Diverse loan book
HDFC lends broadly to two categories, namely Retail and Wholesale. While higher interest rates as well as real estate prices have led to a decline in housing demand, tight liquidity conditions and lower demand raised the probability of defaults from real estate companies. In this background, it assumes importance of how HDFC is safeguarding against possible deterioration in its business.

Retail mortgage accounts for around two-thirds of the total loan book. But, since most of the retail portfolio comprises of individual borrowers (more than 90 per cent of them borrow funds to purchase house for self-occupation), the default rates are minimal. The majority of the loan disbursals are to middle class -salaried employees along with greater focus in Tier 2 and 3 cities also ensures that the retail portfolio is well diversified. In the home mortgage market, HDFC has been increasing its market share, and further share can be garnered as most of the leading banks are going slow in lending.

In the Wholesale segment, advances to developers (about 12 per cent of total loan book) are in the focus, in the aftermath of weakness in the real estate sector. The falling demand for developed properties and lack of liquidity has put pressure on the developers, thereby increasing the chances of defaults. Thus, HDFC being a financier to real estate developers is also in the spotlight. To its credit, the disciplined approach by the company in these disbursals will ensure that HDFC is better placed compared to others. Among stringent norms include a low loan-to- value (LTV) ratio (proportion of loan value to property value) of less than 65 per cent and providing funds for property development rather than land acquisition. The rest comprises of funding to highly rated corporate and loans for acquisition of property in IT parks and industrial zones. 

Disbursals moderating, funding decent
While disbursements have grown 27 per cent in the last five years, it slowed in the high-interest rate environment to 23 per cent in Q2 FY09. A part of this deceleration is due to HDFC moderating disbursements to guard against tight liquid conditions along with slowing exposure to real estate developers. However, as property prices are correcting, the disbursement growth should pick up in conjunction with declining interest rates in the future.

Housing finance qualifies for priority sector lending and in addition with superior track record, HDFC has easier access to funds to grow its business. But, in the present scenario of higher interest rates, bank lending has become expensive, and thus, HDFC has shifted its focus towards deposit mobilisation. The indication of this effect is the increase in share of deposits from around 17 per cent in FY08 to around 20 per cent as on date.

However, debt instruments like bonds and debentures continue to be the major source of funding (around half). The key point is that most of HDFC bonds are of AAA rating, which means raising funds wouldn't mean a problem in the future. The fact that it has been able to mobilise retail deposits at competitive rates also indicates HDFC's strong brand equity and distribution reach.

Strong financials
HDFC has delivered high profit growth of around 30 per cent, on an average, in the five years. Its profitability, too, has been driven by stringent lending norms (among lowest NPAs), a tight tab on operating costs and strong volume growth, over these years. For instance, its cost-to-income ratio has improved from around 14 per cent in FY05 to around 8.5 per cent in FY08.

Although higher interest rates put pressure on the repayment ability of the borrower (customer), HDFC has been able to curtail any possible slippages (NPAs at around one per cent) through strict monitoring and lower LTV allowed to borrowers. The strong risk management systems and the recent decline in interest and property rates should help sustain lower NPAs, going forward.

On the margins front, HDFC has been able to maintain at around 3.5 per cent (net interest margins) on the back of decent spreads, reflecting its ability to revise lending rates (nearly 90 per cent of its loan book is floating rate) as well as source funds at relatively cheaper rates.

Investment rationale
While the demand from real estate developers would remain strong, with the growing risk aversion shown by the banks, HDFC has also been cautious and judicious in terms of its lending to real estate even as it provides higher margins.

Notably, the recent policy measures suggest that the pressure for companies like HDFC should start receding. The moves by RBI like reducing the risk weights on the loans and advances to commercial real estate, along with cut in CRR and repo rate would lead to lower lending rates. Additionally, RBI's has increased the limit for classification of housing loans as a priority sector advance to Rs 20 lakh. Since HDFC's average ticket loan size is around Rs 15 lakh, this should further ease liquidity.

In the long run, HDFC's track record of sustaining earnings in all the business cycles, an underpenetrated mortgage market, would ensure healthy returns for long-term investors.