HDFC’s three-point strategy to beat potential downturn

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Slowdown or no slowdown - here is one company that has continued to perform at a steady 25% growth rate, decade after decade, year after year. This year too HDFC , the country's largest home loan company intends to do exactly the same.

 

Deepak Parekh , Chairman, HDFC said, "I don't know why this doom and gloom scenario is being painted particularly by the media and the press. If one looks at four sequential quarters, India Inc has achieved the highest growth this quarter. The bottomline profits are lower and there are problems. But demand for products has not deteriorated. Indian industry is much more resilient today than seven years ago when we had problems in our economy in the nineties and early 2000. It is far more resilient and confident to tackle 11-12% inflation. Our concerns are oil, commodity prices. The other concern we have is inflation, rising fiscal deficit, rising current account deficit and we have to tackle each one of them. So unless we tackle and find solutions for some of these problems, growth will be impacted."

 

On July 18, at the IDFC Annual General Meeting Deepak Parekh said, "The economy is entering into difficult and dangerous times." But today he seems a lot more bullish. The high interest rates, deteriorating fiscal situation and gloomy markets do have him very worried and he admits that the though the fiscal year has started on a strong note, it may not end the same way. Yet the man whose mood often mirrors the economy is confident that India's GDP will grow between 7.5-8% and refuses to use the word slowdown.

 

Keki Mistry , VC and Managing Director, HDFC said, "If we look at the first quarter of this year to June when all the slowdown is supposed to have happened in the economy, we have not seen that slowdown. We have still grown at the same pace and at the same rate in the same manner as we had last year."

 

Renu Karnad , Joint Managing Director, HDFC said, "If you look at July numbers, we are not only talking of our disbursements but also the numbers that are coming in. There has not been any let out as yet in the applications that are being picked up."

 

HDFC's July numbers indicate that while ticket sizes have stayed the same, the number of loan applications has increased. The demand story is a compelling one. Its plot is often repeated by HDFC's senior management that younger and younger Indians are opting for a home loan. The average age of borrowers is down from 40 years to 35 years. Thanks to tax breaks, the effective cost of a loan works out to a moderate 6%. Unquenchable housing demand has the country short of 2.5 crore homes. The loan market is a vast untapped one yet. It has taken 30 years for mortgage penetration to grow from 2.5% to 6% of GDP. With middle India kicking in, HDFC is confident that unlike other consumer goods, home loans are not that vulnerable to a slowing economy. At least HDFC's home loans are not.

 

Keki Mistry said, "The difference is we target middle-income customers. Our loan size in the current year has been Rs 15 lakh or just Rs 1.5 million. On Rs 1.5 million with a 64% odd loan-to-value ratio, we are looking at a property price of about Rs 2-2.1 million. We are not catering to South Mumbai or Central Delhi or places where prices are very high. These are places that would get hurt the first when we see this kind of a slowdown. Secondly, 95% of our borrowers are salaried employees and are working somewhere. If you are working in a public sector enterprise or even in a private sector enterprise, your salary keeps increasing. The increase may be 6% or in another year 12% or 20%. But the salary will keep increasing. So, affordability of EMI is consistent in that sense."

 

Renu Karnad said, "Whenever an interest rate increase happens, there is always this little reticence that people have and they wait. I have seen so many of these cycles, within a month or month and a half everybody is back."

  

Even if the economy weakens, HDFC is confident of the health of its loan book. At 0.8%, its Non Performing Assets or default rate is far lower than other banks. In 31 years of the USD 40 billion lent, only USD 16 million has not been returned. The company prides itself on healthy lending and strong recovery. But Mr. Parekh is a bit worried about those who have taken a loan in the last 12-15 months.

 

Parekh said, "They have put their last penny in the loan repayment while taking a loan from us, and the EMI goes up immediately before the loan amount comes down because if they are servicing for two years the loan amount will come down. Before the value of property goes up, if there is a three-year old loan, property values are much higher then their loans come down. So, these things have not yet happened to that group of people who have borrowed in the last 12 months. They have to increase their monthly installment, which they may not be able to do because they have gone to the maximum extent of what installment they can pay. In this case, we may have to look at extending the loan from 12-14-15 years to 18 years, to accommodate them. But the ones who borrowed in the recent past get hit badly when interest rates go up."

 

Renu Karnad said, "We now need to do a lot of counseling. The counseling that we need to do is to help people make sure that they are buying from the right builder; builders who have a track record. That is very important because today a lot of schemes are in the market. So, people at times get carried away with that. So, we are trying to do bit of counseling. The other is also to counsel a person to try and borrow just the amount that you will be able to service. Everybody wants to have that three-bedroom house in the best of localities. But maybe this is not the time for you to do that."

 

As far as developers are concerned Renu Karnad said, "First of all the developers we deal with are either AA or AAA developers. They are large developers and may have large loans in large projects in debt. They have a lot of networth that we are looking at and the value of properties that they are holding, makes us very comfortable."

 

Deepak Parekh and his team do run a tight ship. HDFC's cost to asset ratio is seventh that of banks. In 18 years, the business has grown 100 fold, but the workforce has barely doubled. The discipline extends to all things financial. Return on equity will increase by 1% this year, spreads will remain stable at between 2.15-2.2% and a different fund raising strategy will ensure a matched balance sheet.

 

Keki Mistry said, "There was a time in the nineties when deposits used to constitute as much as 45% of total funds. That was in a very high interest rate environment and the rates were 16-17%. Then we had a time in the early part of this decade when rates fell. When interest rates fell sharply, deposit rates did not fall as much as wholesale funding rates fell. So, we started relying more and more on wholesale funding. So, from a situation where deposits used to account for 45% of total funds, we came to a situation a couple of years ago when deposits was only 13% of total funds. In this kind of an environment with interest rates going higher, we find the deposits as a much more palatable and desirable form of funding for wholesale sources. So, we focused a lot on retail deposits. If we take Q1 i.e. April to June and you look at the increase in the balance sheet and deposits, you will find that deposits constitute more than 50% of incremental funding. So, you have to change your funding sources."

 

When the market was running at 30-35%, HDFC walked at a steady 20-25%. Now with growth at 15%, HDFC will still be striding at 20-25%. Since Parekh believes that prevention is better than cure, here is his three-point strategy to beat any potential downturn.

 

Parekh said, "We had a strategy meeting in Shimla last week where we had 30 of our top managers from all over India. One thing we certainly have to be careful of is developer loans. We have to do much more appraisal of a developer. It is probably safer to back an old and established developer than a new developer. That is one message. We also said, look at the people who have taken loans in the last 18 months, and see how we can accommodate them. Call each and every member of the family, every borrower and ask him has his financial position improved? Does he want to give a lump sum to maintain his mode of payment? Does he want an extension of two-three years of his loan amount? Can he pay a little more? But each individual borrower will be called by our office, people who have taken loan in the last year to one and half years to see how we can accommodate. The third message is, when you look forward; let us be more careful about loan to value ratios. Loan to value ratios is much important particularly in this volatile situation. We see prices coming down in the anvil. Loan to value ratios shouldn't give 70-80%. Our average is about 65% or so. So, please stick to that, although on paper we say we give up to 80%. That is the message we all came out at the end of two days to keep us healthy fit and strong."

 

Deepak Parekh said, "I sit on number of boards and not a single company has deffered capital expenditure. Not a single company has postponed setting up a greenfield or a brownfield project and not a single company has deffered their borrowing programme. The only thing that companies have done is postpone their capital issues, ad-hoc-listing and many companies have done private placements but no one has deferred capital expenditure. No new plants, capital spend has postponed or deferred and I can tell you this for variety of industries - from cement, to steel to pharmaceuticals to anything."

 

Excerpts from CNBC-TV18's exclusive interview with Deepak Parekh:

 

Q: On a scale of 1-10, how would you rate the economy today?

A: I would put 6.5-7.

 

Q: Is that satisfactory?

A: It is not the best scenario but compared to what is happening around you globally, if the global growth rate is five and we achieve eight, isn't it satisfying.

 

Q: While all of India Inc is doing fairly well, there is one sector which is connected directly to HDFC that is struggling right now because of the cost of financing - it is realty. What is your assessment and we hear rumours everyday of some company on the brink of losing it, so how bad is it?

A: I hear rumours also everyday and it worries me because we are in this sector.There is liquidity crunch, some cash flow problems because on one hand they have land payments to be made and on the other hand the sales have slowed down. So the cash flows they were expecting from sales are not coming through. So, the land payments have to be deferred or they had to default on their land payments. The landowner will get money a quarter or six months later. There are concerns and sales have certainly slowed down as far as investors are concerned. But the actual user demand is still there. We have seen a fair amount of growth this quarter and we were surprised to see a 28% growth in Q1. It may not sustain over a period of time. We are expecting that we will probably come down to 20-25% but I am reasonably confident that we will get at least minimum 20% growth. 

 

Q: Why aren't we seeing prices go down any further? Across the country, why are we not seeing any sharp drop in prices?

A: We are not seeing sharp drops. We have seen 10-20%. I spoke to a few Mumbai builders and asked why they aren't bringing down prices when there is a cash flow problem.  Their argument is that monsoon season in Mumbai is the worst season and said if we bring prices down in June, we will not have any sales. In festive season comes Dassera; they will start offering big discount. They said that they need to be funded for three months because they need money.

 

Q; Are you buying that argument?

A: We are not buying into that argument.

 

Q: But you don't think in your assessment that anyone or any company is on the brink of collapse in the real estate sector in this country?

A: Not at all.

 

Q: What is the outlook on whatever you are going to continue to see - this kind of demand till the end of the fiscal and even later, once purses start getting pinched even more?

 

A: A hike in interest rate is worrying because the cash flow of a family gets curtailed. So, if they are going to buy an apartment, they have to either postpone it or buy it in further suburb or go more interior or take a smaller apartment. So if our Q1 growth has been 28%, Q2 and Q3 may not be 28%. Maybe it would be 25%. But, we should not look at Mumbai. India is such a large country. We really don't know what is happening in the smaller Tier-II and Tier-III cities. Our growth is really coming from a large number of Tier-II and Tier-III cities. For instance, Surat is booming for us.

 

Q: Do you see that demand sustaining over the next three-six quarters?

 

A: But five years ago, Surat was not booming. Today, it is and this year Surat is booming.

 

Q: Are you saying that the housing loan industry is going to continue to grow between 10-15%?

 

A: It will continue to grow at a minimum 15%-20%.

 

Q: You are not going to have the question of people saying how much more can we pay for a loan or let us defer this by two years and maybe interest rates will start coming down?

 

A: Interest rates will come down. If you see the RBI estimate, they have said that by March 2009 the inflation will come down to 7%. If inflation comes down to 7%, rates are not going to be what they are today. So, maybe it is a temporary three-month or six-month phenomenon of higher interest rates. I do not see interest rates going to the old 16-18% at all.

 

Q: Are you sure about that?

 

A: I am sure about it. I don't anticipate and don't see it. I am sure that is not unlikely; it is impossible to happen. That is my personal view. I may go wrong.

 

Q: Is there a comment on a potential risk or threat to credit quality?

 

A: I don't see it. It has not yet happened in this quarter. We have seen better numbers. I know it has happened in the banking sector in personal loans, which are unsecured and they have much higher rates. They are 18-22%. In credit cards, the losses have increased but the spreads in credit cards is 6% or 8%. The spread in personal loans is 8-10%. Our spread is 2.1-2.2%. I don't think deterioration will happen because you have to have faith in the middle class.

 

Q: What you are telling is you can see storm clouds on the horizon but it ain't going to rain on you?

 

A: I am not saying that and so far it has not rained on us. We have to face it if it rains on us. We must have the resilience. We have 30 years net worth and enough provisioning in our provisions account and we have to face it.

  

Q: Has your view on the economy changed post the data that we have seen this week?

 

A: Two or three bad months do not make a year. Yes there will be blips, but these are passing clouds.