HDB Financial: Is HDFC Bank’s ‘Mini-Me’ On The Fast Track To Growth?

In 2007, HDFC Bank Ltd., now the country’s most valuable lender by market capitalisation, had a choice to make.

The bank held a licence to start a non-banking financial services company, which it had not really used till then. The decision to make was whether that licence should be surrendered or if the bank could find a way to use it to build its network.

Faced with this question, HDFC Bank’s Chief Executive Officer Aditya Puri called for a meeting with senior leaders at the bank, said a person who was part of the team that eventually went on to launch the NBFC’s operations. The decision that emerged from that meeting was that an NBFC could complement the bank, the person quoted above said. The NBFC could do business that the bank was not allowed to do or chose not to do for some reason. But it would do it with the same strong risk-practices employed by the parent bank. It could also serve as a distribution vehicle to expand the bank’s connect with smaller borrowers.

Twelve years later, it appears that the decision paid off.

The NBFC, christened HDB Financial Services, turned in a net profit of Rs 1,153 crore for the year ended March 31, 2019, according to its annual report released this week. Profits were up 24 percent for the year. The NBFC’s loan book grew 23.5 percent to Rs 54,709 crore.

Many believe the NBFC is now ripe for a separate listing but HDFC Bank, which holds over 95 percent equity, is yet to lay down a specific timeline for the same.

HDB Financial’s CEO G Ramesan declined to comment on the story. HDFC Bank did not respond to email queries and a request for a meeting.

A Competitive Business

Over time, HDB Financial has built a diversified loan book with low default rates and a strong funding profile.

The roughly Rs 54,700 crore in loans is spread across three major segments — consumer loans, enterprise loans and asset finance, the company said in its annual report.

Asset financing, which includes commercial vehicle, commercial equipment and tractor loans, made up 41 percent of the company’s loan book in the last financial year, a report by Bernstein analysts Gautam Chhugani, Gaurav Jangale and Monika Aggarwal said on Monday. HDB Financial has been growing the asset finance book by 50-60 percent year-on-year to build a more diversified loan book, the report said.

The loans-against-property segment was the second-highest contributor to HDB Financial’s total loan book at 34 percent. Owing to a recent spike in delinquencies, the NBFC has been growing its loan-against-property book slower than the rest of the book, the Bernstein analysts said.

Unsecured business loans and other secured loans make up the rest of the book.

The overall quality of the loan book remaining strong, with more than Rs 41,000 crore worth loans backed by mortgage or other assets, Bernstein said.

Each of these segments is intensely competitive.

In the asset finance segment, HDB Financial competes with companies like Shriram Transport Finance Corp. Ltd. and Cholamandalam Investment and Finance Co. Ltd., which have larger loan books of over Rs 1 lakh crore each. In the consumer finance business, HDB Financial goes head-to-head with the likes of Bajaj Finance Ltd., which reported Rs 1.16 lakh crore in assets under management as of March 2019.

Not only do its competitors have lead in terms of loan book size, but they are also operating with higher net interest margins.

HDB Financial had a net interest margin of 6.8 percent in FY19, according to the Bernstein report. In contrast, Bajaj Finance had a margin of close to 12 percent and Shriram Transport Finance had a margin of about 7.4 percent. To be sure, the loan mix of these firms is not strictly comparable.

HDB Financial had a net bad loan ratio of 1.26 percent at the end of FY19, higher than the 0.6 percent reported by Bajaj Finance. It was, however, lower than the 2.8 percent reported by Shriram Transport Finance.

Still, the growth and diversification of HDB Financial has attracted investors even before the company is listed, said Sidharth Purohit, research analyst, SMC Global Securities.

“They are likely to continue this pace of growth for a few more years till they hit a critical loan book size. There is considerable investor interest in the company, even though it is unlisted,” Purohit told BloombergQuint.

Apart from lending, HDB Financial has also built fee-based businesses, where it sells mutual funds and insurance products of the HDFC Group. It runs 15 call centres, which act as HDFC Bank’s primary loan recovery cells across 750 locations.

The Hunt For Capital

HDB Financial has a strong funding profile, thanks to its parentage. The company holds AAA ratings from CARE Ratings and Crisil Ltd., it said in its annual report.

Market borrowings contributed 63 percent of the company’s liabilities in FY18 compared with 41 percent in FY14. This meant that HDB Financial was not spared the blushes when the NBFC crisis hit and the company saw its cost of funds rise. This prompted it to shift back to bank lending, which made up 40 percent of liabilities at the end of FY19.

HDB Financial may also need to raise equity capital soon.

It’s capital adequacy ratio stands at around 18 percent at the end of the last financial year, which is above the 15 percent regulatory minimum. Bernstein analysts said the company might need to raise more capital in the near term if it wants to continue to grow its loan book by over 20 percent.

This possibly near-term need for capital is only one reason that speculation of HDB Financial’s listing has picked up.

The other reason is the impending retirement of HDFC Bank’s Puri in 2020. According to the former HDFC Bank official quoted above, Puri has been keen to see the business listed before he steps down from the bank.

Based on FY20 growth estimates, HDB Financial would account for 6 percent of HDFC Bank’s $91 billion market capitalisation, which works out to a valuation of about $5.5 billion.

According to Harshvardhan Roongta, principal financial planner at Roongta Securities, the HDB Financial stock has seen considerable trading in the grey market already because of comparisons with listed subsidiaries of other banks.

“Investors have had a great experience in the past when trading in unlisted securities of ICICI Prudential and ICICI Lombard, before these companies were listed,” said Roongta. He said they stopped trading in unlisted securities of HDB Financials as they appeared expensive.