Rating Rationale

Strengths:
* Majority ownership by, and strategic importance to HDFC Bank: The ratings centrally factor in support that HDB Finance receives from HDFC Bank. The company complements the parent's product portfolio and distribution network, and supports collection activities for the retail portfolio. It receives operational and managerial support from HDFC Bank, with regard to formulation of credit policies, portfolio monitoring and collection practices, if required. Presence of senior functional executives from HDFC Bank on HDB Finance board, ensures adequate supervision over its performance. The company also receives regular funding support from its parent-Rs 3,480 crore has been infused cumulatively.

* Established presence in the retail finance segment: HDB Finance has emerged as one of the larger players in the retail financing space, over the past few years. The overall loan portfolio has grown 20.5% to Rs 57,655 crore as on September 30, 2019, from Rs 47,842 crore a year ago. The loan book has also diversified, with increased presence in commercial vehicle/construction equipment (CV/CE) financing and business loans.

As a result, the share of loans against property (LAP) declined to 33% as on September 30, 2019, as compared to 49% as on March 31, 2017. Whereas, that of CV/CE loans and business loans rose to 42% and 22%, respectively, from 30% and 19%, respectively.

HDB Finance is now expanding into consumer durable financing, digital products loans and other related segments. Apart from its traditional focus on the self-employed segment in non-metros, the company has now widened its reach to the metros as well. With a diversified product offering and a pan India presence, CRISIL expects growth for HDB Finance to be above the industry average over the medium term.

* Healthy capital position: Capitalisation remains healthy, as reflected in Tier-1 capital adequacy ratio (CAR) of 12.7%, and overall CAR of 18.2% (as per Ind AS) as on September 30, 2019. Networth expanded to around Rs 7,444 crore as on September 30, 2019 (from Rs 7,178 crore as on March 31, 2019), while gearing stood at ~6.1 times. Cushion for asset side risks was healthy, as reflected in networth coverage for net non-performing assets (NPAs) at around 6.7 times. While capital generation remains comfortable, the capital profile is also aided by periodic infusion by HDFC Bank.

* Comfortable earnings profile: Return on managed assets was 2.3% for the full year ended March 31, 2019 (1.5% in H1FY20). It has been stable for the past three years, aided by healthy net interest margin of over 6.5% and low credit cost of 1.3% for fiscal 2019. Operating expenses, which had increased to 7.7% (as a percentage of average total assets) in fiscal 2017 on account of amalgamation of its business process outsourcing (BPO) operations fell to 6% during fiscal 2019, but continue to be relatively high.

Weaknesses:
* Ability to maintain asset quality metrics given the current challenging environment to remain monitorable:
Overall asset quality remains adequate, though gross NPAs have risen to 2.7% as on September 30, 2019, compared to 1.78% as on March 31, 2019 (2.0% as on September 30, 2018). The increase in gross NPAs was mainly account of increased slippages in the asset financing and LAP book.

Further, given the evolving situation for non-banking financial institutions on the liquidity front, since September 2018, asset quality in micro, small and medium enterprises segments, and loans against property (LAP) would be a key monitorable. This stems from the sensitivity of such borrowers to an environment of prolonged liquidity tightness. Though delinquencies in these loans are not high currently, owing to strong credit appraisal and risk mitigating mechanisms, if the liquidity situation does not stabilise, asset quality challenges could manifest.