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HDFC: ‘Prime’ advantage - Views on News from Equitymaster
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HDFC: ‘Prime’ advantage
Oct 29, 2007

Performance summary
  • Interest income grows 43% YoY on the back of 24% YoY growth in advances and higher lending rate.
  • Net interest margin improves to 3.8%, from 3.7% in 1HFY07.

  • Other income drops by 35% YoY led by lower dividend and processing fees.

  • Bottomline grows by a whopping 76% YoY buoyed by extraordinary income due to profit on sale of stake in Intelenet Global Services. Excluding the extraordinary item, the bottomline has actually fallen by 9.5% in this quarter.

  • Made preferential allotment to the Carlyle Group and Citigroup Strategic Holdings, Mauritius.

(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Interest income 12,869 18,398 43.0% 24,288 35,622 46.7%
Interest Expense 9,136 12,237 33.9% 17,150 24,671 43.9%
Net Interest Income 3,733 6,161 65.0% 7,138 10,951 53.4%
Net interest margin       3.7% 3.8%  
Other Income 1,693 526 -68.9% 2,429 1,588 -34.6%
Other Expense 686 823 20.0% 1,353 1,588 17.4%
Provisions and contingencies 39 40 2.6% 76 77 1.3%
Profit before tax 4,701 5,824 23.9% 8,138 10,874 33.6%
Extraordinary items - 3,133   330 3,133 849.8%
Tax 1,020 2,493 144.4% 1,820 3,815 109.6%
Effective tax rate 21.7% 42.8%   22.4% 35.1%  
Profit after tax/ (loss) 3,681 6,464 75.6% 6,648 10,192 53.3%
Net profit margin (%) 28.6% 35.1%   27.4% 28.6%  
No. of shares (m) 249.5 271.6   249.5 271.6  
Book value per share (Rs)*         219.4  
P/BV (x)         12.9  
* (Standalone book value as on 31st March 2007)

India’s largest HFC
HDFC, India’s largest housing finance company (HFC), with strong brand equity and market share of 21%, has an extensive reach with 237 branches (FY07) spread across the country and abroad. HDFC’s strength over the years has been its core business of housing loans. Meanwhile, it also has tried to benefit from the retail reach of its banking subsidiary (HDFC Bank) and has entered into an agreement to source ‘home loan accounts’ from the latter. However, 70% of the accounts are sold back to HDFC Bank in the form of Pass Through Certificates (PTCs). Over the years, HDFC has emerged as a financial conglomerate by not restricting its ambitions to just housing finance but also venturing into new businesses like insurance, banking and asset management (mutual funds). It has recently set up a ‘real estate fund’. The HFC has grown at a scorching pace over the years despite competition from banking entities in the mortgage financing space.

What has driven performance in 2QFY08?
Margins gain ground: While mortgage lenders across the world sped for cover with the subprime ruckus attempting to spare only a few, our largest domestic mortgage lender, HDFC, emerged unscathed in 2QFY08. Having said that, with a host of PSU, private sector and foreign banks and NBFCs offering home loans these days, mortgage loan has become a commoditised product. Profitability from the same solely depends upon the pricing power of the lender. HDFC’s proactive moves in the last 9 months has saved it from any blushes on NIMs that have improved marginally in this quarter despite the pressure on borrowing costs.

The statistics of mortgage finance contributing 6% of India’s GDP in FY07 from 3% in FY05 may appear enthusing. As per the NHB (National Housing Bank, the regulator for HFCs), during the 11th 5-year plan (2007 – 2012), the total shortage of dwelling units is pegged at 74 m while that in rural areas is 47 m. The total funding required from HFCs and banks to meet this requirement is estimated at Rs 1,200 bn and Rs 4,000 bn respectively of which NHB is targeting disbursements of Rs 750 bn (63% of the funding from HFCs) until FY10. This adequately explains the prospects for HDFC, which continues to cash in on the latent demand in the Indian housing finance industry. However, despite the fiscal incentives, housing finance has become very expensive in the last 12 months and thus the growth trajectory is unlikely to be even.

The spike in home loan interest rates during this period, which has not been commensurate to the rise in income levels, has had a lagged impact on the institution’s incremental approvals which have grown by 29% YoY. The disbursal to sanction ratio has also slowed down to 75% from 77% in 1HFY07, possibly due to higher propensity for slippages in a high interest rate scenario. The mix of individual and corporate loans has been retained by the HFC at 65:35.

Loan book break up…
(Rs m) 1HFY07 1HFY08 Change
Approvals 147,290 189,480 28.6%
Disbursements 112,800 142,750 26.6%
D/A ratio 77% 75%  
       
Loans      
Individuals 348,031 424,454 22.0%
% of total 67.8% 66.9%  
Corporate Bodies 156,563 195,414 24.8%
% of total 30.5% 30.8%  
Others 8,726 14,593 67.2%
% of total 1.7% 2.3%  
Total loans 513,320 634,460 23.6%

The growth of 24% YoY in loan book is in line with the sector average and the institution’s targets. This is also marginally higher than our estimate of 23% YoY growth in loan book in FY08.

Other income – Solely relying on cash surpluses: HDFC’s other income dropped by 35% in 1HFY08 over that in 1HFY07. Lower dividend and fee income (linked to reduced disbursements) had a telling impact on the HFC’s other income that failed to bear the fruits of doubling of surplus cash deployed with the mutual funds. The same may, however, not be sustainable going forward. The institution has not divulged the growth in the unrealised gains on its investments at the end of the September quarter. It must also be noted that the profits earned on the sale of stake in Intelenet Global Services in 2QFY08 has been shown as extraordinary income in the income statement.

Breakup of other income
(Rs m) 1HFY07 % of total 1HFY08 % of total Change
Fee income 1,441 59.3% 507 31.9% -64.8%
Surplus from deployment in MFs 238 9.8% 460 29.0% 93.3%
Profit on sale of investments 124 5.1% 73 4.6% -41.1%
Dividend & other incomes 626 25.8% 548 34.5% -12.5%
Total other income 2,429   1,588   -34.6%
*Excluding sale of stake in Intelenet Global Services

Resource constraints addressed: HDFC’s capital adequacy ratio (CAR) stood at 17% in 1HFY08. The corporation has received an amount of Rs 31 bn through the preferential allotment of equity shares to Carlyle Group and Citigroup Strategic Holdings, Mauritius, which has further strengthened its balance sheet. In September 2005, the institution issued FCCB of US$ 500 m and in 2QFY08 it allotted 0.5 m equity shares of Rs 10 each pursuant to part conversion of the FCCBs. The outstanding amount under the FCCB as at September 2007 was US$ 483.8 m. Also, gross NPAs of 0.9% and net NPAs of 0.2% keep the asset quality provisioning requirements low for the institution. The fact that the institution restricts its exposures largely to ‘prime’ borrowers (ones with good credit history and repayment ability) is a matter of great comfort.

What to expect?
At the current price of Rs 2,793, the stock is trading at 4.7 times our estimated FY10 adjusted book value. HDFC’s unique business model (sales through direct selling agents and arrangement with HDFC Bank) enables it to sustain the lowest cost to income ratio (12.3% in 1HFY08) and enjoy operating leverage. The management has indicated that the timely lending rate hikes will ensure that its spreads are protected. However, this may have an impact on its asset growth.

In search for new avenues of growth, the institution is now targeting smaller cities, where real estate prices have risen, but not as much as the rise witnessed in metros and other large cities. HDFC's ability to profitably sustain market share in mortgage portfolio and enhance its fee income share will determine its growth going forward. Notwithstanding the fact that our concerns with respect to quality of real estate loans were vindicated in FY07, we see improving prospects for the HFC, given its risk averseness, in the medium to long term. Having said that, the current valuations of the HFC warrant caution from fresh investment perspective.

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