Rating Rationale

Strengths
* Majority ownership by, and strategic importance to HDFC Bank: The ratings centrally factor in support that HDBFS 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 HDBFS' board, ensures adequate supervision over its performance. The company also receives regular funding support from its parent; the bank had infused Rs 3,480 crore cumulatively in HDBFS.

* Established presence in the retail finance segment: HDBFS has emerged as one of the larger players in the retail financing space, over the past few years. The overall loan portfolio has grown by 25% to Rs 55,425 crore as on March 31, 2019, from Rs 44,268 crore in March 31, 2018.. 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 35% as on March 31, 2019, as compared to 60% as on March 31, 2016. Whereas, that of CV/CE loans and business loans rose to 34% and 21%, respectively, from 21% and 15%, respectively, for the same period.

HDBFS 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 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 12.8%, and overall CAR of 17.9% (as per Ind AS) as on March 31, 2019. Networth expanded to Rs 7,178 crore as on March 31, 2019 (from Rs 6,040 crore in March 31, 2018), while gearing stood at 6.3 times. Cushion for asset side risks was healthy, as reflected in networth coverage for net NPAs at around 12 times. While internal capital generation remains healthy, the capital profile is also aided by periodic capital infusion by HDFC Bank.

* Comfortable earning profile: Return on managed assets (RoMA) was 2.3% for the full year ended March 31, 2019. It has been stable for the past three years, aided by healthy net interest margin (NIM) and low credit cost. Operating expenses which had increased to 7.7% (as a percentage of average total assets) in 2016-17 on account of amalgamation of its BPO operations have now declined to 6% during fiscal 2019, but continue to remain relatively high.

Weaknesses:
* Portfolio performance yet to be fully tested across economic cycles: Overall asset quality remains adequate, though gross NPAs have risen to 1.78% as on March 31, 2019, compared to 1.58% as on March 31, 2018.. Strong loan origination and credit underwriting practices, with a focus on risk management systems, help mitigate asset quality risks.

However, the loan book has grown by nearly 40% in compounded terms over the past five years. The unsecured loans segment (business loans) have grown at higher rate, and constituted around 21% of the overall portfolio as on March 31, 2019. Given the high growth, the portfolio is yet to be fully tested across economic cycles. The company's ability to manage asset quality across cycles or sector-specific issues, will be closely monitored.

Further, given the evolving situation for non-banking financial institutions on the liquidity front, since September 2018, asset quality in loans against property (LAP) and micro, small and medium enterprises (MSME) segments, would be a key monitorable. This stems from sensitivity of 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 over a period of time, asset quality challenges could manifest. Banks have been open to lending to non-banks via securitisation and traditional loans, and if they continue to do so, non-banks can benefit from the much-needed support. Growth in certain segments, nevertheless, would be curtailed for non-banks in the near to medium term, given their propensity to conserve liquidity and slow down disbursements in this space.