In today’s Finshots, we tell you how banks package their loans to sell them to investors, and what’s happening with HDFC Bank on that front.

The Story

HDFC Bank’s loan growth has been nothing short of spectacular, consistently rising around 20% year-on-year until Q1FY25. But the growth came to a screeching halt, dropping to a mere 7% in the second quarter.¹

Now we don’t need to tell you that loans are the bread and butter of a bank’s business. And HDFC Bank being the private sector market leader, faltering here could have sent shivers down stakeholders’ spines.

Yet, no one seemed to be losing sleep over it. Investors were pleased, the management had a plan, and HDFC Bank’s stock even rose after it announced its results.

The reason?

Well, you might have guessed it ― the bank’s merger with HDFC Ltd. in July last year, which changed how HDFC Bank’s balance sheet looked.

For context, before the merger, HDFC Bank’s liabilities were primarily made up of deposits from customers like you and me. In fact, just 8% of its liabilities came from other borrowings.² But post-merger, that 8% figure shot up to over 20%. It’s quite the shift because for every ₹100 the bank owed, ₹21 came from borrowed money, compared to just ₹8 earlier.

And this increased reliance on borrowings, had a ripple effect.

For starters, it raised HDFC Bank’s cost of funds from about 4% to 4.9%.³ Meaning, the costs of its borrowed money increased. Its credit-to-deposit ratio (C/D ratio) shot up too, from a comfortable 85% before the merger to a hefty 110%. In simple terms, HDFC Bank was lending out ₹110 for every ₹100 in deposits. This meant that it was relying heavily on more expensive borrowings with higher interest costs than customer deposits.

Now, a C/D ratio above 100% isn’t ideal in the banking industry. It means that the bank’s lending is outpacing its deposit growth. And that’s risky business, especially if the economy turns sour.

So, HDFC Bank needed a game plan to tackle this. And boy, did they have one!

HDFC Bank’s MD and CEO, Sashidhar Jagdishan, outlined it pretty clearly in the latest annual report:⁴

The Bank will continue to focus on granular deposit mobilisation…

It is our endeavour to bring down the credit to deposit ratio to pre-merger levels…

During this time of adjustment, the Bank would grow its advances a little slower than the deposit growth.

In short, the focus was on growing cheaper deposits, slowing down loan growth and offloading some loans. And here’s where things get interesting. Because one of the big ways HDFC Bank is managing its C/D ratio is by selling off chunks of its loan portfolios or simply loan securitization.

What’s that, you ask?

Imagine HDFC Bank has given out a batch of car loans. Now, instead of keeping all these loans on its books, the bank bundles them and slices it up to sell to investors — mutual funds, insurance companies, etc., who are hungry for steady returns.

You could think of HDFC Bank as a baker, who’s baked a car loan cake with just the right ingredients —  high-quality loans with an internal rate of return of 8.9%. Instead of eating the whole cake, it sells slices to eager investors who want a taste of these steady returns. HDFC Bank still services these loans, collecting payments from borrowers. And just like that, HDFC Bank offloads the piping-hot liabilities, keeps the kitchen clean (their balance sheet) and collects a tidy sum upfront, all while continuing to serve slices to investors as their loan payments come in.

In September 2024, HDFC Bank securitized over ₹9,000 crores worth of car loans. And now, they’re at it again, securitizing another ₹12,300 crores in car loans.⁵ These loans are rated AAA by India Ratings & Research, meaning they’re of top quality. Plus, a default guarantee of about ₹330 crores is bundled in to give investors extra assurance. Simply put, it’s a guarantee or a safety net of sorts to reassure investors that they won’t lose their money if something goes wrong with the loan repayments.

So has this strategy worked for the bank?

Well, you see, selling loans like this does a few things.

First, it improves liquidity or frees up cash for the bank, which it can use for other purposes, like expanding its branch network or pursuing new growth opportunities.

Further, since the loans are now off the books, the bank’s credit figure drops, which helps bring the C/D ratio closer to its pre-merger levels. In fact, after the September securitization, HDFC Bank’s C/D ratio has already improved from 110% to 100%. And that means the bank is moving towards bringing this to pre-merger levels of about 80%.

Offloading these loans also means that HDFC Bank isn’t stretching itself too thin. It’s focused on a more sustainable and profitable growth. So essentially, the sale of these loans helps it avoid taking on too much risk and instead concentrate on controlled, consistent expansion.

And the results are starting to show. As of September 2024, HDFC Bank’s total deposits grew by 15% year-on-year, its C/D ratio dropped (as mentioned earlier) and the bank has been expanding rapidly, adding new branches across India.

But before we all cheer, let’s take a step back and ask ― Are securitizations always a good thing? Because if they were, wouldn’t every other lender be securitizing their loans?

Look, selling loans means that HDFC Bank also gives up future interest income from these loans. So instead of earning regular interest payments over the years, it gets a one-time payment from investors. This could impact profitability in the long run if the bank doesn’t effectively redeploy that cash into other profitable areas.

For instance, the car loans being securitized have maturities extending to as far as November 2030. This means that HDFC Bank has essentially swapped future cash flows for immediate liquidity. Sure, that gives flexibility now. But it also means that the bank will need to work harder to generate income from new sources to repay the securitized loans.

Moreover, loan securitization only works well when there’s enough demand from investors for these assets. If investor appetite dries up, the bank could find it harder to offload loans, especially if those loans are riskier or have a higher chance of default.

But at least for now, it looks like HDFC Bank’s approach seems to be working. Investors are pleased with the bank’s careful balancing act which is slowing down loan growth, ramping up deposits and strategically selling loans. The bank’s shares even jumped after announcing the second car loan securitization. So maybe that reflects the market confidence in its strategy.

In the latest earnings call, the bank’s management also mentioned that the cash it generated from securitization could be used for growth purposes, like branch expansion.⁶ Just last year, the bank added around 900 new branches, and plans to open another 1,000 branches by the end of this (calendar) year.

So yeah, now you know why HDFC Bank is selling its loan portfolios — to stay nimble, keep growing and make sure that it’s always ready for whatever comes next.

Until next time…

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Story Sources: The Hindu [1], The Daily Brief [2], HDFC Bank [3], [4], [6], The Economic Times [5]

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