Sreeraman runs a road-side eatery in Madurai and earns ₹40,000 a month. He has grown into this career from a day job because he wanted to be a self-employed microentrepreneur. As he progressed in his life, he got married to Mahalakshmi and wanted to settle in Madurai by constructing an 800 square-foot. house for his family worth ₹20 lakh. He tried applying for a loan at public and private sector banks but faced tough luck as most of them rejected him due to his lack of a clear source of income. Finally, in a conversation over tea, he heard from one of his friends about a housing finance company that could offer him a ₹10 lakh loan. Sreeraman walks into the branch and gets his loan sanctioned in a week’s time, finally being able to make his dream come true.
Sreeraman is among the 10 crore households in India facing a housing shortage (according to the RBI report), primarily due to inadequate last-mile credit availability in peri-urban and rural areas. This situation arises because banks and large NBFCs have their primary focus on the top end of the spectrum: prime and middle-income groups with relatively higher ticket sizes, where the ability to underwrite is comparatively simpler. They have their shops in urban and Tier 1 cities where the sheer volume of business justifies their business presence and the kind of risk appetite that they have.
There have been strong tailwinds driving the demand for housing finance. The demand for housing finance has been steadily growing, at a 15% CAGR over the last decade, to an estimated ₹30 lakh crore. Out of these, the affordable category contributes 30% of the value, and over 70% of disbursement volumes. As per the market definition, affordable housing loans are those with ticket sizes up to ₹35 lakh for individuals in metros and up to ₹25 lakh for individuals in other places. Although the existing market in itself looks large, we believe that there is a huge white space being driven by the demand and aspirations of the middle class as well as the lower penetration of housing finance in certain customer segments. Our internal estimates indicate that this market can potentially grow to ~50 lakh crore in the next 10 years (5x growth) on the back of strong macros.
This space spans various customer personas: there are prime customers (>₹8 lakh annual income with formal income source and salaried customers), middle and low-income salaried employees (₹2-8 lakh), self-employed with formal income sources, cash salaried, and self-employed with variable and informal income. Considering the nature of the income source and the variability, these are in increasing order of risk/ease of underwriting. Beyond the formal salaried segment, especially in urban/Tier I markets, the underwriting of the customers involves subjective assessments as well as a strong on-ground operating model and an understanding of the local geographical nuances. Considering ticket sizes are also lower in Tier 2+ markets, banks and large NBFCs have stayed away from this segment. Over the last 10 years, we have seen different players demonstrating good traction in the affordable self-employed space with strong operating models, and scaled players delivering 30%+ growth with strong ROAs [>3% and <1% credit costs].
In the last 2 years, banks have been ceding market share to HFCs in the affordable category. HFCs have expanded their share to 35% in the <₹15 lakh and 25% in the ₹15-25 lakh category. With banks focusing on the highly competitive prime customer segment and leveraging their cost of capital advantage, HFCs have grown well in the affordable segment with niche operating models. HFCs focused on the affordable housing segment grew the fastest at a 25% CAGR in the last 5 years.
Going forward, we believe that banks and large NBFCs will continue to focus on the prime segment, where there is sufficient growth and which is also highly competitive. In this segment, the lower cost of funding proves to be a competitive advantage. Considering the operational nuances and lower ticket sizes in servicing the self-employed customer segments, this would not be a significant area of focus for them. Having said that, given the easier availability of capital, they would have shops in urban locations where they have exposure to the self-employed segment.
Prevailing market structures also make this space interesting, and one may ask why. This is because this product primarily operates on a branch-based model (hub and spoke), given subjective underwriting assessments (cashflows and property assessments) and heavy documentation procedures. Underwriting has three layers to it, which are: 1) Property – which includes valuation, title, locality, etc., 2) customer cashflows and ability to payback. Considering the operationally intensive nature of operations, economics comes from contiguous expansion adopted to bring in effective supervisory layers. Hence, we believe that this will be a regional play, and with significant whitespace available in the space, every region will have 4-5 players.
Now on understanding the market size and dynamics, we next look at unit economics. The main levers for driving profitability are as follows: (in italics, we present our view on what we look at from an investment standpoint).
- Interest yield and the right mix of housing and LAP products to maintain the topline. [Having an exposure of 20% LAP becomes important to push the yields up]
- Operational expenditure levels are high considering this business is operationally intensive one. Cost/income ranges from 20% to 80%. [Drive the efficiencies of feet of street (FOS), build supervisory layers, use technology as a workflow enabler, and drive productivity of FOS, while maintaining the attrition lower than the market – these variables help maintain an efficient opex of 40-50% of the income.]
- Ability to Leverage: Can the management build a great liability franchise and take it to 3x-4x at a mature state? Historically, there has been limited evidence of companies in this space without group backing or levering beyond 3x [Build a strong liability franchise by showcasing good growth metrics, profitability, GNPA, NNPA, etc.,] .
From analysing the landscape and mapping the opportunity, we think that new players can emerge in the low-income salaried category and expand till self-employed with no-income proof category in the self-construction segment. Companies like Aptus, Vastu, and Home First have demonstrated that a housing finance company (HFC) can successfully achieve a scale of ₹10,000 crore in 10 years. This space can be tapped with a physical distribution model and deliver attractive metrics of 3 to 4% ROAs and 15 to 16%. We at TVS Capital Funds do branch visits to build our thesis in the space, as we meet microentrepreneurs like Sreeraman who are aspirational to build a house for family, expand their business to send their children to good schools, improve offerings in their shops, and what not. We continue to actively look into opportunities in this space.