The Indian financial sector is undergoing a significant transformation, with the affordable housing finance segment emerging as a powerful driver of future growth and value creation. With rising incomes, rapid urbanization, and notably low mortgage penetration, India is set to witness a secular scale-up in mortgage credit, presenting a colossal opportunity for specialized lenders.

A Sleeping Giant Awakens: The Mortgage Opportunity

For the past decade, India’s retail credit growth has been primarily fueled by expanding formal financing access to a vast consumer base, adding over 200 million new borrowers. However, with approximately 60% of the labor force now having access to credit, the next phase of growth is expected to stem from increasing credit per borrower, with mortgages leading the charge. India’s current mortgage penetration, at around 11% of GDP, remains significantly below that of China (~30%) and developed markets (>50%). This substantial gap underscores a tremendous untapped potential, projected to drive a USD 1.5 trillion mortgage opportunity by FY35E.

Within this vast landscape, affordable mortgages, defined by a ticket size of less than USD 30,000 (or INR 2.5 million currently), are anticipated to consistently account for approximately one-third of the total mortgage market. This translates into an estimated USD 500 billion (or INR 50 trillion) lending opportunity by FY35E within the affordable segment alone. This segment is particularly appealing due to its robust growth prospects and healthy profitability, often exceeding a Return on Assets (RoA) of 3%.

Affordable Housing Finance Companies (AHFCs): The Differentiated Model

Specialized non-bank lenders, including Non-Banking Financial Companies (NBFCs) and Housing Finance Companies (HFCs), are uniquely positioned to spearhead mortgage penetration into India’s mass market segments. These Affordable Housing Finance Companies (AHFCs) cater specifically to low-income and informally employed borrowers, necessitating a differentiated and operationally intensive business model. The operational intensity is evident in the much lower Assets Under Management (AUM) per employee compared to prime lenders; for example, Aavas Financiers requires approximately 55 times more employees per INR billion AUM than ex-HDFC Limited. This higher operational expenditure (opex to assets ratio is ~5x that of prime mortgage businesses) often renders this segment less attractive for large banks. Indeed, banks have historically shown much slower growth in the sub-INR 2.5 million mortgage segment.

Despite the higher operational costs, AHFCs maintain healthy economics through significantly higher loan yields, which effectively compensate for their increased expenses. Furthermore, their asset quality has proven resilient even during recent credit cycles, including the Covid crisis, with stable credit costs and sustained healthy RoAs. The risk of balance transfers (customers switching lenders) is also contained, as the typical cost of funds differential (~60 basis points) between AHFCs and larger HFCs/NBFCs is often not significant enough to incentivize borrowers to undergo the switching process.

Leading the Charge: Preferred Picks and Their Strengths

Bernstein’s analysis initiates coverage with a constructive view on AHFCs, assigning “Outperform” ratings to HomeFirst Finance, Aptus Value Home Finance, and Aadhar Housing Finance.

• HomeFirst Finance (HFF) is designated as the top pick, primarily for its demonstrated ability to consistently replicate its operating model successfully across multiple states. Its smaller size, faster growth, superior productivity metrics, and greater flexibility to sustain profitability further bolster its appeal. HomeFirst’s centralized credit underwriting and integrated relationship manager model contribute to its efficiency and effectiveness.
  
• Aptus Value Housing Finance (Aptus) is well-positioned for a falling interest rate environment due to its higher proportion of fixed-rate loans and its engagement in small business lending. Its concentration in four southern states, while limiting geographic diversification, provides it with higher yields, partly due to its focus on deeper geographies.
  
• Aadhar Housing Finance (Aadhar) serves as a robust proxy for the affordable housing sector. As the largest and most geographically diversified player, it is expected to maintain a steady Asset Under Management (AUM) Compound Annual Growth Rate (CAGR) of approximately 20%. Its larger size also contributes to a lower cost of borrowings compared to its peers.

The Differentiating Factor: Replicability of Operating Model

The ability to replicate a successful operating model across multiple states is identified as the single most critical success factor for AHFCs. HomeFirst Finance exemplifies this strength, demonstrating remarkably similar branch productivity across all the states it has entered, with consistent improvements even in newer locations. This contrasts with some peers who struggle to scale their models effectively beyond core regions.

Other factors influencing growth and profitability include loan yields, which are driven by the mix of housing vs. non-housing loans (e.g., higher yields for Loan Against Property – LAP), average ticket size (lower ticket sizes often command higher rates due to higher servicing costs), and customer segments (e.g., self-employed or informal income customers may be charged higher yields). Cost of borrowings also plays a role, with HFCs often enjoying a lower cost of funds than similarly sized NBFCs due to access to National Housing Bank (NHB) funding and demand from banks for priority sector lending (PSL) friendly portfolios. Operational expenses (Opex) are influenced by sourcing strategies (in-house vs. Direct Selling Agents – DSAs), organizational structure, and the pace of branch and employee expansion.

Areas of Concern: The Laggards

Not all players in the segment are positioned equally for success. Aavas Financiers lags its peers in terms of yield and profitability, having experienced a sharp slowdown in growth and exhibiting inconsistent outcomes in its geographic expansion efforts. It also faces sustained competition from AU Small Finance Bank, its former parent, with which it shares significant geographic overlap.

PNB Housing Finance (PNBHF), while strategically pivoting towards smaller-ticket mortgage loans, raises concerns due to its aggressive pace of expansion, high reliance on balance transfer-ins, and substantial use of Direct Selling Agent (DSA) channels. Its affordable segment loan yields are notably lower than peers, suggesting an aggressive pricing strategy despite having a similar cost of borrowing.

Future Growth Trajectory and Long-term Value

The outlook for India’s housing finance industry remains overwhelmingly positive. Mortgage to GDP ratio is expected to steadily increase by approximately 6 percentage points, reaching ~16.5% by FY35E, driven by an estimated 15% CAGR in mortgages over the next decade. This growth signifies a pivotal shift towards increasing credit per consumer, fueled by large-ticket products like mortgages, moving India further along the “credit per borrower” axis.

The Indian banking sector as a whole is poised for continued growth, with credit growth projected to outpace GDP growth, supported by the nation’s still-low credit-to-GDP ratio compared to global peers. AHFCs, with their tailored and operationally intensive models, are uniquely positioned to drive financial inclusion by catering to the underserved population, proving that meeting societal needs can align with delivering healthy financial returns.

However, potential risks include increased competitive intensity from banks and other lenders, which could lead to reduced spreads and higher portfolio attrition rates (Balance Transfer Outs). A significant increase in attrition, for instance, a 5 percentage point rise, could impact Earnings Per Share (EPS) by approximately 12% over a ten-year period. A general decline in economic activity could also impact borrower incomes and credit quality. For Aptus, regulatory actions limiting loan pricing or increased competition in its core markets pose risks to its higher yields. For PNBHF, aggressive lending practices in its new segments could lead to higher credit costs.

In summary, despite potential headwinds, the Indian housing finance industry, particularly the affordable segment, is on a secured growth path. With a massive addressable market, evolving consumption patterns favoring larger loans, and specialized lenders adept at navigating its unique challenges, the sector is well-positioned for substantial long-term value creation, playing a crucial role in India’s broader financial and economic development.

(Note: This information is for educational purposes only and does not constitute investment advice. We hold the mentioned stocks, but we neither recommend nor solicit their purchase or sale.)

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