Why are smaller housing finance companies under a lot of pressure in the last few weeks?

Ever since the RBI turned the stance hawkish with rate hikes, the housing finance companies are under pressure. How steep has the hawkishness of the RBI been? For instance, RBI hiked the rates by 40 basis points in its May 2022 policy and again hiked by another 50 basis points in the June 2022 monetary policy. That adds up to 90 bps between May and June plus a 50 basis points hike in the cash reserve ratio (CRR). That kind of hawkishness was inevitable with the inflation consistently above 7% mark.

One consequence of this hawkishness has been the spike in the bond yields, which have shot up to above the 7.4% mark. That has clearly transmitted and translated into higher lending rates. If you look at the structure of the housing finance market in India, there are the banks and then there are the NBFCs like HDFC, LIC Housing Finance, GIC Housing Finance, Can Fin Homes and PNB Home Finance. In the last few weeks, the negative on the smaller NBFCs in the housing finance space has been a lot sharper. Why is that?

Just check the numbers. In the last 2 months, the Nifty has shed 9% but smaller NBFCs into housing finance shed 35% to 40%. One reason is that they are considered the most vulnerable to business contraction due to higher lending rates. In addition, higher inflation is also putting pressure on the finances of the borrowers. All this is likely to have a trickle down impact on the volumes of smaller HFCs and also their net interest margins. But there is a larger reason why the bigger banks and NBFCs are immune to this risk.

Banks have relatively lower cost of funds while the larger HFCs possess balance sheet strength. They can handle higher rates by either partially absorbing the increased interest costs or even passing on some of the hikes, without losing their business. Bigger NBFC names like HDFC and LIC Housing have pricing power which smaller HFCs don’t. Larger housing finance companies also have protected margins due to floating rate assets and fixed rate liabilities. It may not be alarming but could worsen if RBI gets more hawkish.

Actually, the HFCs that cater to the price-sensitive affordable housing segment, would be the most vulnerable. Here, margin erosion is inevitable since this space is crowded and very competitive. The cost of shifting from one lender to another lender is not much. The moral of the story is that the affordable housing lenders may be at risk of compression of margins, lower revenues and also higher NPAs in the medium term. While the lenders would gain from the credit recovery, higher rates would offset some of these gains.