India’s home loan market is seeing intense competition with banks and non-bank financial companies vying for a slice of the most secure credit segment. This, along with the benign interest rate regime, are beginning to put pressure on spreads that housing finance companies (HFC) earn.
According to analysts at Nomura Financial Advisory and Securities India Ltd, incremental spreads of HFCs have narrowed sharply to 125 basis points in the past two months. This compares with a spread of around 200 basis points in the second half of 2020. One basis point is one-hundredth of a percentage point.
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Much of this can be attributed to the rise in bond yields, which has made it expensive for home loan lenders to borrow. Ergo, with the increase in the cost of borrowing, spreads have narrowed. Sovereign bond yields have surged nearly 50 bps since January and the effect is visible on corporate bonds as well. Government bond yields are unlikely to cool off in the coming months. The Reserve Bank of India (RBI) has also indicated it would progressively normalize liquidity.
In other words, the liquidity surplus would reduce. That means less funds available for investment in corporate bonds. HFCs are large borrowers across tenures in the corporate bond market.
Another factor has been the benign interest rate regime. Incremental home loans are priced at a spread over the repo rate, which has been reduced by 115 bps in the past one year.
Even on loans that are still priced under the marginal cost of funds lending rate (MCLR), the rates have been slashed. Big banks such as State Bank of India (SBI) have announced cuts in home loan rates. They have essentially narrowed the spread over the repo rate for this category of loans.
“While we think this decrease in rates is just transitory and more likely to be a year-end phenomenon especially as stamp duty cut benefit ends in March 2021, we think incremental spreads now compressing to just 125 bps requires close monitoring," said a Nomura note.
The reason behind banks cutting interest rates is that home loans are the safest category of loans. Amid a general slowdown in retail credit growth, banks are targeting home loan growth. Further, special sops on stamp duty by states and other benefits by the central government have helped increase home sales. This augurs well for growth in home loans. Competition is intensifying in the sector and this too would put pressure on pricing.
Larger HFCs would weather this transitory pressure on spreads better than smaller players, analysts said. Shares of housing finance companies have shown a divergent trend so far this year. The largest player Housing Development Finance Corp. Ltd’s shares have hardly moved, while those of LIC Housing Finance Ltd and Indiabulls Housing Finance Ltd have surged by 20% and 11% respectively. As pressure on spreads increases, valuations may come under scrutiny.
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