For HDFC, the best days are still ahead

HDFC’s profitability stems from an enviable level of proactive provisioning. At the end of September quarter, the lender held provisions worth ₹13,340 crore, far higher than the ₹6,605 crore that regulatory rules would have required it to have, the company said in a statement. It holds ₹1,304 crore specifically for pandemic risks. The company said it may continue to hold the provisions.

Clearly, HDFC’s shares derive much of their premium valuation from this level of insurance against delinquency risks. As such, the lender has been able to keep a check on its defaults even during the pandemic. Bad loans as a percentage of total loans stood at 2%, lower than most peers. In fact, on a sequential basis, HDFC showed a slight improvement in delinquency rates as is visible from the fall in gross bad loan ratio. Also, the stock of gross bad loans fell by 7% from the preceding quarter.

The other sign of reducing stress is the collection efficiency that came in at 98% for the quarter. The lender has been able to show quick recovery from the impact of the pandemic’s second wave, thanks to its balance sheet heft and also a general pick up in economic activity.

But there is trouble at the margins front for the lender. HDFC’s bad loan ratio for its non-individual book remained high at 4.7%. This is a worry, especially when home sales and launches have increased in the run up to the festive season. A revival in home sales augurs well for realty developers and improves their risk profile. That hasn’t seemed to have happened.

To be sure, the lender has pointed out that this portfolio’s stress is reducing. Moreover, HDFC has a restructured loan pile in excess of ₹7,000 crore. Granted, as a percentage of the total book, it is just at 1.4%.

Even so, this pile needs monitoring because roughly 60% of it is from the safe individual loan book, while the rest are loans to developers and for construction finance.

That brings us to the other factor supporting valuations: growth. The lender has been shrinking its non-individual loan book even before the pandemic. This portfolio shrank 4% y-o-y for the September quarter. HDFC has indicated that its non-individual book will show growth in coming quarters.

“We have a reasonably healthy pipeline. I would expect we should close the financial year on a positive growth figure," said Keki Mistry, managing director of the company in a call with analysts. For the September quarter, HDFC reported healthy assets under management growth of 10.5% from a year ago, driven by 15% growth in individual loans.

Loan disbursements showed a swift revival with retail disbursements jumping 44% from the year-ago period. Low interest rates, coupled with festive season discounts, has prompted Indian consumers to purchase homes, which has helped lenders such as HDFC. And, the company expects this trend to continue.

The increase in home sales during October and the rise in project launches are an optimistic sign for sustained loan growth. While competition in the home loan market has increased, analysts were confident that the lender will weather the challenges as it has done in the past. In short, HDFC’s growth is expected to improve from here on.

As the largest non-bank mortgage lender, HDFC has enjoyed a premium valuation mainly due to its pristine asset quality. But its balance sheet has not been immune to the pandemic and growth has decelerated. While loan growth has improved to 10% for the September quarter from 8% a quarter ago, it still remains lower than its historic trend of 12-13%.

“HDFC remains the best among peers for asset quality which is an important consideration, but growth has to improve, too," said an analyst, seeking anonymity. He added that the valuation reflects most positives now.

Shares have moved in tandem with the broader market over the past six months indicating this. For the HDFC stock to outperform, the key ingredient of growth will need to align to its historic trend.