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HDFC Bank: ‘NIM’ble growth! - Views on News from Equitymaster
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HDFC Bank: ‘NIM’ble growth!
Apr 24, 2007

Performance summary
HDFC Bank has announced its results for the fourth quarter and year ended March 2007. Notwithstanding the liquidity constraints and embargo on the bank’s branch expansion plans, the bank has clocked an appreciable performance for the quarter under review, rounding up this fiscal with higher than expected net interest margins (NIMs). A healthy CASA (current and savings account) mix and little deterioration in asset quality also reiterates the operating efficiency of the bank. The sustenance of high operating costs and higher provisioning requirement has however, contracted the bank’s net profit margins by around 200 basis points (2.0%) for both the periods under review.

Rs (m) 4QFY06 4QFY07 Change FY06 FY07 Change
Income from operations 13,785 19,898 44.3% 44,753 68,890 53.9%
Interest Expense 6,391 8,721 36.5% 19,295 31,794 64.8%
Net Interest Income 7,394 11,177 51.2% 25,458 37,096 45.7%
Net interest margin (%)       4.3% 4.5%  
Other Income 3,042 3,944 29.7% 11,239 15,162 34.9%
Other Expense 4,823 6,839 41.8% 16,911 24,208 43.1%
Provisions and contingencies 1,816 3,303 81.9% 7,252 11,663 60.8%
Profit before tax 3,797 4,979 31.2% 12,534 16,387 30.7%
Tax 1,164 1,544 32.6% 3,827 4,973 29.9%
Profit after tax/ (loss) 2,633 3,435 30.5% 8,707 11,414 31.1%
Net profit margin (%) 19.1% 17.3%   19.5% 16.6%  
No. of shares (m) 313.2 319.6   313.2 319.6  
Diluted earnings per share (Rs)       27.8 35.7  
P/E (x)*         28.3  
* 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 FY07, the bank had a franchise of 684 branches and 1,605 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 13.1% at the end of FY07.

What has driven performance in 4QFY07?
Re-pricing benefits: While HDFC Bank’s marginal outperformance of our advance growth estimates have not been much of a surprise, the fact that the bank has been able to prop up its net interest margins (NIMs) with a commensurate PLR hike, to counterbalance the rise in funding costs, has been the sweetener.

HDFC Bank has surpassed the sector average asset growth of around 28% YoY in FY07, reporting a 33.9% YoY growth in advances for FY07. Retail assets continue to enjoy dominance in the bank’s portfolio allocation (60% in FY07). Given the rise in lending rates, the corresponding growth in the bank’s retail assets (33% YoY) explains the bank’s ability to re-price the high-yielding retail assets and provide for the higher funding costs, thus guarding its NIMs. What has also enabled the bank to hike its net interest margins (to 4.5%) is the fact that it continues to enjoy the distinction of having the highest proportion of low cost deposits in its books (57% in FY07). The bank has attributed the sharp increase in net interest margin during the quarter to higher transactional floats, an increase in lending rates and a move to temporarily reduce bulk fixed deposits in the quarter due to the then prevailing high interest rates.

Asset book: Balancing costs with growth
(Rs m) FY06 % of total FY07 % of total Change
Advances 350,613   469,448   33.9%
Retail 212,346 60.6% 283,270 60.3% 33.4%
Corporate 171,753 49.0% 214,520 45.7% 24.9%
Deposits 557,970   682,980   22.4%
CASA 278,985 50.0% 393,970 57.7% 41.2%
Term deposits 278,985 50.0% 289,010 42.3% 3.6%
Credit deposit ratio 62.8%   68.7%    

Having said that, 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.

Other income–Treasury hits: Although the bank has been able to grow its fee income base by 20% YoY in FY07, the 30% YoY growth in other income has been impacted by the higher amortisation of available-for-sale (AFS) securities in its investment book. Investment losses during the quarter were primarily a result of mark-to-market of non-SLR investments, reflecting the sharp increase in short term yields in the debt market in March 2007. A large portion of the non-SLR investments were bonds in which the bank had invested in previous years for meeting priority sector requirements.

The lower growth in fee income over the past couple of quarters has largely been a 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. 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: In January 2007, the Reserve Bank of India increased the general provision requirement for certain standard assets such as personal loans, credit card receivables, capital market exposures and real estate exposures resulting in the bank incurring an extraordinary one-time general provision of Rs 1.2 bn.

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 for the bank, however, has remained stable (0.4% at the end of FY07 against 0.2% in FY06). 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: FY07 saw a healthy expansion in the bank’s distribution network with the total number of branches increasing from 535 to 684 and the number of ATMs from 1,323 to 1,605. It may be recalled that the IPO scam in early FY07 proved to be very detrimental to the growth of the bank’s franchise, with the RBI placing an embargo on additional branch licenses to be issued to it for a year. Based on receipt of regulatory approvals for new branches, the entire branch expansion was done in the second half of the year, with 101 branches being opened only in the last quarter. The cost to income ratio has been retained at 46% in FY07 as was the case in FY06.

What to expect?
At the current price of Rs 1,012, the stock is fairly priced at 4.0 times our estimated FY09 adjusted book value. While the bank’s overall performance continues to remain largely in line with our estimates except for the fact that we had a conservative stance with regards to the sustenance of NIMs, the results do not evince any immediate upgrade in our forward estimations. 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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