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Is HDFC’s merger
a with its subsidiary
a bailout plan?
The mortgage lender’s books are not
in the pink of health. A merger offers
its chairman a shot at glory.

T Surendar
Mumbai

Furquan Moharkan
Delhi
June,
 Unlocked story

No one turns down Deepak Parekh, the non-executive chairman of Housing Development Finance Corp. Ltd, India’s biggest
home loan lender. After all, he is among the most respected executives in the corporate world, credited with having laid the
foundation of the mortgage loan business in the country and on the boards of several companies.

Yet, it turns out that in , when Parekh broached the subject of a merger between HDFC with its more valuable listed
subsidiary HDFC Bank, to create India’s most valuable financial entity, it was shot down quietly.
In banking circles, the reasons for this were ascribed to an ego clash between Parekh and Aditya Puri, then CEO of HDFC
Bank. HDFC's top management was senior in age, whereas the bank had younger management. But, Puri felt that since the
bank had surpassed its parent in financial metrics, its executives should call the shots in the merged entity. Parekh, on his
part, was said to be uncomfortable with his team playing second fiddle.

It now transpires that there were deeper reasons for the merger not going through. Parekh apparently ran into stiff
resistance from Puri and his trusted lieutenants like Abhay Aima, then head of private banking. Their resistance stemmed
from a basic issue—HDFC’s books weren’t as good as they were made out to be.

“Both Adi Puri and Abhay vehemently opposed the merger. Adi felt that the swap ratio was unreasonably in favour of HDFC,
while Abhay’s resistance was more nuanced; his argument was HDFC can’t make money on its retail book, and its wholesale
book is a mess,” says a former HDFC Bank executive, with direct knowledge of the matter, asking not to be named.

Five years on, the mega merger is back on track; it was announced in April that HDFC Bank would take over HDFC in a $
billion, or around Rs lakh crore, deal. But the issues that stalled it the first time around remain; in fact, they may have
actually worsened.

On paper, HDFC’s business, which has always been strong, grew by leaps and bounds between the financial years and
, with its profits touching a high of Rs , crore in - . Its delinquent loans, at less than . % of a massive book
of Rs . lakh crore, were on the lower side of the industry average. Yet the runaway growth and subsequent slowdown after
the pandemic’s onset seem to have taken their toll. HDFC’s stressed book has been mounting over the last two years and the
size of its doubtful portfolio is estimated at a whopping Rs , crore, three times the number disclosed. Besides, HDFC is
stuck in several real estate projects.
“HDFC’s sheer scale gave it the power to whitewash several questionable deals, which will all be dug up as the merger
process is put into motion,” says a senior executive who previously headed a housing finance company, asking not to be
named.

With Puri out of the picture after his retirement, Parekh is making a renewed effort at a merger. One that will give him the
sign-off he is looking for—where HDFC’s issues stay hidden in plain sight and he gets to cement his legacy as the architect
of India's most valued financial services company.

We sent a questionnaire to HDFC on Tuesday but haven’t heard back. That said, let’s take a closer look at what ails HDFC and,
by extension, how Parekh may have contributed to many of its problems.

What lies beneath

HDFC was set up in but its first real competition, state-owned LIC Housing Finance, arrived only years later. At the
turn of the century, public sector banks started lending to a growing home mortgage market, but none of them came close to
threatening HDFC’s pole position in the mortgage loan business. Its scale and prudence saw it through many storms and it
grew at a steady pace.

In the last decade, private equity money supercharged the growth of the industry, the effects of which became apparent in
the last seven years. According to a report by Sameer Padole in Investing.com, between the financial years and , the
home loan market grew at %. The contribution of high-priced housing increased from % in fiscal to % in .

These years were also marked by mortgage lenders extending loans to realty firms, besides their usual home loan customers.
HDFC, which desisted for the longest time from advancing loans to realty firms, had to follow the others. So, it began giving
loans to builders of big-ticket housing projects and also to customers who bought homes in these projects. In , the
collapse of infrastructure finance firm IL&FS wreaked havoc on the non-banking finance sector and HDFC also felt the
impact.

As on March , HDFC reported gross non-performing assets of Rs , . crore. The number may not be large given
the fact that it constitutes just . % of the lender’s Rs . lakh crore loan book. But the pace at which its bad loans have
grown is alarming: from Rs , . crore in - to Rs , . crore in - —a . x jump in the span of just two
years.

Significantly, of those two years, for almost a year, the NPAs were under a freeze because of a Reserve Bank of India
moratorium. HDFC tried to minimize the impact of the growing NPAs by giving out more loans. But that didn’t help. In these
two years, gross NPAs, in absolute terms, were up % while the loan book grew by just %.

Also, owing to its somewhat opaque reporting, HDFC’s bad loan numbers make for confusing reading. In its annual report
for - , HDFC claimed that . % of its builder/project housing loans and . % of its corporate housing loans were
NPAs. However, it is impossible to ascertain the absolute quantum of bad loans in these segments as HDFC doesn’t give out a
detailed breakup of housing and non-housing loans. A company executive, asking not to be named, says these loans aren’t a
big part of its lending portfolio, hence the skewed NPA percentage.

Growing NPAs aren’t the only problem in the books of HDFC. At the end of March , the unsecured loan book stood at Rs
, . crore. In the next two years, almost every other financial institution went about trimming its unsecured loan book,
given the prevalent economic uncertainty. Yet, HDFC saw its unsecured loan book more than double to Rs , . crore at
the end of March .
The jump in unsecured loans amid a pandemic and large-scale economic uncertainty raises a key question: Who was HDFC
betting on during a crisis to lend without any collateral?

“When HDFC’s loans to construction firms turned doubtful, it could have given further loans without collateral to salvage
the position. That may be one explanation but it is really surprising that unsecured loans increased when the non-banking
financial companies crisis hadn’t yet been resolved fully,” says the CEO of a realty consultancy firm, requesting anonymity.

HDFC also has a peculiar category of loans: loans against intangible assets worth Rs , . crore as of March . Such
loans, if given against patents (that can be monetized), are perfectly normal. But HDFC operates primarily in the real estate
space, where patents are almost non-existent. The company executive mentioned above says these intangible assets are in
the form of “personal guarantees”. Clearly these loans are a concern.

All these are over and above the expected credit loss of Rs , . crore at the end of - —more than twice the Rs
, . crore for Bajaj Finserv, another successful NBFC. The expected credit losses and bad loans alone leave a Rs ,
crore hole in HDFC’s book. This is excluding the problems in the unsecured book and loans against intangible assets—which
have been a cause of concern for most lending institutions in the last two years. Industry veterans and people within HDFC
Bank peg the hole in HDFC’s book at Rs , crore.

“In many cases where YES Bank is stuck, HDFC is also stuck. They have lent to a lot of troubled realtors,” says the CEO of a
private bank, asking not to be named. This claim was confirmed by two former executives at HDFC Bank, with direct
knowledge of the matter.

Among troubled realtors, HDFC has a large exposure in Radius Estates and Developers, DB Realty and Nirmal Lifestyle. The
case of Radius reveals how reckless HDFC has been while lending to realtors. The National Company Law Tribunal has
accepted claims worth Rs . crore from HDFC during the insolvency proceedings pertaining to Radius. In the unsecured
segment, HDFC’s claims are the highest among all lenders—worth Rs . crore and making up % of all the unsecured
claims submitted.

In the secured segment, HDFC’s loans constitute % of the total exposure (debentures included) of all lenders to Radius—
worth Rs . crore. If you exclude non-convertible debentures, HDFC accounts for % of the secured claims of financial
creditors from Radius. When secured, unsecured and operational creditors are taken together, HDFC accounts for % of the
claims. Clearly, risk metrics at the country’s largest mortgage lender were sent for a toss.

In the midst of all this stands Parekh, who hasn’t exactly covered himself in glory.

Far from kosher

Parekh deserves credit for navigating the ups and downs of the real estate industry without as much as a blip in HDFC’s
performance, especially since the Lehman Brothers crisis in . But, a retired public sector banker we spoke with says that
since he quit his executive position in , Parekh’s style of functioning has raised eyebrows. The clout that HDFC wielded
with realty firms—its endorsement of a project was all that was needed to sell apartments to buyers, many of whom
borrowed from the firm—led Parekh to use tactics that were not always above board. To stop loans extended to realty firms
turning into NPAs, he would use his discretion and hand out structured finance that would only increase the risks a project
faced. He would recover his money but the methods weren’t exactly by the book.

A very recent example is the loan given to the Shapoorji Pallonji Group, one of HDFC’s oldest clients. HDFC lent Rs ,
crore on the penultimate day of the financial year . The group was still under a one-time debt recast and reported in
early April that it had paid off its entire outstanding debt to exit the recast scheme. It is not immediately clear if HDFC’s loan
helped the group clear its debt, but there is every indication that loans to the group won’t figure as stressed assets when
HDFC publishes its audited balance sheet for the fiscal.

“This wouldn’t have been possible in a bank as RBI rules don’t allow it. These are exactly the kind of loans which should have
been qualified as delinquent and Parekh may have well used his discretion against doing so,” says the retired banker, on
condition of anonymity.

Parekh is also on the boards of several publicly traded companies as well as several of HDFC’s subsidiaries whose businesses
are closely linked with the parent. Take HDFC Asset Management Company, which manages HDFC Mutual Fund. It invests in
several companies that have Parekh as a director and also in real estate firms that HDFC lends to.

“There are a lot of lines that cross within Parekh’s businesses and there is bound to be at least some conflict of interest,”
says the retired banker quoted above.

In , a bunch of institutional investors voted to remove Parekh from the board of HDFC as they felt he was already on too
many boards of listed companies and wasn’t focused enough on his company. Parekh managed to stay on, but by a slim
margin.

Coming back to the Rs , crore hole in the books of HDFC. The Morning Context couldn’t independently verify the
number. But it’s not as if no one is aware of the issues at the lender. “The mess in HDFC’s books has been talked about in the
[finance] ministry for the past five months. Only thing is that HDFC is too big to make this problem public,” says a senior
central government official, asking not to be named.
“Parekh was always known as the smart, connected lender in the street and always escaped collapses nicely. That he is stuck
in several real estate projects shows that he has lost his touch over the years. He should have quit two years ago when HDFC
posted record profits,” says the principal of a London-based private equity firm that specializes in real estate.

The former HDFC Bank executive quoted above agrees. “When the plan for a merger was floated earlier, we realized that
there was little to no risk assessment in most of the wholesale loans. They were given more on the basis of personal
relationships.”

It took Parekh all of days from appointing bankers Merrill Lynch, Morgan Stanley and Dhruva Captial to announcing the
merger plan. But, by the looks of it, he has a long haul ahead of him before final approvals come in.

Parekh has the next months to get things cleared up. According to RBI rules, banks are not allowed to lend against land as
collateral, which HDFC has done in the case of realty firms. The company will also need to retire structured loans and loans
that have been rolled over inordinately to ensure that they don't become NPAs. Parekh, according to a former CEO of a
private bank, is personally supervising the closing of several of these loan accounts by pushing for prepayments. This is
important as if it is not done, HDFC Bank will have to report a chunk of these loans as NPAs.

For Parekh, the countdown has begun.

Lead image by Chetan Singh/The Morning Context

Banking & finance

Deepak Parekh
HDFC Bank
NPA
HDFC
Aditya Puri
Disclaimers: The Morning Context has raised money from a clutch of investors, entirely in their personal capacity.
It is quite likely that some of them may be directly or indirectly involved in a competing line of business similar to
the companies we write about. Our full list of investors is here

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