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HDFC Bank – Setting new standards

Feb 17, 2001

The very essence of a leadership is that you have to have a vision. The saying is most apt for HDFC Bank. When it started out in 1994 few would have thought that it would become one of India’s fastest growing private sector banks. Infact, it re-defined the rules of the Indian banking industry. Customer convenience became its driving motto. And it was amply rewarded for this. The bank has grown its small assets base of Rs 9 billion (1995-96) to over Rs 116 billion as on March 2000, a compounded annual growth rate (CAGR) of 90%. Its trail blazing financial performance coupled with service quality nearly matching levels of foreign banks, excellent network and the rapid implementation of latest technology has placed the bank one step ahead of its competitors. But setting new standards was not new to the bank’s management. Promoted by India’s No.1 housing finance company HDFC (29 percent stake), the bank had leadership qualities in its blood. Added to that its business partner, Chase Manhattan’s (15 percent holding) global clientele base, some of whom have offices in India, put the bank on a firm footing. Moreover, Chase is a leading custodian for foreign institutional investors (FIIs) in India. Not only this kind of strategic alliances but also the ‘HDFC’ brand name is likely to fuel HDFC Bank’s future revenue generation.

HDFC Bank was among the first to realise that consolidation was important to stay ahead. So in February 2000, it became the first bank, which successfully amalgamated its operations with Times Bank. The merger added a significant value to the bank in terms of increased branch network, expanded geographic reach, enhanced customer base, skilled manpower, the opportunity to cross-sell and leverage alternative delivery channels. Fiscal year 2001 is likely to be a momentous year for the bank, which will see the integration of Times Bank and its own robust organic growth. Interestingly, the merger set a precedent for the industry to follow. Since then the industry has already seen two mega mergers (ICICI Bank and Bank of Madura, UTI Bank and Global Trust Bank). What’s more, HDFC Bank is now considering $ 200 million ADS issue to fund for the future acquisitions.

From the outset HDFC Bank focused on the retail segment. It recognized that the Indian mass was looking for more convenient and sophisticated ways to bank. HDFC Bank just tapped this opportunity. Retail business thus became its key driver. Today, the bank provides almost the entire range of retail products with a network of 126 branches and 148 ATMs spread across the country. These include auto loans, personal loans, consumer durable finance and loan against shares. The bank leveraged its customer base of over 1.3 million to cross-sell various banking products, snatching away the market share from other banks. HDFC Bank was among the first to offer real time online banking across its branches and ATM network coupled with value added services like mobile banking, Internet banking, debit cards, bill payment and Internet based cash management products. Added to that, as consumers grow technology savvy, HDFC Bank would accrue the benefits of lower cost of transactions in the future.

HDFC Bank’s business strategy in terms of marketing and distribution has yielded it a reach dividend by increasing its retail asset portfolio. Remarkably the bank is able to grow without compromising its asset quality. The bank’s non-performing assets (NPA) to advances ratio stood at 0.8 percent as on March 2000. Better control and monitoring systems has contained the level of NPAs of the bank. An interest rate cut of 50 basis points by the Reserve Bank of India in bank rate and cash reserve ratio is expected to ease the asset quality concerns further, and will also provide returns on the bank’s treasury operations. Nevertheless, its operating margins are under pressure with increasing competition (including foreign banks) in the financial markets.

Performance parameters
ParticularsFY98FY99FY00FY01E
Operating margins42.9%39.1%44.9%41.7%
Returns on net worth22.2%24.3%16.0%22.9%
Assets/employee (Rs m)42.944.277.7107.4
Revenues/employee (Rs m)3.63.84.56.5
Operating profits/employee (Rs m)1.61.52.02.7
Employees/branch (Nos.)19.417.313.516.7

HDFC Bank has shown excellent growth in its financials in the last three years. While the bank’s topline grew at a CAGR of 68 percent (excluding the merger), operating profits witnessed a faster CAGR of 72 percent. Also, during the nine months period ended December 2000, it has displayed an outstanding performance (including the merger impact). While revenues soared by more than 100 percent, profits jumped 83 percent year on year. Its operating margins however, have come down to 40 percent from 45 percent in March 2000. Nevertheless, it is incredible considering the fact that Times Bank had comparatively lower margins. Also, the profit margins of HDFC Bank are the highest in the banking sector thanks to low cost of deposits (contributes 14 percent to total deposits) and high yield on investments. An increase of 190 percent in saving account deposits in the first half of the current year compared to corresponding previous period contributed in maintaining its margins. The bank’s total number of retail accounts climbed up from 825,000 as on March 2000 to over a million in the first half of the current year.

HDFC Bank’s strong positioning in capital market business as well as cash management business provides it a fair degree of float, as these are interest free deposits. This would further buoy the overall deposit base from over Rs 170 billion projected for March 2001. It is the only bank in the country to have clearing bank status for seven major stock exchanges of the country. It also has the dominant position in share depository business with total number of depository base of over 400,000 as on September 2000. But the concern remains that the bank derives more than 55 percent of its revenues from investment income, which is a volatile stream of revenues. This could make a dent in the future profit growth of the bank if it fails to maintain its treasury operations efficiently.

In light of the above, valuations of HDFC Bank are at a significant premium to other banks both in terms of price to book value and P/E. The premium attached to the stock is not only in the expectation of strong growth performance in the next few years but also its ability to maintain the highest returns on equity (ROE) among the other banks across the region. Its price to book value ratio is expected to improve further as its ROE rises substantially backed by superior asset quality.

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