Housing Development Finance Corporation Ltd. - (Amalgamated) - Stock Valuation and Financial Performance

HDFC Ltd | Market Cap: 393,290 Cr

CMP 2,170 | P/B 2.1x FY23 (Housing Fin.)

Results: HDFC Ltd reported net interest income decreased 14% year on year for Q4FY22. Operating income before provisions grew sluggish 8% year on year and overall AUM growth was 14%.

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Key highlights:

• Loan book grew 14% year on year and Individual disbursement growth was 37% for FY22. ~76% of the loan book is individual loans.
• The growth was seen across affordable housing. ATS for EWS and LIG segment stood at Rs 11.2 lakhs and Rs 19.7 lakhs.
• GNPA declined to 1.91% (vs 1.98% in Q4FY21). Credit cost during the quarter reduced by 0.29% (annualised). Credit cost is expected to come down, which should improve the ROEs.
• Total provisioning for the year declined 44% and stood at Rs. 13,500 Cr.
• In Q4FY22, there was an uptick in interest rates, consequent to which corporation increased deposit rates as well as rates on non-individual loan products.
• Loans restructured under the RBI’s Resolution Framework for COVID-19 Related Stress was equivalent to 0.80% of the loan book. Of the loans restructured, 98% are individual loans and 2% are non-individual loans.
• Certain aspects of the merger were clarified i.e. HDFC Ltd’s non-individual loans, borrowings and deposits would form part of the merged balance sheet.

Management Outlook: Management highlighted that Q4FY22 saw pick up in non-individual loans as well. Healthy pipeline in construction finance segment and lease rental discounting and the trend is expected to continue. Average collection efficiency in individual loan segment in cumulative basis for Q4 was over 99%. Current liquidity is higher than requirement and management believes there won’t be further need to build up liquidity.

Management also clarified that construction finance would form a part of the merged balance sheet and the bank would continue to operate in these segments. Similarly, HDFC Ltd.’s borrowings and deposits would be carried forward to the bank balance sheet at their funding cost. These liabilities would be replaced as and when they would mature. In terms of synergies, HDFC Bank currently sources 28% of new loans for HDFC Ltd. and post the merger, all bank branches would source home loans which could drive strong home loan growth for the bank.

Event: HDFC Bank and HDFC Ltd. announced that they have received board approval for amalgamation of HDFC Ltd. with HDFC Bank. Shareholders of HDFC Ltd. will get 42 shares of HDFC Bank for 25 shares of HDFC Ltd. The record date is yet to be announced and the transaction is expected to be completed within ~18 months.

The equity shares held by HDFC Ltd in HDFC Bank will be extinguished as per the scheme. And upon the scheme becoming effective, HDFC Bank will be 100% owned by public shareholders and existing shareholders of HDFC Ltd will own ~41% of HDFC Bank.

Why this makes sense?

Firstly, the merger fulfils the implicit RBI policy of not allowing a bank to be owned by an NBFC/HFC, and having its lending business housed mainly in the bank.

Secondly, in the past when compared to Banks, NBFCs have enjoyed lesser regulations. However, in last 3 years post IL&FS crisis, the norms and regulations have become stricter for NBFCs. For instance, NBFCs would report NPA only if no single instalment is paid in 6 months. And even if a single instalment is paid in 6 months, that account would not be termed as NPA. However, the norms have been changed from 6 months to 3 months recently. Therefore now there is no specific regulatory advantage that a large housing NBFC like HDFC Ltd. would enjoy by remaining an NBFC and not merging with a bank.

Benefits of this merger

• Better Loan Mix: The merger will increase the share of mortgages in HDFC Bank’s loan book. HDFC Bank has not had material portion of home loans and mortgages in its loan book. The default rates for home loans are generally lower which will therefore, improve the overall asset quality. For HDFC Bank, a higher share of the mortgage business (33%) could be margin dilutive, but risk-adjusted margins will still be healthy and also increase the tenor of the loan book.
• Increased Cross-Selling Opportunities: The merger strategically fits HDFC Bank’s product basket. Home loans are long tenor, thus providing the bank opportunities to cross-sell unsecured, lower tenor and profitable credit to the customer during the loan repayment cycle. This will drive up the lifetime value of the customer. Nearly 70% of HDFC Bank’s 6.8 Cr customers do not have housing loans. Thus the merger will provide an opportunity to cross-sell mortgage loans, while HDFC Ltd customers will be offered banking products. HDFC Bank’s cost advantage will make the housing loan business much more competitive amid the rising dominance of banks in the segment.
• Benefits coming from HDFC- HDFCBank will benefit from the expertise of HDFC in the real estate space and its efficient processing of loans which has enabled a favourable cost to income ratio. Also, lower cost of funds will be made available for the mortgage business. The bank will have access to the efficient mortgage origination and loan servicing processes of HDFC Ltd.
• Lower cost of Funds to HDFC Ltd- Thecost of borrowings to the banks is lower than NBFCs. NBFCs have to rely on the wholesale fund raising from banks or markets both of which are relatively costly.  On the other hand banks have CASA which is lowest cost of borrowings. The merger augments the ability to raise big ticket loans especially at such a time when capital investment is picking up.

Challenges in the Merger

• SLR & CRR requirement- The bank is required to follow certain regulatory commitments such as SLR (Statutory Liquidity Ratios) (18% of net demand and time liabilities), CRR (Cash Reserve Ratios) (4% of net demand and time liabilities). The merger will require higher appropriation for SLR and CRR, which would reduce the RoAs (return on assets) because of lower yield on amounts in CRR & SLR.
• Regulatory risk- The merger is subject to regulatory approvals from the RBI, IRDAI, CCI, SEBI and stock exchanges. RBI advocates the holding company structure for non-lending businesses. If the structure is not approved, the companies will have to reconsider the scheme of arrangement.
• Impact on Margins: The merger may lower Net Interest Margin (NIM) due to inculcation of mortgages on HDFC Bank’s loan books. Mortgages generally have a lower default rates and lower margins because of its secured nature. However, the housing cycle in India is poised for an uptick and the growth in housing loans can compensate for the lower NIM.

Short Term Impact on Stock Price

HDFC Ltd. forms ~6% of the MSCI India Index whereas HDFC Bank is not a part of the index. HDFC Ltd. will cease to be a part of the MSCI Index post the merger. Thus, FII may reduce their exposure to HDFC Ltd. steadily. On the other hand, DIIs on aggregate have been under-exposed to HDFC Ltd. as compared to their benchmarks. Thus, they may want to increase their exposure to it. Due to the above reasons, the stock may see some volatility in the medium-term.

HDFC Ltd | Market Cap: 4,73,036 Cr

CMP 2,528 | P/B 2.5x FY23 (Housing Fin.)

Results: HDFC Ltd reported net interest income decreased 2.4% year on year. Operating income before provisions grew sluggish 2% year on year. Overall AUM growth was 12% with growth individual loans being 16%

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Key highlights:

• Loan book grew 12% year on year and Individual disbursement growth was 48% during the same period. 64% of the loan book is individual loans.
• Overall non-individual loan book declined by 1.9% YoY and 1.1% QoQ
• 89% of new loan applications were received through digital channel.
• 1.21% of the loan book was restructured post recovery from one non-individual account.
• Total provisioning for the quarter stood at Rs. 3,930 Cr which was down 33.8% YoY.
• Individual segment’s GNPA increased from 1.1% in 2QFY22 to 1.44% in 3QFY22 while non-individual segment’s GNPA ratio
• saw a QoQ uptick of 35bps to 5.04%
• Individual segment’s GNPA increased from 1.1% in 2QFY22 to 1.44% in 3QFY22 while non-individual segment’s GNPA ratio
• saw a QoQ uptick of 35bps to 5.04%
• Individual segment’s GNPA increased from 1.1% in 2QFY22 to 1.44% in 3QFY22 while non-individual segment’s GNPA ratio
• saw a QoQ uptick of 35bps to 5.04%
• Overall GNPA reduced by 0.25% over previous quarter to 2%. Individual GNPA were at 1.44% (up by 34bps sequentially) and non-individual GNPA were at 5.04% (up by 35bps sequentially).

Management Outlook: Management highlighted that Individual disbursements in the month of December 21 were the 2nd highest in the HDFC history. Pipeline from construction finance and lease rental discounting segment is strong and positive growth is expected for non-individual loan for full year.
The company has stated that it does not expect to raise capital for a long time and that it would focus on higher AUM growth and ROE expansion . Management has guided for a good pipeline and positive growth for FY22. It also expects the credit costs to reduce going further and reach pre-covid levels.

HDFC Ltd | Market Cap: 5,24,327 Cr

CMP 2,900 | P/B 2.5x FY23 (Housing Fin.)

Results: HDFC Ltd reported net interest income growth of 17% year on year. Operating income before provisions grew 29% year on year. Overall AUM growth was 11% with growth in both affordable housing segment and high income group.

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Key highlights:

• Loan book grew 9.8% year on year and Individual disbursement growth was 44% during the same period. 63% of the loan book is individual loans.
• 1.4% of the loan book was restructured. 35% of these restructured loans are employed and rest 65% are self-employed.
• As per the regulation, HDFC is required to carry a total provision of Rs. 6,505 Cr of which actual provisioning carried by the company is Rs. 13,340 Cr. Covid related provision stood at 1,304 Cr which is 10% of overall provisioning.
• Overall GNPA reduced by 0.25% over previous quarter to 2%. Individual GNPA were at 1.1% (down 0.25% sequentially) and non-individual GNPA were at 4.9% (down sequentially).

Outlook: Management has guided for a good pipeline and positive growth for FY22. It also expects the credit costs to reduce going further. As per the management, sharp recovery in the quarter was visible post the second wave of Covid.