial adviser in Singapore.As per the approved agreement under Paragraph 9 of Third Schedule of Securities and Futures Act (CAP 289) and Paragraph 11 of First Schedule of Financial Advisors Act (CAP 110) provided to MOCMSPL by Monetary Authority of Singapore. Persons in Singapore should contact MOCMSPL in respect of any matter arising from, or in connection with this report/publication/communication. This report is distributed solely to persons who qualify as “Institutional Investors”, of which some of whom may consist of "accredited" institutional investors as defined in section 4A(1) of the Securities and Futures Act, Chapter 289 of Singapore (“the SFA”). Accordingly, if a Singapore person is not or ceases to be such an institutional investor, such Singapore Person must immediately discontinue any use of this Report and inform MOCMSPL. Specific Disclosures 1 MOFSL, Research Analyst and/or his relatives does not have financial interest in the subject company, as they do not have equity holdings in the subject company. 2 MOFSL, Research Analyst and/or his relatives do not have actual/beneficial ownership of 1% or more securities in the subject company 3 MOFSL, Research Analyst and/or his relatives have not received compensation/other benefits from the subject company in the past 12 months 4 MOFSL, Research Analyst and/or his relatives do not have material conflict of interest in the subject company at the time of publication of research report 5 Research Analyst has not served as director/officer/employee in the subject company 6 MOFSL has not acted as a manager or co-manager of public offering of securities of the subject company in past 12 months 7 MOFSL has not received compensation for investment banking/ merchant banking/brokerage services from the subject company in the past 12 months 8 MOFSL has not received compensation for other than investment banking/merchant banking/brokerage services from the subject company in the past 12 months 9 MOFSL has not received any compensation or other benefits from third party in connection with the research report 10 MOFSL has not engaged in market making activity for the subject company ******************************************************************************************************************************** The associates of MOFSL may have: - financial interest in the subject company - actual/beneficial ownership of 1% or more securities in the subject company - received compensation/other benefits from the subject company in the past 12 months

January 2021 93 Thematic: Housing Finance

- other potential conflict of interests with respect to any recommendation and other related information and opinions.; however the same shall have no bearing whatsoever on the specific recommendations made by the analyst(s), as the recommendations made by the analyst(s) are completely independent of the views of the associates of MOFSL even though there might exist an inherent conflict of interest in some of the stocks mentioned in the research report. - acted as a manager or co-manager of public offering of securities of the subject company in past 12 months - be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as a market maker in the financial instruments of the company(ies) discussed herein or act as an advisor or lender/borrower to such company(ies) - received compensation from the subject company in the past 12 months for investment banking / merchant banking / brokerage services or from other than said services.

The associates of MOFSL has not received any compensation or other benefits from third party in connection with the research report Above disclosures include beneficial holdings lying in demat account of MOFSL which are opened for proprietary investments only. While calculating beneficial holdings, It does not consider demat accounts which are opened in name of MOFSL for other purposes (i.e holding client securities, collaterals, error trades etc.). MOFSL also earns DP income from clients which are not considered in above disclosures. Analyst Certification The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issues, and no part of the compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations and views expressed by research analyst(s) in this report. Terms & Conditions: This report has been prepared by MOFSL and is meant for sole use by the recipient and not for circulation. The report and information contained herein is strictly confidential and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of MOFSL. The report is based on the facts, figures and information that are considered true, correct, reliable and accurate. The intent of this report is not recommendatory in nature. The information is obtained from publicly available media or other sources believed to be reliable. Such information has not been independently verified and no guaranty, representation of warranty, express or implied, is made as to its accuracy, completeness or correctness. All such information and opinions are subject to change without notice. The report is prepared solely for informational purpose and does not constitute an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments for the clients. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. MOFSL will not treat recipients as customers by virtue of their receiving this report. Disclaimer: The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent. This report and information herein is solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgment by any recipient. Each recipient of this document should make such investigations as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult its own advisors to determine the merits and risks of such an investment. The investment discussed or views expressed may not be suitable for all investors. Certain transactions -including those involving futures, options, another derivative products as well as non-investment grade securities - involve substantial risk and are not suitable for all investors. No representation or warranty, express or implied, is made as to the accuracy, completeness or fairness of the information and opinions contained in this document. The Disclosures of Interest Statement incorporated in this document is provided solely to enhance the transparency and should not be treated as endorsement of the views expressed in the report. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alternations to this statement as may be required from time to time without any prior approval. MOFSL, its associates, their directors and the employees may from time to time, effect or have effected an own account transaction in, or deal as principal or agent in or for the securities mentioned in this document. They may perform or seek to perform investment banking or other services for, or solicit investment banking or other business from, any company referred to in this report. Each of these entities functions as a separate, distinct and independent of each other. The recipient should take this into account before interpreting the document. This report has been prepared on the basis of information that is already available in publicly accessible media or developed through analysis of MOFSL. The views expressed are those of the analyst, and the Company may or may not subscribe to all the views expressed therein. This document is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, copied, in whole or in part, for any purpose. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject MOFSL to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction. Neither the Firm, not its directors, employees, agents or representatives shall be liable for any damages whether direct or indirect, incidental, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information. The person accessing this information specifically agrees to exempt MOFSL or any of its affiliates or employees from, any and all responsibility/liability arising from such misuse and agrees not to hold MOFSL or any of its affiliates or employees responsible for any such misuse and further agrees to hold MOFSL or any of its affiliates or employees free and harmless from all losses, costs, damages, expenses that may be suffered by the person accessing this information due to any errors and delays. Registered Office Address: Motilal Oswal Tower, Rahimtullah Sayani Road, Opposite Parel ST Depot, Prabhadevi, Mumbai-400025; Tel No.: 022 71934200/ 022-71934263; Website www.motilaloswal.com.CIN no.: L67190MH2005PLC153397.Correspondence Office Address: Palm Spring Centre, 2nd Floor, Palm Court Complex, New Link Road, Malad(West), Mumbai- 400 064. Tel No: 022 7188 1000. Registration Nos.: Motilal Oswal Financial Services Limited (MOFSL)*: INZ000158836(BSE/NSE/MCX/NCDEX); CDSL and NSDL: IN-DP-16-2015; Research Analyst: INH000000412. AMFI: ARN - 146822; Investment Adviser: INA000007100; Insurance Corporate Agent: CA0579;PMS:INP000006712. Motilal Oswal Asset Management Company Ltd. (MOAMC): PMS (Registration No.: INP000000670); PMS and Mutual Funds are offered through MOAMC which is group company of MOFSL. Motilal Oswal Wealth Management Ltd. (MOWML): PMS (Registration No.: INP000004409) is offered through MOWML, which is a group company of MOFSL. Motilal Oswal Financial Services Limited is a distributor of Mutual Funds, PMS, Fixed Deposit, Bond, NCDs,Insurance Products and IPOs.Real Estate is offered through Motilal Oswal Real Estate Investment Advisors II Pvt. Ltd. which is a group company of MOFSL. Private Equity is offered through Motilal Oswal Private Equity Investment Advisors Pvt. Ltd which is a group company of MOFSL. Research & Advisory services is backed by proper research. Please read the Risk Disclosure Document prescribed by the Stock Exchanges carefully before investing. There is no assurance or guarantee of the returns. Investment in securities market is subject to market risk, read all the related documents carefully before investing. Details of Compliance Officer: Name: Neeraj Agarwal, Email ID: [email protected], Contact No.:022-71881085. * MOSL has been amalgamated with Motilal Oswal Financial Services Limited (MOFSL) w.e.f August 21, 2018 pursuant to order dated July 30, 2018 issued by Hon'ble National Company Law Tribunal, Mumbai Bench.

January 2021 94