Well played HDFC, the bond market will miss you

With the merger, there is a large gap in the bond market, giving opportunity for other lenders to fill the gap. But who will be the next HDFC? There is no straight answer to this simply because stepping into HDFC’s shoes is no mean feat.

In the past two financial years, HDFC, on average, raised Rs 640 billion each year over the E-Bidding platforms (EBP) of NSE & BSE, around 10% of the total amount raised by issuers over the EBP platforms. However, prior to the completion of the merger, HDFC already raised Rs 460 billion in the current financial year. HDFC’s large-ticket bond sale was necessitated by its balance sheet that grew on strong demand for housing loans. As of 31st Mar’23, HDFC’s loan book stood at Rs 6.2 trillion.

Market participants are betting on other housing finance companies to gain from HDFC’s exit. This is because, with the merger, the classification of HDFC’s outstanding bonds will move from housing finance to banking sector exposure. The Indian bond market is largely dominated by the banking sector – specifically by non-banking finance companies. Mutual funds are among the top buyers, but their investment in debt securities issued by NBFCs and housing financiers is capped at 30% of the assets under management, with a 20% ceiling for NBFC debt. There are similar exposure and rating caps for investors, including insurers and pension funds.

Given that demand for home loans remains strong, housing finance companies will look to also up their game and go aggressive on growth. Higher demand for quality paper will also give them access to funding at a lower cost, ensuring that growth is backed by healthy margins. But size and scale remain an issue.

Even if the home financiers go aggressive in lending, the process is likely to be gradual. This would mean that the investors will look for a variety of bonds within the broader NBFC space. Incidentally, Power Finance Corp, whose AAA-rated papers also have higher demand, seemed to have benefitted from the changing dynamic post classification of HDFC from housing finance company to banking sector one. This was the first large issue to be fully subscribed after yields rose in June-end/July-start. On July 10, PFC raised Rs 31 billion through the re-issuance of bonds maturing in May 2025 and a 10-year paper. Strong demand from long only investors like Insurance companies & Mutual funds helped compress the spread of PFC’s 10yr bonds over 10yr G-Sec.

Given the investor demand, banks are also expected to throw their hats into the ring by coming out with affordable housing and infrastructure bonds and capital-compliant bonds. The Reserve Bank of India (RBI) is also widely expected to keep interest rates unchanged – this is comforting for both investors as well as issuers as they will benefit from less yield volatility and no further rise in policy rates, respectively. Last month, IDFC First Bank and Punjab National Bank issued tier-II bonds, while Kotak Mahindra Bank raised nearly ₹19 billion through infrastructure bonds.The country’s largest lender State Bank of India also issues additional Tier-1 Bonds amounting to Rs30 billion. Other state-owned banks may follow suit to solidify their capital position to meet the growing demand for credit. There are already talks of the revival of private sector capex and banks gearing up to fund the next round of infrastructure building.

Credit growth in the banking sector remains strong. Deposit growth, though sluggish, has picked up in part aided by the withdrawal of Rs 2,000 notes from circulation. Nonetheless, banks may look to issue infrastructure and affordable housing bonds because of certain advantages.

According to the RBI’s rules, these bonds can be issued for a minimum of seven years, making the funds suitable for long-term lending. Moreover, the funds raised through such bonds are exempted from calculating reserve requirements such as cash reserve ratio and statutory liquidity ratio. HDFC Bank, post the completion of the merger, is expected to issue long-term affordable housing bonds to match the liabilities with home loans, which also have a longer maturity. For exactly this reason, the bank’s rival may also compete with it in the bond market.

HDFC’s exit has changed the dynamics of the bond market. NBFCs, home financiers and banks are all in the race to win the hearts of bond investors. Only time will reveal who, if any, becomes a worthy successor of HDFC in the bond market.

(Ajay Manglunia is MD & Head, Investment Grade Group at JM Financial)