HDFC Bank Unit HDB Financial Looks To Shake Off Covid After Effects Ahead Of Value Unlocking
HDB Financial Services Ltd., the non-bank lending arm of India's largest private bank HDFC Bank Ltd., expects to see asset quality troubles ease in the July-September quarter as the brutal second wave of the Covid crisis abates.
The wave, which hit was at its peak in April and May, nearly doubled bad loans on the lender's books. As of June 30, HDB Financial reported a gross NPA ratio of 7.75%, a significant jump from 3.9% reported in March 2021 and 3.5% as of March 2020.
In an interview with BloombergQuint, G Ramesh, managing director and chief executive officer, HDB Financial said the sharp rise in stress in the April-June quarter this year was largely due to two reasons. First, the company's employees were unable to meet borrowers in person due to lockdowns across various states in India. This impacted collection efficiency.
The second reason, according to Ramesh, was that borrowers sought more time to tide over medical emergencies and business disruption.
"Wave one was much slower, in the sense that it peaked only around September last year. But wave two came up in April and peaked by May.
Set up in 2007 as a subsidiary of HDFC Bank, HDB Financial lends in segments where its parent doesn't. After a strong run for over a decade, the lender hit uneven ground just before the Covid crisis hit.
In March 2019, the lender had gross bad loans of 1.8%, which rose to 3.5% by March 2020. This, as the company slowed growth significantly. In FY20, the assets under management for HDB Financial rose 6% year-on-year to Rs 58,833 crore, as compared with a 25% growth in the book in FY19.
The Covid crisis added to these troubles as growth stalled and stress rose.
Apart from the recognised bad loans, HDB Financial has restructured loans worth Rs 5,321 crore as of FY21-end, according to the company's annual report. In the April-June quarter, the company did not restructure any new loans, Ramesh said.
The company is now engaging with customers to see where restructuring is needed and where collection efforts can help stabilise the situation.
We have extensive collection capabilities. But we did believe that the last two quarters was not the time to engage beyond what we have done. We are quite confident that things will get better from here.G Ramesh, MD & CEO, HDB Financial
Is There An Underwriting Issue?
Coming from the HDFC stable — a group that prides itself on stable and predictable asset quality — the rise in bad loans at HDB Financial raised eyebrows.
HDB Financial lends to customers who are a couple of notches below what HDFC Bank services. The bank's tougher risk standards do not allow it to go below the mass affluent segment of borrowers.
Is the non-bank lender then taking on the risk that the bank is not willing to? Ramesh does not see it that way.
"The couple of notches lower that we are talking about is in terms of demographics and not credit behaviour. In terms of credit behaviour we are talking to customers who are credit worthy but under-banked," he said.
The non-bank lender does not target sub-prime customers, or those with bad credit history, but does chase new-to-credit borrowers. "These customers are not the kind which have never borrowed money, but have very limited exposure to formal credit from institutions," Ramesh said.
While the lending business is spread across 1,000 locations for HDB Financial, its underwriting remains largely centralised.
To enable this, the company uses internal scorecards, which can be used by their employees to consider a loan application.
According to Ramesh, HDB Financial develops scorecards which are highly customised to the regions the company operates in and the reason for the borrowing. "So your scorecard will be different when buying a car, than when you are buying a television, because consumer behaviour is different across product categories," he said.
The lender's book is currently split between three major business segments, Ramesh said.
Small and medium enterprise lending is about half of the book, where the company lends to small manufacturing units. Under the asset financing business, which is at about 35% of the loan book, HDB Financial lends for commercial vehicle, commercial equipment purchase and loans against property.
The consumer finance business, which has grown to about 15% of the book in the last four years, gives out loans for two-wheelers, four-wheelers, gold loans, consumer durables and other unsecured credit, Ramesh said.
Going ahead, HDB Financial will look at introducing new products in these lending segments and enter new segments too.
"We want the customer to continue to come to us as their needs grow. We do not want a situation where we help the borrower grow with initial financing and then they go to others because we don't lend under a specific product," Ramesh said.
Between the customer selection and the segments they operate in, Ramesh believes the business is sustainable as the addressable market is large.
Our projection is that the addressable market (for the segments HDB Financial operates in) should reach about 150 million households by 2025. We have only reached about 10 million borrowers now. There is a long growth path we can see for the company in the next few years.G Ramesh, MD & CEO, HDB Financial
How Large Can HDB Financial Get?
HDB Financial's loan book of Rs 57,390 crore as of June 30, is at about 5% of HDFC Bank's total advances of Rs 11.47 lakh crore.
How large does the bank want the NBFC to grow?
There is no particular target (for size of HDB Financial)... they have been around this Rs 60,000 crore size for a while. We feel Rs 50,000-70,000 crore is a comfortable size to work on.Srinivasan Vaidyanathan, Chief Financial Officer, HDFC Bank
Ramesh sees the 20% annual loan book growth, which the company maintained before the Covid-19 pandemic, as ideal. But it is not necessary that all of those loans will continue on HDB Financial's balancesheet, he explains.
"We will take a call, depending on the debt we carry, to sell down some of these loans to others. We do currently sell down loans under securitisation transactions, where we service the loans but they are on someone else's books. Going forward we will work on a different strategy (for securitisation)," Ramesh said.
In FY21, HDB Financial sold loans worth Rs 473 crore under securitisation, where HDFC Bank bought Rs 379 crore, according to the latest annual report. The NBFC is required to report any related party transactions with its parent.
At its last annual general meeting held on June 25, the company got shareholder approvals to conduct securitisation transactions worth Rs 7,500 crore with HDFC Bank in the current year. In the future too, the company will continue to enter into such transactions with HDFC Bank and others, depending on the price it gets, Ramesh said.
The Value Unlocking Question
For awhile now, speculation over unlocking of value from HDB Financial has persisted.
While an IPO was anticipated, HDFC Bank CEO Sashidhar Jagdishan at the lender's AGM said that the lender may first bring in an outside investor for price discovery.
According to two people with direct knowledge of the matter, who spoke on conditions of anonymity, the bank may look to bring in domestic and international investors to help establish the value of HDB Financial. The bank will likely wait for HDB Financial's asset quality concerns to abate, as the second wave of the Covid-19 pandemic wanes, the people said.
Presently, HDB Financial shares trade in the unlisted market at a price of around Rs 885 per share, lower than its peak of Rs 970 per share last year, according to Manan Doshi, founder, Unlisted Arena.
At current prices, HDB Financial is valued at around Rs 70,000 crore. The prices have dropped as some investors clearly have concerns about the asset quality problems of the company. But it is still one of the most actively traded stocks, with investors looking to buy the dip and hold on to it till the company recovers.Manan Doshi, Co-Founder, Unlisted Arena
Could price discovery in HDB Financial also help HDFC Bank's own sum-of-parts valuation of Rs 8.4 lakh crore move higher? As of March 31, HDFC Bank owned 95.11% stake in the company, with the remaining shares split among employees and others.
Siddharth Purohit, analyst at SMC Global Securities says any re-rating for HDFC Bank will likely be driven by its own business trajectory rather than that of HDB Financial.
"While HDB Financial will surely help, a rerating wont happen till they are allowed to start issuing credit cards again and the asset quality headwinds abate," Purohit said.
Agrees Gautam Chhugani of Bernstein Research.
"For HDFC Bank valuation to improve, core bank retail and digital execution needs to fire again. HDB Financial's price discovery is not the magic formula. The core needs to build momentum again on the back of solid digital fundamentals," Chhugani said.