HDB Financial Services Ltd Management Discussions

Macro Economic Environment and Industry Developments

The year was marked by an extraordinary spell of financial turbulence arising from the US Fed contemplating tapering its large scale asset purchase programme. The event resulted in a rapid deterioration of financial conditions across emerging markets, including India. The rupee depreciated against the US dollar, amid sudden foreign exchange reserve depletion. To defend the rupee exchange rate, RBI raised short term rates to reduce excess liquidity. Government introduced measures such as gold import restrictions to rein in the current account deficit (CAD). These policies, along with a forward-looking blueprint for further financial market reforms laid down by the RBI helped turn the tide and stabilize financial markets. The RBI has since maintained a tight monetary policy stance but has desisted from further tightening keeping in mind the weak state of economy.

The economic slowdown persisting for last couple of years deepened in FY 2013-14. The economic environment remained subdued throughout the year. Gross Domestic Product (GDP) growth is estimated to have declined to approx. 4.8% for the FY 2013-14, against 6.2% for the previous year. While manufacturing and mining continued to be the laggards, good monsoon helped in stepping up of agricultural growth to 4.6% from 1.4% in 2012-13. Service sector registered a marginal decrease in growth from 7% a year ago to 6.9%. The fiscal deficit for FY 2013-14 stood at 4.6% of GDP. Against the backdrop of high CAD and sustained high CPI inflation, the RBI reversed its stance and hiked the bank rate to 8% and it remained the same as at the end of FY 2013-14. This translated to higher interest rates due to continuing liquidity concerns.

During the year, private consumption expenditure, the mainstay of aggregate demand in the economy, stayed low in the face of high inflation that caused discretionary demand to fall. It directly affected sales and margins of manufacturing and service sector and indirectly affected financial sector in terms of lower credit demand from both retail and business segment and higher delinquencies.

The economy is expected to show a modest recovery going forward, basis leading indicators of the services sector. Stagnant industrial growth, persistent inflation, bottlenecks facing the mining and infrastructure sectors continue to remain a challenge. The RBI expects growth in FY 2014-15 to be in the range of 5 - 6%. However, public spending cuts proposed by the Government in its budget for FY 2014-15 have increased the downside risk. The upside can also be limited because, even with an improvement in private investment climate, the benefits will take time to flow at the ground level because of the long gestation periods involved in execution of approved projects.

Fiscal year 2014-15 could be a year of new leadership and old challenges. The outcome of general elections in May 2014 could swing the medium term growth outlook either way. Political stability is, therefore, an important factor for FY 2014-15. A fragile political outcome, in contrast, could further delay long-pending critical reforms, particularly in agriculture, manufacturing, education and skill development.

Opportunities

Agriculture grew at 4.6% in FY 2013-14, thanks to timely and well-distributed monsoon, as compared to 1.4% in FY 2012-13. This should help check food inflation and support consumption in rural areas. To instill momentum in the manufacturing sector, the Government has announced a number of policy measures. With weak currency and improving growth prospects in Americas and European Union countries, exports have started looking up. Sectors such as textiles, leather, pharmaceutical and IT-ITES have reported export growth. Steps are being taken to address requirements of mining and power generation sectors which will remove supply bottlenecks to a number of sectors. Many mines have resumed activity post lifting of bans by the courts. Large infrastructure projects have been approved by the Government to drive economic growth. FDI caps in many sectors have been increased with some sectors such as retail and railway projects being opened up for FDI. Government and FIPB have approved many proposals for foreign investment through both routes i.e. FDI and Portfolio Investment Scheme. Deepening of financial markets especially the corporate bonds market and attracting foreign long term investment flows for infrastructure projects are likely to happen in future.

Growth in agricultural sector output will drive demand from rural areas. With the governments initiative to boost infrastructure projects and resumption of mining activity, NBFCs can also look for growth in asset financing.

Threats

Growth of the Companys asset book, quality of assets and ability to raise funds depend significantly on the economy. Unfavorable events in the Indian economy can affect consumer sentiment and in turn impact consumer decision to purchase financial products. Competition from a broad range of financial services providers, unstable political environment and changes in Government policy / regulatory framework could impact the Companys operations.

Operations

Loans - The Company offers a range of loan products both in the secured and unsecured categories that fulfills the financial needs of its target segments.

• Unsecured loans - These loans are in the range of Rs 100,000 to Rs 30,00,000. These loans are offered as term loans with a maximum tenure of 48 months. Interest rates on these loans are higher than the rates on secured loans.

• Secured loans - These loans are offered to customers to address the larger loan requirements or longer repayment requirements. Secured loans are in the range of Rs 100,000 to Rs 800,00,000. These loans are offered as term loans with the maximum tenure at 120 months. These loans are normally offered on a floating rate basis.

The Company provides loan against the following collaterals as security for the loans:

• Residential / commercial property

• Cars / automobiles (both new and used)

• Marketable securities

• Gold jewellery

• Commercial Vehicle Loans - The Company provides loans for purchase of new and used commercial vehicles.

• Construction Equipment Loans - The Company provides loans for purchase of new and used construction equipments.

Fee based products

• Insurance services - The Company is a corporate agent for HDFC Standard Life Insurance Company Limited and HDFC Ergo General Insurance Company Limited. The Company sells life and general insurance bundled with its loan as a value-add as well as a standalone product.

BPO services business

• BPO services - The Company has a contract with HDFC Bank to run collection call centers and collect overdue from borrowers. The Company has set up call centers across the country with a capacity of over 2600 seats. These centers provide collection services for the entire gamut of retail lending products of HDFC Bank. The Company offers end to end collection services in over 400 locations through its calling and field support teams.

Infrastructure

The Company has 275 branches in 201 cities thus creating the right distribution network to sell its products and services. The Company has its data centre at Bangalore and centralised operations in Hyderabad and Chennai. The Business Process Outsourcing (BPO) services vertical now runs 9 call centers with a capacity of over 2,600 work stations.

Internal Control Systems

In the opinion of the Management, the Company has adequate systems and procedures to provide assurance of recording transactions in all material respects.

Outlook

The markets will continue to grow and mature leading to differentiation of products and services. Each financial intermediary will have to find its niche in order to add value to consumers. The Company is cautiously optimistic in its outlook for the year 2014-15.

Cautionary Note

Certain statements in the Management Discussion and Analysis Report may be forward-looking and are stated as may be required by applicable laws and regulations. Many factors may affect the actual results, which could be different from what the Directors envisage in terms of future performance and outlook. Your Company does not undertake to update these statements.

Internal Audit And Compliance

The Company conducts its internal audit and compliance functions within the parameters of regulatory framework which is well commensurate with the size, scale and complexity of operations. The internal controls and compliance functions are evolved, installed, reviewed, and upgraded periodically.

The Company has appointed CNK & Associates, Chartered Accountants, to conduct internal audit covering all areas of operations including branches. The reports are placed before the Audit Committee of the Board. The Audit Committee reviews the performance of the audit and compliance functions, the effectiveness of controls and compliance with regulatory guidelines and gives such directions to the Management as necessary / considered appropriate. The Company has framed a compliance policy to effectively monitor and supervise the compliance function in accordance with the statutory requirements.

Risk Management And Portfolio Quality

The Company recognizes the importance of risk management and has invested in appropriate processes, people and a management structure. The function is supervised by the Risk Committee. Risk Committee reviews the asset quality on quarterly basis. Product policy programs are duly approved before any new product launches and are reviewed regularly. The asset quality of the Company continues to remain healthy. The ratio of gross non-performing assets to gross advances and net non performing assets to total assets as of March 31, 2014, stood at 0.81% and 0.42%, respectively. The specific loan loss provisions that the Company has made for its non-performing assets continue to be more conservative than those prescribed by the Regulator.

RBI Guidelines

The RBI granted the Certificate of Registration to the Company in December 2007, to commence the business of non-banking financial institution without accepting deposits. Your Company classifies to be a Systemically Important Non-Banking Financial Company (NBFC-ND-SI). The Company has complied with and continues to comply with all the applicable regulations and directions of the RBI.

Human Resources

People remain the most valuable asset of your Company. Your Company is professionally managed with senior management personnel having rich experience and long tenure with the Company. Your Company follows a policy of building strong teams of talented professionals. Your Company encourages, appreciates and facilitates long term careers. Your Company continued to build on its capabilities in getting the right talent to support different products and geographies and is taking effective steps to retain the talent. The Company continues to focus on training programs for skill development and improved customer service. As on March 31, 2014, your Company had 7,614 employees as compared to 6,404 as on March 31, 2013.

Statutory disclosures

1. The information required under Section 217(2A) of the Companies Act, 1956, and the rules made there under are given in the Annexure I appended hereto and forms part of this report.

2. The provisions of Section 217(1)(e) of the Companies Act, 1956, relating to conservation of energy and technology absorption do not apply to your Company as it is not a manufacturing company. However, your Company has been increasingly using information technology in its operations and promotes conservation of resources.

3. The Company had no foreign exchange inflow and outgo during the period under review. Directors responsibility statement

The Board of Directors hereby state that:

1. In preparation of the annual accounts, the applicable accounting standards have been followed along with proper explanation relating to material departures.

2. Appropriate accounting policies have been selected and applied consistently and judgments and estimates made are reasonable and prudent so as to give a true and fair view of the state of affairs of the Company at the end of the financial year and of the profit and loss of the Company for that period.

3. Proper and sufficient care has been taken for the maintenance of adequate accounting records in accordance with the provisions of the Companies Act, 1956, for safeguarding the assets of the Company and for preventing and detecting fraud and other irregularities.

4. The annual accounts have been prepared on a going concern basis.

Directors

Pursuant to provisions of the Companies Act, 1956 and Articles ofAssociation of the Company, Mr. Kaizad Bharucha will retire by rotation at the ensuing Annual General Meeting and being eligible, offers himself for re-appointment.

Auditors

M/s. B S R & Co. LLP, Chartered Accountants, are the Statutory Auditors of the Company for the financial year ended March 31, 2014 and will hold office till the ensuing Annual General Meeting. They have expressed their willingness to continue, if re-appointed.

M/s. B S R & Co. LLP, Chartered Accountants, are eligible for re-appointment and have consented to the same and have confirmed that the appointment, if made, shall be within the limits prescribed the Companies Act, 2013 and that they are not disqualified for such appointment within the meaning of Section 139 and 141 of the Companies Act, 2013, read with Companies (Audit and Auditors) Rules, 2014.

The Board recommends the re-appointment of M/s. B S R & Co. LLP, Chartered Accountants, as Statutory Auditors of the Company for a further period of 4 (four) years i.e. upto financial year 2017-18, subject to the ratification of such appointment by the members at every Annual General Meeting to be held during their term,.

Corporate Governance Report

The report on Corporate Governance for the Company is annexed and forms an integral part of this Annual Report.

Acknowledgement

Your directors take this opportunity to place on record their appreciation to all employees for their hard work, spirited efforts, dedication and loyalty to the Company which has helped the Company maintain its growth. The Directors also wish to place on record their appreciation for the support extended by the Reserve Bank of India, other regulatory and government bodies, Companys auditors, customers, bankers, promoters and shareholders.