SynopsisFrom aiming for an INR80,000 crore IPO to now engaging with investors for stakes, things have changed rapidly for HDB Financial Services. At over 7% NPAs in the June quarter, observers say it’s unlikely that operations will normalise even after a year. Analysis of limited available data leads to questions of whether HDB Financial is worthy of an IPO.
HDFC Bank’s investor calls are among some of the most attended meets by analysts. The eventful nature of these calls, especially in the past six months, makes them interesting.
Something new crops up every time.
This time around, when the bank declared its June quarter results, it indicated that some investors have evinced interest in its non-banking finance (NBFC) arm – HDB Financial Services.
For bankers, this may seem like a routine fund-raising activity. But for investors and the rest of the world, it came as quite a surprise.
Listing HDB Financial Services was HDFC Bank’s former boss Aditya Puri’s dream project. The bank presently holds 95% stake in the NBFC.
In June 2019, when Puri announced the tentative listing of the subsidiary, the Street was quick to ascribe valuations as high as INR80,000 crore to the company.
The constantly rising grey-market premium for HDB Financial was the talk of the town and at INR1,150 a share, its valuations were just some shades below Bajaj Finance’s 6x price-to-book.
But then, the plan never really took off and, in fact, the listing of HDB Financial may not happen in the foreseeable future. Market sources indicate that the bank may test the investor appetite by offering stake to interested investors. This should help in price discovery as well, and an IPO, if it happens, will be three years or after the price-discovery process.
There are other issues as well.
For an NBFC which boasted of pristine asset quality, its Q1 results’ gross non-performing assets (NPA) shot up to 7.75% from 2.86% a year ago.
This was enough to lose acceptance in the grey market, which has fallen sharply. “Now at less than INR900 a share, the demand for HDB has significantly come off. There are barely any takers,” says Dinesh Gupta, founder and CEO, Unlisted Zone.
Among its competition, some well-established NBFCs such as Bajaj Finance or Shriram Transport have demonstrated that they could tide over the pandemic better. Investors are preferring these stocks over HDB.
This brings us to some important questions.
Was HDB Financial riding the favourable wave for NBFCs? More importantly, is it IPO worthy?
Understanding the genesis of HDB could help find some answers.
How HDB Financial evolved
Banks across the world and in India operate a step-down NBFC subsidiary.
These are primarily vehicles to cater to customers which the bank may not be able to service. At another level, they help banks manage their asset quality. When an account turns difficult or tricky for the bank to handle in terms of potentially becoming a bad asset, they are sold down to the in-house non-bank.
“If someone wants to take exposure to the lending entities of HDFC Group, there’s HDFC Bank and HDFC Limited. What’s unique about HDB to attract investors?”
— Nilesh Shah, founder and CEO, Envision CapitalHDB Financial, incorporated in 2007, wasn’t conceptualised any differently, say people who were earlier associated with the bank.
“In fact, at that time, the then senior management of HDFC Bank were gifted shares of HDB as an appreciation of their work in the bank,” says a former senior executive of HDFC Bank.
They agree that in the initial years, HDB, like any captive bank-led NBFC, took some burden off the parent, especially on corporate loans. It was towards the mid-2010s that Puri sensed an opportunity in retail loans, especially unsecured loans.
“The bank had its constraints on whom they could lend, whereas for HDB, the customer’s credit score alone wasn’t the primary benchmark. So, they aggressively chased this segment and every possibility that came its way. This motivated Puri to consider listing HDB. But by the end of 2019 we realised that wasn’t going to happen. The environment started turning unfavourable for NBFCs,” he adds.
Make hay while the sun shines
Aditya Puri’s family, Paresh Sukthankar (the former deputy managing director of HDFC Bank), Pralay Mondal, Ravi Narayanan (both former senior vice presidents of the bank) and their spouses, kith and kin, who held shares of HDB, cashed in on the grey-market premium we spoke about earlier.
Meanwhile, slowing growth and a bulging pool of troublesome assets became more evident at HDB.
With normalisation still some quarters away for NBFCs, there could be more pain for HDB. Simply put, HDB may have just rode along or mirrored the overall upcycle for NBFCs in the system. It hasn’t differentiated itself from the rest leading to the question of whether HDB was really built on a strong and resilient asset base.
Much of HDFC Bank’s stress in Q1 came from retail assets and the same was true for HDB as well. The bank’s gross NPA rose to 1.45% in Q1, while the NBFC’s ballooned to over 7%.
G. Ramesh, managing director and chief executive officer, HDB Financial Services, acknowledges that the non-bank lends to a certain set of customers who are a notch below when compared to the bank. “A feature of this segment is that when there is a problem, it shows up immediately. Unlike prime customers, (for) the customer segment that we service, the problem shows up immediately,” he said in HDFC Bank’s Q1 investor call.
Another point that iterates HDB’s weak asset quality compared to banks is the concentration of NPAs. At 26% in FY21, this is way higher than the 10% –15% levels which banks have seen in the past.
What this points to is that HDB may have had to lower its guards to grow its book. A comparison of HDB’s NPAs with those of Bajaj Finance (the market leader in the consumer finance and the company that may have inspired HDB to aggressively enter the retail market), buttresses this further.
For investors, whether at IPO or those showing interest to take a stake in HDB, this aspect would test their comfort on the non-bank lender. This also moots a critical point — for a bank which prides itself at having best underwriting standards in the country — did its NBFC subsidiary have to mandatorily let down its guards to build a certain scale?
Also, despite a significant correction in HDB’s valuations, the Street is still pricing it 75% higher than average valuations of NBFCs. JM Financial, for instance, is ascribing a value of 3x price-to-book for HDB.
Moreover, if the brand value and pedigree of HDB’s parent is removed, can the lender justify its asking price?
That’s a grey area and it leads to another question.
Is HDB IPO worthy?
With the exception of PNB Housing Finance and CanFin Homes, there aren’t many bank-led listed NBFCs, and the reason is well-established – they primarily exist to take the burden off the bank.
Some though have grown from being just a captive non-bank to having their own client base. Yet, the underlying aspect is that given the nature of the relationship they enjoy with the parent, their functioning may continue to remain unlike any standalone NBFC, even if it is a part of a large business group. Bank-led NBFCs enjoy a certain comfort with respect to borrowings, equity and revenues.
For instance, in FY21, 10% of HDB’s bank borrowing (INR2,350 crore out of INR22,569 crore) came from HDFC Bank. Likewise, INR2,020 crore or 18% of total revenues came from the BPO operations largely rendered to HDFC Bank.
More importantly, whether pandemic or not, HDB’s customer profile will remain notches below that of its parent.
Simply put, the business landscape may not mimic that of Shriram Transport, Bajaj Finance or even Indiabulls Housing Finance.
These non-banks have the compulsion to match the asset quality of banks even if they cater to customers who aren’t typically credit-worthy for banks.
Discipline on the quality of the books is imperative to preserve their valuations and make themselves attractive in the debt and capital market.
HDB may never have these compulsions for a foreseeable future. Moreover, the abovementioned lenders have also created a niche for themselves in the products they offer and markets they operate in, thereby justifying their valuations. With HDB, that’s not the case.
Its asking rate is largely derived from its parent’s clout.
Nilesh Shah, founder and CEO of Envision Capital, asks whether HDB has anything different to entice investor interest? “If someone wants to take exposure to the lending entities of HDFC Group, there’s HDFC Bank and HDFC Limited. What’s unique about HDB to attract investors?”
What’s more, the dynamics of the IPO market have changed significantly. NBFCs as an asset class are losing sheen to new-age businesses. “IPO market is broad-based today and investors are spoilt for choices. Merely tagging on HDFC Bank’s image isn’t going to work for HDB anymore,” Shah adds.
On HDB’s part, the company spokesperson said they continuously review the business strategies and the approach best aligned with the company’s objectives on an ongoing basis.
But clearly, having missed the bus two years ago, supporting HDB for capital is now entirely on the bank. “We will ensure at any point in time HDB is adequately capitalised in any case,” Srinivasan Vaidyanathan, CFO, HDFC Bank, mentioned in the recently concluded investor call.
That said, with the Reserve Bank of India continuing to push banks towards capital preservation, HDFC Bank supporting its subsidiary with RBI’s blessing will be interesting to see.
HDB’s 19.8% capital adequacy in FY21 despite lower net profit and higher provisioning is a saving grace.
If HDFC Bank doesn’t want to heavy lift its subsidiary’s burden, then it surely has a clock ticking. The bank needs to find willing investors for HDB soon.
And thus, the wait for HDFC Bank’s next investor call begins.
(Graphics by Mohammad Arshad)
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