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HDFC Bank: Research meet extracts
Mar 20, 2006

We recently met HDFC Bank to get an update on the bank’s take on liquidity constraints and credit demand in general and its own operational outlook in particular. Following are the key excerpts of the meet.

What is the company’s business?
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 9mFY06, the bank had a franchise of 535 branches and 1,326 ATMs. Strong understanding of the retail sphere and inorganic growth initiatives has made the bank the second largest private sector bank in the country. Despite having raised capital in the form of ADS issue during 4QFY05 the capital adequacy ratio stood at 10.3% at the end of 3QFY06.


Banking sector’s ability to mobilise deposits and sustenance of credit growth…
The bank cited some causes that were inflicting margin pressures on the sector and reasons why incremental deposit mobilisation will ease going forward. The former were:

  • Availability of liquidity at a premium.

  • Banks being compelled to raise tier-II or subordinated debt at higher costs.

  • 6 to 12 months gap between rise in costs and repricing of assets.

It however, noted that with interest rate on bank deposits being raised across the board, their relative attractiveness against equity-linked savings schemes has improved. At the same time, the tax incentive on long-term deposits will help them compete effectively with postal savings schemes. Also, with small household savings registering a growth of 70% to 80% YoY, the banking sector is expected to seize a sizeable pie of the same going forward.

As far as credit growth is concerned, while the demand in the retail segment remains firm, capex borrowing from corporates has also started materialising. Although most ‘AAA’ rated corporates prefer quasi-debt options like FCCBs, long-term bank borrowings are expected to increase (not just working capital loans).

Mortgage loans - residential demand Vs investment demand…
As against the trend in demand for mortgage loans in the developed countries (primarily investment driven i.e. purchase of house for investment purpose), demand in India is primarily driven by need for ‘owned accommodation’. The same is encouraged by the tax incentive being offered on mortgage loans. Given this rationale, the elasticity of demand for housing loans is unlikely to diminish significantly, in case property prices in India were to soften. Also, the repayment of housing loans being in the nature of EMIs (equated monthly installments), a rise upto 100 to 150 basis points will not have a dampening effect on the credit demand.

HDFC Bank’s credit portfolio…
HDFC Bank currently has 54% of its loan portfolio in the retail segment. While the bank reiterated its outlook of sustaining a CAGR of atleast 30% in this segment until FY08 (5-year CAGR until 9mFY06 is 95%), exposure to the corporate segment will be increased depending on the segment’s profitability going forward. Of the retail exposure, the bank allocates equal weightage to both mortgage and auto loans. It currently sources nearly 30% of parent HDFC’s home loans (average loan origination Rs 3 bn per month). The corporate credit book comprises of 24 industries with automobile, commercial vehicle, engineering, fertilizer and financial sectors enjoying the maximum exposure. The bank substantiated the rationale behind retaining a higher exposure to retail and SME segments on the premise that the advances to retail and SMEs is likely to yield atleast 9% to 17%, depending on the account. This is comparable to the most profitable corporate accounts. While the bank’s credit book has witnessed a CAGR of 41% between FY01 to FY05, we have assumed a CAGR of 30% in the same until FY08.

Cost – margin trade off…
HDFC Bank has raised Rs 4.1 bn in the form of subordinated bonds (having maturity of 9.5 years) in 3QFY06. This is a high cost borrowing option, given that a bank’s commercial paper is priced at 50 to 60 basis points above the 10-year G-Sec yield, while a subordinated debt is priced at 80 to 90 basis points above 10-year G-Sec yield. However, higher concentration of low cost deposits (53% in 3QFY06) has helped the bank sustain margins despite the rise in interest costs. The bank has consistently achieved NIMs of over 3% in the last 6 years, which is commendable by any yardstick. Going forward, although the bank does not assure sustenance of NIMs at the current levels (3.9% in 9mFY06), it hopes to keep it in the range of 3.5% to 3.9% in the next 2 to 3 years, thus maintaining the differential of 20 to 30 basis points above the industry average. We have assumed the bank’s NIMs to pare to 3.6% by FY08E.

Operating costs (cost to income ratio) for the bank, though lower as compared to the sector average (40%), has risen from 20% in FY02 to 29% in 9mFY06. The bank does not see this marginalising in the near future in the wake of expansion in its branch franchise and employee additions.

Other income – reasonably hedged…
The bank has 65% of its treasury portfolio in the SLR category of which 75% to 80% is in the HTM basket (held to maturity). While the rest of the SLR portfolio has bonds with duration less than 1-year, the non-SLR portfolio is more vulnerable to any uptick in interest rates due to the portfolio’s average duration of 2 to 3 years. However, on a relative basis, we believe the bank is reasonably hedged on the treasury side as compared to its peers.

Our view…
At the current price of Rs 774, HDFC Bank’s stock is trading at a rich 3.8 times our estimated FY08 adjusted book value. Our meeting with the bank’s management helped us reconfirm our belief that despite competition, HDFC Bank will be able to comfortably safeguard its margins and market share. Having said this, while we certainly expected a slow down in asset growth (due to high base effect) combined with lower margins and marginally higher delinquencies, the bank will continue to be well placed so as to deserve premium valuations. Also, given that HDFC Bank has no plans to raise equity in the next 2 to 3 years, equity dilution is ruled out.

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