Net interest Margin, Leverage and Capital Adequacy Ratio

Net interest Margin is one of the major parameters used in assessing the performance of a finance company

NIM = Net Interest Income / Asset(i)

= (Interest Income – Interest Expense)/Asset

= (Lending Rate X Asset – Borrowing Rate X Debt)/Asset First Formula

= Lending Rate – (Borrowing Rate X (Debt/Asset)) Second Formula

=Lending Rate -(Borrowing Rate X(Debt/Equity X Equity/Asset)

=Lending Rate -(Borrowing Rate X Leverage X Capital Adequacy Ratio) Expanded Formula

(i)  Please note that Assets here are the loans made by the finance company and not other assets.

How to Value the stock price of a Housing Finance NBFC

The HFCS in India catering only to sub prime housing loans must be valued at and only at the future growth prospects of its earnings, provided they have similar ROE/ ROA and NPA levels compared to their peers

When we value the price of a company's share, in the stock market, the parameters that comes to mind are P/E, P/B. ROE, ROA etc

So how do we value a finance company that primarily deals with housing loans catering to subprime category in India.

The subprime housing loan sector is one of the fastest growing in India. In India, unlike in most developed countries, people usually live in their mortgaged property rather than treating the property a trade commodity. As people do not like to lose their home in which they live, they tend to not to default on their loans. Therefore, the NPA for housing finance companies dealing with sub prime mortgage lending is much lower, when compared to other finance companies.

A typical sub prime mortgage HFC, has an average LTV ( loan to value ) of 70%. Thus the customers are required to put up 30% of the consideration as down payment. This also forces them to treat the loan seriously, unlike what happened in the US sub prime mortgage crisis, where more LTV reached more than 100% at one point.

According to estimates only 15% of the population in India are salaried, 35% non salaried, and rest 50% wage earners. Thus the HFCs which have 50% non salaried customers have a huge untapped market.  This lets them grow their loan book at a rate of more than 20%. Their ROE/ROA is also much higher than other Finance Companies.

Since their earnings also grow rapidly, and have a future predictable growth in earnings, the HFCs are typically values based on their P/E than the P/B multiple.

Normally a finance institution is value based on its P/B ie Price to Book value of Equity. But in case of HFCs, the P?B multiples typically are quite higher.

Why?

Let us examine the ROE

ROE=Earnings/ Book value of Equity

P/E = Price / Earnings

So ROE X PE = Price/ Book value of Equity

So P/B=P/E X ROE

Now we can see that, assuming ROE to be constant, P/B will only depend on P/E which in turn depends on the prospects of future earnings. Since the HFCs PE multiples are valued similar to FMCG companies due to their predictable future earnings growth, PE tends to be very high when compared to other finance companies. 

Another way to value an HFC is Market Cap/ AUM multip

AUM is assets under management

So MCap/ AUM = Price per Assets ( Here other assets are considered insignificant )

= P/A

=P/E X E/A

=P/E X ROA

So again we come to P/E multiple if we consider similar ROA companies.