CREDIT RATING REPORT. Gruh Finance Limited. September 2017

CREDIT RATING REPORT Gruh Finance Limited September 2017 1

Instruments & ratings Rs 5.0 Billion Non Convertible Debentures Non Convertible Débentures Aggregating Rs 36.50 Billion Rs 0.35 Billion Subordinated Debt Issue Fixed Deposit Programmed Rs 55.0 Billion Short-Term Debt Programme CRISIL AAA/Stable Assigned) CRISIL AAA/Stable (Reaffirmed) CRISIL AAA/Stable (Reaffirmed) FAAA/Stable (Reaffirmed) CRISIL A1+ (Reaffirmed) Analytical contacts Krishnan Sitaraman Senior Director - CRISIL Ratings Phone:+91 22 3342 8070 krishnan.sitaraman@crisil.com Ajit Veloni Director - CRISIL Ratings Phone:+91 22 4097 8209 Ajit.veloni@crisil.com Customer service helpdesk Timings: 10:00 am to 7:00 pm Toll-free number: 1800 267 1301 To receive a copy of rationale and/or rating report, write to crisilratingdesk@crisil.com For analytical queries, write to ratingsinvestordesk@crisil.com CRISIL Complexity Levels are assigned to various types of financial instruments. The CRISIL Complexity Levels are available on www.crisil.com/complexity-levels. Investors are advised to refer to the CRISIL Complexity Levels for instruments that they propose to invest in. Investors can also call the Customer Service Helpdesk with queries on specific instrument 2

Rating history Date Long-Term Fixed Deposit Short-Term Rating watch/ Outlook September 08, 2016 CRISIL AAA FAAA CRISIL A1+ Stable May 03, 2016 CRISIL AA+ - Positive CRISIL A1+ - FAAA Stable November 25, 2014 CRISIL AA+ FAAA CRISIL A1+ Stable Analytical approach and adjustments Portfolio performance/networth/ gearing/parent or group support Return on assets (RoA) Adjusted networth Weak assets Support from parent Analytical treatment CRISIL has used RoA to measure profitability in the absence of a securitised portfolio. Networth is adjusted for intangible assets and deferred tax assets CRISIL calculates weak assets for housing finance companies (HFCs) by taking the current year s gross non-performing assets (NPAs) as a percentage of gross advances two years ago Gruh Finance Ltd s (Gruh s) strategic importance to, and significant support expected from, its parent, Housing Development Finance Corporation Ltd (HDFC; rated CRISIL AAA/FAAA/Stable/CRISIL A1+ ) has been factored into the rating. CRISIL has assigned its 'CRISIL AAA/Stable' rating to the Rs 5.0 Billion non-convertible debenture issue of Gruh Finance Ltd (Gruh). The ratings on Gruh s other debt instruments have been reaffirmed at 'CRISIL AAA/FAAA/Stable/CRISIL A1+'. Rating drivers Supporting: Expectation of continued strong support from the company s majority owner, HDFC Healthy asset quality Comfortable earning profile Constraining: Modest asset-liability management (ALM) profile given its high dependence on short-term funds Geographical concentration in operations Outlook: Stable CRISIL believes HDFC will retain its majority shareholding in Gruh, and continue to extend strategic, management, and financial support to the company, over the medium term. Moreover, the company will maintain healthy asset quality and a comfortable earnings profile over this period. Downside Scenario: The outlook may be revised to negative if there is Diminution in support from HDFC, or weakening, in CRISIL's view, of HDFC's credit risk profile. Significant and sustained weakening in Gruh's asset quality or earnings profile 3

Recent developments and performance update Gruh Finance s disbursements grew 27.7% (y-o-y) to Rs 12.0 Billion for first quarter of fiscal 2018 (Rs 9.4 Billion for first quarter of fiscal 2017). Disbursement 5 year CAGR stood at ~22%. Loan outstanding as on June 30, 2017 was Rs 136.95 Billion, registering an 18.6% y-o-y growth. As on June 30, 2017, the gross NPAs and two-year lagged gross NPAs stood at 0.6% and 0.9% respectively (0.3% and 0.5% as on March 31, 2017), and were lower than the industry average. This is despite the company catering to relatively riskier low-income group customer segments and having nearly 45% of the customers in the non-salaried segment. Resource profile is diversified with National Housing Board (NHB) financing and bank loans forming 29% and 5%, respectively of the borrowings as on June 30, 2017. Fixed deposits, non-convertible debentures (NCDs) and Commercial paper form 12%, 29% and 25%, respectively. Average cost of borrowing declined to 7.7% (annualised) for the first quarter of fiscal 2018 from 8.5% (annualised) for the first quarter of fiscal 2017. Gruh has comfortable capitalisation with Tier I and overall CAR of 15.57% and 17.02%, respectively as on June 30, 2017 (16.82% and 18.32% as on March 31, 2017). Networth was Rs ~10.75 Billion as on June 30, 2017 (Rs 11.13 Billion as on March 31, 2017). Gruh had a gearing of 11.60 as on June 30, 2017 (10.8 times as on March 31, 2017). Company's return on average assets (RoA), at 2.1% in the first quarter of fiscal 2018 (2.4% in fiscal 2017), was higher than that of some large housing finance companies (HFCs). While Gruh's profitability may moderate driven by the intense competition from banks and other HFCs, its profitability is expected to remain higher than industry average over the medium term supported by healthy interest spreads and low credit costs. About the company Gruh (formerly, Gujarat Rural Housing Corporation Ltd) was set up in 1986 by HDFC and the Aga Khan Fund for Economic Development, with the objective of providing an institutional structure to rural housing finance. Gruh primarily extends housing loans to individuals in rural and semi-urban areas to relatively low-income group market segment for multiple purposes, ranging from house construction to renovation. The company has a distinct target market segment, which complements HDFC s market. Shareholding pattern as on March 31, 2017 Shareholder particulars % 1 Promoter and promoter group 58.45 HDFC 58.45 2 Public 41.55 Mutual Funds 8.13 Foreign Portfolio investors 11.34 Others 22.08 Total 100.0 Key credit factors Industry risk profile Housing financing companies (HFCs): performance to remain steady Growth in the HFC industry remains healthy at around 20%, with outstanding advances aggregating ~Rs 8.1 trillion as on March 31, 2017. Affordable housing has emerged as a new growth driver for HFCs. HFCs have also been able to ramp up their non-housing portfolios, including loans against property (LAP) and wholesale finance (developer funding and LRD). However, some slowdown in overall growth is envisaged in the near term, primarily due to implementation of the Real Estate Regulation Act (RERA), as developers realign their business models. Nevertheless, RERA is expected to provide long-term benefits to the sector. 4

Given the growing demand for housing, long-term growth potential remains high with the overall portfolio expected to touch ~Rs 14 trillion by fiscal 2020. Growth in individual home loans will be driven primarily by Tier-II and -III cities, with affordability in the metros likely to remain low. Competition from banks will, nevertheless, remain intense, especially given decline in the corporate segment s demand for loans, and the lower risk weights and strong asset quality in home loans. While there was some slowdown in disbursement of housing loans by banks in the third quarter (Q3) of fiscal 2017, due to demonetisation, growth has picked up again from Q4 fiscal 2017; the trend is expected to continue over the medium term. Chart 1: Growth in overall advances of HFCs Chart 2: Growth in home loans Banks vs HFCs Asset quality remains comfortable, with limited impact of demonetisation: overall gross non-performing assets (NPAs) were low at 0.9% as on March 31, 2017. Performance of CRISIL-rated mortgage-backed security (MBS) pools also remains healthy with a cumulative collection ration of 99.7%. A marginal increase in delinquencies is, however, expected by March 2018 (refer to Chart 3). With seasoning in the portfolios of rapidly-growing HFCs, many of which are focused on a diverse set of customers, there could be a gradual increase in delinquencies in the home loan segment. Asset quality in the non-individual segment will also be closely monitored with delinquencies inching up in both developer financing and LAP portfolio. The large HFCs have managed their LAP portfolios better, backed by strong underwriting practices. However, despite strong collateral cover, systemic delinquencies in the segment should rise as the portfolios attain seasoning. Chart 3: Asset quality to remain healthy 5

Profitability is expected to remain stable over the medium term, with the HFCs return on assets (RoA) expected at 1.8-1.9% (refer to Chart 4). Despite a favourable interest rate scenario, RoA may remain rangebound on account of the competitive dynamics in the home loan market. Profitability continues to be supported by healthy net interest margin (NIM) and low operating costs. Furthermore, credit costs are unlikely to increase materially in fiscal 2018 given the adequate provisioning coverage of around 45%. Chart 4: Profitability to remain adequate Affordable housing: the new growth engine Affordable housing is fast emerging as a new growth driver for HFCs especially the new entrants given the increased competition and relative saturation in key metro markets. To top it up, Government initiatives such as Housing for all by 2022 and regulatory impetus have provided some much needed stimulus. CRISIL estimates the affordable housing segment at around Rs 1.6 trillion, constituting more than 25% of all housing loans as on March 31, 2017. CRISIL Ratings defines affordable housing loans as those with ticket sizes of less than Rs 1.5 Million. Several HFCs, whether part of large financial services groups, or funded by private equity, have entered the segment in recent years, focusing on affordable housing. These players have grown rapidly, and are expected to register a CAGR of 40% over the next three years. However, given the underlying borrower profile, asset quality tends to be more volatile in the segment. Also, given the lack of seasoning, asset quality remains largely untested. Operating and credit costs are also high in the segment. Nevertheless, higher returns compensate for these risks and costs to a large extent. Overall, appropriate credit assessment and underwriting practices, as put in place by the established players, will be a determinant of growth in the long term. Parent support Strong support from parent, HDFC HDFC is expected to continue to provide strategic, management, and financial support to Gruh. CRISIL believes that HDFC will likely retain its majority ownership in the company over the medium term. However, the extent of HDFC s ownership in, and support to, the company remains a rating sensitivity factor. HDFC owns 58.5% of Gruh s equity shares as on March 31, 2017. Gruh derives strong management support from HDFC in formulation of guidelines and policies. HDFC s vice-chairman and chief executive officer, and managing director are Gruh s chairman and non-executive director, respectively. Gruh s managing director is a former HDFC employee. In the past, HDFC has also invested in Gruh s subordinated debt programme and has bought Gruh s securitised portfolio. Gruh s association with HDFC enables bank funding at competitive rates. Additionally, 6

HDFC extends support to Gruh, as its operating policy, sanctioning norms, and loan schemes are formulated with inputs from HDFC. Gruh is focused on a niche segment primarily the low-income groups in rural and semi-urban areas as distinct from HDFC s target segment; Gruh and HDFC are, therefore, not direct competitors, despite operating in the same industry. Gruh also cross-sells HDFC products, such as insurance; the company is a referral agent for HDFC Standard Life Insurance Company Ltd. However, the quantum of agency business remains small. The extent of HDFC s ownership in, and support to, Gruh will be a rating sensitivity factor. Business risk profile Higher-than-industry average loan growth, to capitalize on strong growth in affordable housing Chart 5: Trend in Disbursements Chart 6: Trend in portfolio outstanding Gruh has maintained a higher-than-industry-average loan growth over the past several years. Its loan book increased to Rs 132.4 Billion as on March 31, 2017, registering a compound annual growth rate (CAGR) of 27% against industry average of around 20% between fiscal 2012 and fiscal 2017. Loan disbursement also grew at a strong CAGR of 23% over the same period. Gruh has more than three decades of experience in the affordable housing segment and is therefore expected to benefit from strong growth potential in the affordable housing segment. A major chunk of the demand for housing over the next few years may be in this segment, where the financing potential is sizeable. Government of India is also offering incentives such as credit-linked subsidy to customers, and schemes for builders under Affordable Housing in Partnership, under the Pradhan Mantri Awas Yojana. Further, state Governments such as Maharashtra, Gujarat, Madhya Pradesh and Rajasthan are more active than other states in promoting the affordable housing segment. Gruh has created a strong competitive position in affordable housing finance segment. Its assets under management have grown at a compound annual growth rate of around 27% over the past five years. The company has requisite expertise, reach and risk management systems to cater to this segment which will translate to a strong growth potential for the company in this segment. CRISIL believes Gruh, being a leading player, will benefit from the expected growth potential in the affordable housing finance segment and maintain healthy growth over the medium term. However, the company continues to be a relatively small player in the housing finance market which is primarily dominated by banks and few large HFCs. Gruh faces stiff competition from these banks and other housing companies. Gruh operates primarily in the rural and semi-urban areas of Gujarat and Maharashtra; these two states accounted for 69% of outstanding loans as on March 31, 2017. Therefore, the company is exposed to risks related to geographical concentration. However, operations have been expanded across 7

other states including Rajasthan, Madhya Pradesh, Tamil Nadu, Karnataka, Chhattisgarh, Uttar Pradesh, Jharkhand and Bihar to support growth and diversification. Hence, risks related to geographic concentration are likely to decline gradually over the medium term. Healthy asset quality, supported by strong risk management systems and processes Chart 7: Trend in NPAs and weak assets Gruh has demonstrated its ability to maintain healthy asset quality over the business cycles as the gross non-performing assets (NPAs) have remained lower than the industry average, over the past few years. Its gross NPAs were 0.31% as on March 31, 2017, as against the industry average of 0.85%. Additionally, weak assets (two-year lagged gross NPAs), at 0.46% as on March 31, 2017, remains significantly lower than the industry average of around 1.2%. Asset quality has remained healthy, despite above-industry average growth in the loan portfolio over the past five years. Further, the company has high exposure to relatively riskier self-employed segment (comprising professionals, and customers with formal business income, and assessed income); at around 41% of the advances as on March 31, 2017. Asset quality is supported by stringent credit appraisal, monitoring systems, and processes, which helps the company to mitigate inherent challenges arising from lending to riskier lowincome customer segments. Furthermore, conservative lending policies have also helped Gruh minimise risks in the builder loan segment; as there has been no delinquency in its portfolio for the past five years, though the segment has always been a small proportion of its portfolio (4.49% of the portfolio as on March 31, 2017). Gruh has benefited from its linkages with the parent, and has put in place strong risk management systems as reflected in the rigorous strong credit underwriting standards and efficient credit monitoring, and recovery mechanisms. It has conservative loan eligibility norms. Currently, around 95% of the outstanding loan portfolio has been sanctioned to individuals, which, therefore, reduces risks related to customer concentration (due to low average ticket-size loans). Large exposures (above Rs 50 Million) are primarily sanctioned to builders with an established track record of more than five years. CRISIL believes Gruh s strong risk management systems, prudent underwriting norms, and collection mechanism will enable it to maintain healthy asset quality over the medium term. 8

Diversified resource profile and competitive borrowing costs Chart 8: Borrowing mix and cost of borrowing 100% 80% 60% 40% 20% 0% 12.0% 9.3% 9.6% 9.2% 8.8% 8.3% 34 0 31 47 39 8.0% 46 9 0 13 1 7 14 13 16 15 4.0% 36 28 33 39 30 20 11 2 8 9 0.0% 2012-13 2013-14 Bonds and Debentures 2014-15 2015-16 Banks 2016-17 Fixed deposits CPs NHB Cost of borrowing (yearly average- RHS) Resource base is stable and adequately diversified. The company has established relations with over 25 banks, and has access to capital market, mutual funds and insurance companies to meet its short term and long term funding requirement. NHB financing, bank loans and NCDs form 31% 36%, and 20%, of the borrowings as on March 31, 2017, respectively. Gruh also focuses on raising retail deposits (around 13% as on March 31, 2017), which provides stability to its resource profile. It raises fixed deposits with renewal rate of more than 42.9%. Further, Gruh regularly accesses the short-term debt market, to take opportunistic advantage between short-term and long-term interest rates. In addition, the company also has an option of securitisation with HDFC, which further supports its resource profile. Average cost of borrowing declined to 8.3% for fiscal 2017 from 8.7% in fiscal 2016 and remains lower than the industry average. 9

Financial risk profile: Adequate capitalisation Chart 9: Trend in Networth and Capital Adequacy Capitalisation is adequate in relation to current business and growth plans, underpinned by healthy accrual to networth and flexibility to raise additional capital, if required. The company had an adequate tangible networth of Rs 11.13 Billion as on March 31, 2017 (Rs 8.35 Billion as on March 31, 2016). Tier I and overall capital adequacy ratios increased to 16.8% and 18.3%, respectively, as on March 31, 2017 (16..1% and 17.8%, respectively, as on March 31, 2016) on account of reduction in risk weights for the housing loan. Capitalisation is supported by healthy accretion to networth (return on equity exceeding 30% over the past three years), flexibility to raise additional capital if required, and robust asset quality. A significantly high provision cover for NPAs provides strong cushion against asset-side risks. However, Gruh has a higher-thanindustry average gearing of 10.8 times as on March 31, 2017 (12.3 times as on March 31, 2016) and remains a key monitorable. CRISIL believes that Gruh will maintain adequate capitalisation, supported by healthy accruals to net worth, flexibility to raise capital and strong net worth coverage for asset-side risks. 10

Comfortable earnings profile, with high spreads and low credit costs Chart 10: Trend in PAT and ROA Earnings profile remains comfortable, marked by higher-than-industry average return on assets (RoA). This is primarily driven by higher interest yields and lower than industry average borrowing costs, supported by efficient treasury management practices. RoA has remained above or close to 2% on a consistent basis, which is higher than that of some large housing finance companies. RoA at 2.4% in fiscal 2017 remained higher than that of peers (industry average RoA of 1.9% in fiscal 2016). The RoA, however, has declined from high levels three years back due to pressure on interest yields. Increased competition, primarily from banks, is lowering interest yields in the industry. Net profitability margin (NPM) in fiscal 2017 remains higher than industry average at 2.60%, despite declining from 2.86% in fiscal 2016. Decline in yield has been partially compensated for by lower interest costs in fiscal 2017. Table 1: Trend in Net Profitability Margin (In per cent) For the year ended 2016-17 2015-16 2014-15 2013-14 Yield on average funds deployed 11.61 12.04 12.65 12.84 Borrowing cost 8.26 8.75 9.24 9.67 Spread 3.35 3.29 3.41 3.16 Operating expenses/average funds deployed 0.75 0.83 0.79 0.88 Core fee income/average funds deployed 0.00 0.40 0.41 0.53 Net Profitability Margin 2.60 2.86 3.02 2.83 Strong focus on the affordable housing segment helps generate above-average yields. Furthermore, Gruh raises significant short-term debt through commercial paper that carries relatively low interest rates and help reduce overall interest cost compared to the industry average. Gruh also has robust asset quality, thus supporting its profitability. Its credit costs are expected to remain low (0.26% of average assets in fiscal 2017) over the medium term. Gruh s policy of maintaining significantly high provision to cover NPAs also reduces the impact of adverse asset quality movements on its future earnings. Gruh s operating expenses also remain low and have declined from earlier high levels. Its operating expenses at 0.75% of the average assets in fiscal 2017, declined from the level of 1.09% in fiscal 2011. 11

CRISIL believes that while the company s profitability may moderate driven by intense competition from banks and other HFCs, profitability is expected to remain better than that of its peers over the medium term supported by healthy interest spreads and low credit costs. Modest ALM profile Gruh resorts to short-term debt to benefit from relatively lower interest rates for short-term loans as compared to rates for long-term loans. As a result, the company runs negative cumulative mismatches in short-term buckets of up to one year. The cumulative mismatches in up to one year bucket, on a steady state basis remain in the range of 20-70% of cumulative outflows. As on March 31, 2017, cumulative positive mismatches in up to one year bucket were around 57.25%. However, Gruh s liquidity through unutilised National Housing Board (NHB) limits and bank lines, and fixed deposits with banks of Rs 29.19 Billion as on March 31, 2017, adequately covered the negative cumulative mismatches in the maturity bucket of up to one year. Further, the company has efficiently managed ALM mismatches thus far, across interest rate cycles, and during stretched liquidity situations in the market, reflecting its good treasury management practices and good relationships with its bankers. Ability to manage asset-liability mismatches and liquidity in tight liquidity conditions remains a key monitorable. Base case assumptions for 2017-18 AUM growth 20%-30% Gearing 11 to 12 times RoA 2.3%-2.5% Management Assessment: Organisation structure Name Mr Sudhin Choksey Mr Kamlesh Shah Mr Hitesh Agarwal Mr Marcus Lobo Mr Suresh Iyer Mr Amit Chokshi Mr Venu G Menon Mr Jayesh Gangwani Designation Managing Director Executive Director Chief Financial Officer Company Secretary Head of Operations Head of Project Finance & Legal Head of Resources Head of IT and Software Support Experienced management with strong risk management practices Gruh has a professional and experienced senior management team with more than two decades experience in the housing finance industry. Despite the company s higher-than-industry average growth rate, the management has put in place strong risk management practices. Further, the management has a strong focus on maintaining healthy profitability level. This is also reflected in the company s lower-than-industry average gross NPA levels and higher the industry average RoA levels. 12

Financial Summary As on / for the period ended March 31 2017 2016 2015 2014 2013 Equity capital Rs Billion 0.7 0.7 0.7 0.4 0.4 Networth (reported) Rs Billion 11.1 8.3 7.1 6.1 4.9 Borrowings Rs Billion 120.2 102.1 82.2 64.5 49.1 Disbursement Rs Billion 41.3 38.6 31.2 25.8 21.7 Housing loans outstanding Rs Billion 132.4 111.1 89.1 70.0 54.4 Total assets Rs Billion 135.9 114.4 91.8 71.5 56.0 Interest income Rs Billion 14.5 12.3 10.2 8.1 6.2 Interest expense Rs Billion 9.2 8.1 6.8 5.4 4.0 Total income (net of interest expenses) Rs Billion 5.7 4.7 3.8 3.0 2.5 Operating expense Rs Billion 1.3 1.1 0.8 0.6 0.5 Reported PAT Rs Billion 3.0 2.4 2.0 1.8 1.5 Ratio PAT/average total assets % 2.4 2.4 2.4 2.7 2.8 Pat/average reported networth % 30.7 31.5 30.9 32.2 33.3 Tier-I capital adequacy ratio % 16.8 16.1 13.9 14.7 12.9 Overall capital adequacy ratio % 18.3 17.8 15.4 16.4 14.6 Total debt/reported networth Times 10.8 12.2 11.5 10.3 10.0 Gross NPA % 0.3 0.3 0.3 0.3 0.3 Year ended June 30 2017 2016 Reported networth Rs Billion 10.8 9.6 Borrowing Rs Billion 124.8 108.0 Disbursement Rs Billion 12.0 9.4 Loans outstanding Rs Billion 137.0 115.4 Total assets Rs Billion 140.7 120.2 Interest income Rs Billion 3.9 3.4 Interest expense Rs Billion 2.4 2.2 Total income Rs Billion 4.0 3.5 Total income (net of interest exp) Rs Billion 1.6 1.2 Operating expense Rs Billion 0.3 0.2 Reported PAT Rs Billion 0.7 0.6 Ratio Interest income/average total assets % 11.2 11.5 Interest expense/average borrowings % 7.7 8.5 PAT/average total assets % 2.1 2.1 Gross NPA % 0.6 0.6 Total debt/networth times 11.6 11.2 13

Criteria Details Links to related criteria Rating Criteria for Finance Companies Criteria for Notching up Stand Alone Ratings of Companies based on Parent Support Criteria for rating Short-Term Debt (including Commercial Paper) 14

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