Macquarie questions HDFC accounts over provisioning

“Reported RoE (return on equity) would have been 600 and 400 bps (basis points) lower at 16% and 18%, respectively, if the adjustments had been made through the P&L (account)," the analysts wrote. “In other words, earnings growth has been managed, in our view." A basis point is one-hundredth of a percentage point.

The mortgage company refuted the report’s findings in a release late on Thursday.

“HDFC management completely disagrees with the contents of the Macquarie report... as the concerned analyst has not attempted to meet anyone from HDFC before making the aforesaid report and verify the facts and statements made therein," it said. “Moreover, it is surprising that Macquarie in its report as recently as May 7, 2012, had put a price target of ₹ 775 on HDFC’s stock with an outperform rating based on the same facts and figures. We are therefore unable to understand as to what prompted the analyst to change his recommendation and outlook within a month’s time."

Macquarie on Thursday downgraded HDFC two notches to an “anti-consensus" “underperform" rating from “outperform", with a 12-month target price of ₹ 550. HDFC fell 1.63% to ₹ 644.60 on BSE on Thursday. The benchmark Sensex index declined 1.2% to 16,677.88 points.

Zero-coupon bonds don’t have any interest payment obligation, but are issued at a steep discount to face value. At the time of maturity, the issuer pays the face value of the bond. This creates an implied yield that needs to be charged to the P&L account as interest cost.

“Looking at earnings could be misleading as the company manages these well by taking recourse to a higher spread corporate book, making accounting adjustments through reserves, and booking profits on sale of investments from listed and unlisted equities," Macquarie said, adding that even as the broker is negative on the Indian financial sector, the call on “HDFC is more a structural one and there is no cyclical element to the call".

According to the report, after the regulator in fiscal 2011 (FY11) changed the provisioning on “teaser loans" (on which interest rates were fixed at a lower level for the first few years to attract customers) from 0 bps to 200 bps on a retrospective basis, “HDFC took substantial provisioning through reserves instead of passing this through the P&L".

The analysts go on to say: “In FY12, the regulator again increased standard asset provisioning on commercial real estate loans from 40 bps to 100 bps and on normal retail loans from 0 bps to 40 bps. Again HDFC took the provisions through the P&L."

The mortgage finance company also charged the implied interest expenses of the zero-coupon bonds it issued primarily to invest in HDFC Bank Ltd and insurance subsidiaries, through reserves and not through the P&L.

Macquarie calculated the accounting adjustments involving the provisions and zero-coupon bonds at ₹ 980 crore in FY11 and ₹ 805 crore in FY12. Profits after adjustment would have been ₹ 2,555 crore and ₹ 3,317.6 crore, respectively, for the years.

HDFC said in its emailed clarification that the investments in subsidiaries and associates out of the amounts borrowed by way of zero-coupon debentures and “therefore the interest cost on such borrowings amounting to ₹ 485 crores during the year 2011-12 (net of tax) has been charged to securities premium account as per Section 78 of the Companies Act".

Further, HDFC said for the year ended 31 March 2012, if the proportionate share of profits of HDFC in its subsidiaries and associates is considered, the profits of HDFC will actually be higher by ₹ 1,340 crore after reducing dividends received from subsidiaries and associates. “Under these circumstances, if the aforesaid interest costs on zero-coupon debentures are charged to profit and loss account, HDFC’s profits would still be higher by ₹ 855 crore," the emailed clarification said.

“Further, the one-time provisioning requirements in respect of standard assets is not reflected in profit and loss account as it relates to all the past assets and is transitory in nature. The interest rates on retail home loans are lower on account of lower risk weights, lower NPAs and also diversified risk profile," the clarification said.

Macquarie compared HDFC with another mortgage lender, LIC Housing Finance Ltd (LIC HF), and said that the latter doesn’t have any zero-coupon bonds and has made all provision adjustments through the P&L rather than through reserves.

In its 7 May report, Macquarie had highlighted the zero-coupon bond issue, but said that HDFC’s fundamentals are “solid" and the management’s “ability to dynamically manage its resources is helping it to maintain consistent spreads".

The latest report was critical of HDFC’s disclosure practice.

“It’s quite surprising to us that HDFC Ltd doesn’t disclose any of its corporate sanctions and disbursements which LICHF does regularly every quarter. Additionally, LICHF also discloses interest income on corporate advances—something that HDFC doesn’t do and which makes it tough for investors and analysts to compute the actual spreads earned in their corporate business," the report said.

Going forward, HDFC will face tougher competition and the “premium product pricing that HDFC Ltd used to enjoy no longer exists", the Macquarie report added.

anup.r@livemint.com