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HDFC Bank: Holding fort! - Views on News from Equitymaster
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HDFC Bank: Holding fort!
Jan 11, 2007

Performance summary
HDFC Bank has announced its results for the third quarter and nine-months ended December 2006. Despite severe funding pressures across the sector and embargo on the bank’s branch expansion plans, HDFC Bank has been able to grow its assets at rates above the sector average and sustain its net interest margins. A healthy CASA (current and savings account) mix and little deterioration in asset quality also reiterates the operating efficiency of the bank. The significant rise in funding costs and higher provisioning requirement has, however, contracted the bank’s net profit margins by 220 basis points (2.2%) for both the periods under review.

Rs (m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Income from operations 11,798 17,593 49.1% 30,968 48,993 58.2%
Other Income 2,961 3,733 26.1% 8,198 11,218 36.8%
Interest Expense 5,092 8,307 63.1% 12,904 23,074 78.8%
Net Interest Income 6,706 9,286 38.5% 18,064 25,919 43.5%
Net interest margin (%)       4.0% 4.0%  
Other Expense 4,491 6,050 34.7% 12,087 17,368 43.7%
Provisions and contingencies 1,972 2,664 35.1% 5,436 8,360 53.8%
Profit before tax 3,204 4,305 34.4% 8,739 11,409 30.6%
Tax 961 1,349 40.4% 2,663 3,429 28.8%
Profit after tax/ (loss) 2,243 2,956 31.8% 6,076 7,980 31.3%
Net profit margin (%) 19.0% 16.8%   19.6% 16.3%  
No. of shares (m) 312.3 315.3   312.3 315.3  
Diluted earnings per share (Rs)       25.9 33.7  
P/E (x)*         29.6  
* trailing 12 months

Pioneer of retail banking
HDFC Bank, the pioneer of the retail-banking movement in India, is one of the fastest growing and most profitable banks in India with a strong urban presence. At the end of 9mFY07, the bank had a franchise of 583 branches and 1,471 ATMs. Strong understanding of the retail sphere (56% of total advances) and inorganic growth initiatives has made the bank the second largest private sector bank in the country. The bank’s capital adequacy ratio stood at 12.8% at the end of 9mFY07.

What has driven performance in 3QFY07?
No compromise on margins: Surpassing the sector average asset growth of around 28% YoY, HDFC Bank reported a 33% YoY growth in advances for 9mFY07. While the dominance of retail assets in its portfolio allocation has understandably reduced (from 57% of advances in 9mFY06 to 52.5% in 9mFY07), given the rise in lending rates, the corresponding growth in the bank’s corporate assets continues to remain appreciable. What has enabled the bank to retain its net interest margins (at 4%) is the fact that it continues to enjoy the distinction of having the highest proportion of low cost deposits in its books (55% in 9mFY07). Given the fact that the bank has recently raised subordinated debt of Rs 2 bn for its Tier II funding, the pressure on cost of funds will continue to linger. With further rise in funding costs and persistence of liquidity crunch, we envisage incremental advance growth to get moderated for players across the sector. However, the impact on private sector banks that are more prompt in passing on the rate hikes is likely to be subdued.

Asset book: Balancing costs with growth
(Rs m) 9mFY06 % of total 9mFY07 % of total Change
Advances 361,562   480,213   32.8%
Retail 206,590 57.1% 252,110 52.5% 22.0%
Corporate 154,972 42.9% 228,103 47.5% 47.2%
Deposits 511,946   667,487   30.4%
CASA 271,843 53.1% 366,450 54.9% 34.8%
Term deposits 240,103 46.9% 301,037 45.1% 25.4%
Credit deposit ratio 70.6%   71.9%    

Other income–Not compensatory enough: Despite a 17% YoY growth in fee income, the proportion of HDFC Bank’s fee income to other income has declined from 28% in 9mFY06 to 25% in 9mFY07. This seems to be largely fallout of competition with other foreign and private sector peers besides some PSU banks that have started offering services like CMS (cash management services) in which HDFC Bank earlier had dominance. The growth in HDFC Bank’s other income treads close to the growth witnessed in its fee income base. This is because there has been no perceptible change in its treasury portfolio with 85% of its investments in the HTM (held to maturity) basket and duration of less than 2 years in the AFS (available for sale) portfolio. It is also pertinent to point out that the high reliance of non-fund based income on mutual fund distribution (25% of fee income in FY06) may suffer some set backs going forward.

Provisioning proactively: HDFC Bank has stated that the delinquencies and NPAs in its asset book are in line with the changing mix of the loan book towards retail loans. Although the bank sees the riskiness of high-risk assets being compensated by higher yields, the same may not augur well for its asset quality going forward. The net NPA to advance ratio continues to inch upwards (0.4% at the end of 9mFY07 against 0.2% in 9mFY06), although very trivial when compared to its peers in the sector. Also, we also draw comfort from the fact that the bank has made adequate provisioning for possible delinquencies in the event of unexpected hardening in interest rates.

Branch expansion: The IPO scam early this fiscal proved to be very detrimental to the growth of banks like HDFC Bank, with the RBI placing an embargo on the additional branch licences to be issued to it for a year. HDFC Bank that traditionally grows its branch franchise by nearly 25% each fiscal had not added a single branch in 1HFY07. While the bank has added around 50 branches in the third quarter, it is appreciable that it has not let the franchise handicap come in its way to augmenting its advance base so far besides continuing to focus on low cost deposits.

What to expect?
At the current price of Rs 1,000, the stock is fairly priced at 3.9 times our estimated FY09 adjusted book value. The bank’s performance continues to remain largely in line with our estimates except for the fact that we reserve a conservative stance with regards to sustenance of NIMs. In the event of the bank sustaining the present level of NIMs longer than our estimates, we shall have to upgrade our numbers. Having said that, excessive reliance on retail assets and inability to grow its fee income base are our lingering concerns with regard to the bank.

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