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HDFC Bank: Leading the tally - Views on News from Equitymaster
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HDFC Bank: Leading the tally
Jul 10, 2007

Performance summary
  • Interest income grows by 41% YoY on the back of higher PLR and 32% YoY growth in advances
  • Visible slowdown in retail asset growth – 26% YoY in 1QFY08 against 67% YoY in 1QFY07
  • Net interest margins stable at 4.2%
  • Fee income growth at 60% YoY
  • Net profit margins decline to 15.1% due to higher provisioning

Financial snapshot
Rs (m) 1QFY07 1QFY08 Change
Interest Income 15,043 21,259 41.3%
Interest Expense 6,867 10,836 57.8%
Net Interest Income 8,176 10,423 27.5%
Net interest margin (%) 4.0% 4.2%  
Other Income 2,909 5,158 77.3%
Other Expense 5,527 7,744 40.1%
Provisions and contingencies 2,040 3,071 50.5%
Profit before tax 3,518 4,766 35.5%
Tax 1,125 1,554 38.1%
Profit after tax/ (loss) 2,393 3,212 34.2%
Net profit margin (%) 15.9% 15.1%  
No. of shares (m) 313.7 333.0  
Diluted earnings per share* (Rs)   37.7  
P/E* (x)   30.6  
* 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 June 2007, the bank had a franchise of 753 branches and 1,716 ATMs. Strong understanding of the retail sphere (57% 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 (CAR) stood at 13.1% at the end of 1QFY08 of which the Tier-1 CAR was 9.2%.

What has driven performance in 1QFY08?
Visible retail slowdown: While continuing to outperform the sector average in terms of incremental advances and deposit growth (both 25% YoY), the bank despite being largely retail assets centric, has recorded a slowdown in incremental accretion to this segment of assets. The fact that HDFC 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, however, been the sweetener.

Retail assets continue to enjoy dominance in HDFC Bank’s portfolio allocation (57% in 1QFY08). Having said that, given the rise in lending rates, the corresponding growth in the bank’s retail assets (26% YoY) has merely been a third of that clocked in the corresponding quarter of FY07 (67% YoY). The same may also be due to the fact that banks have realised the delinquency risks in retail portfolios with the rise in interest rates.

What has also enabled HDFC Bank to hike its net interest margins (to 4.2%) is the fact that it continues to enjoy the distinction of having the highest proportion of low cost deposits in its books (52% in 1QFY08). The sharp increase in net interest margins of the bank in the last two quarters have been attributed to higher transactional floats, an increase in lending rates and a move to reduce bulk fixed deposits due to the prevailing high interest rates and availability of other sources of funds.

Deposits take the lead…
(Rs m) 1QFY07 % of total 1QFY08 % of total Change
Advances 405,653   538,393   32.7%
Retail 243,392 60.0% 306,884 57.0% 26.1%
Corporate 162,261 40.0% 231,509 43.0% 42.7%
           
Deposits 606,301   816,045   34.6%
CASA 303,151 50.0% 420,100 51.5% 38.6%
Term deposits 303,151 50.0% 395,945 48.5% 30.6%
Credit deposit ratio 66.9%   66.0%    

With further rise in funding costs and persistence of liquidity crunch, we envisage incremental advance growth to get moderated for players across the sector in this fiscal. However, the impact on private sector banks that are more prompt in passing on the rate hikes is likely to be subdued.

Fees vs. treasury: Although HDFC Bank has been able to grow its fee income base by 60% YoY in 1QFY08, bringing the fee to total income proportion to 33% against 25% in FY07, the loss on the treasury side has capped the growth in other income. The bank’s 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 this quarter. A large portion of the non-SLR investments were bonds in which the bank had invested in previous years for meeting priority sector requirements.

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 60% YoY higher provisioning in 1QFY08 as compared to 1QFY07.

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 1QFY08). 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 bank added 69 branches during the first quarter of FY08 taking the network to 753 in 320 cities from 535 in 228 cities in June 2006. 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 50% in 1QFY08, as was the case in 1QFY07.

Capital raising on the cards: During 1QFY08, HDFC Bank had obtained the shareholder approval to raise equity capital to the tune of US$ 1 bn or Rs 42 bn, whichever is higher, either as domestic public issue or private offerings in one or more international markets. The bank also received approval to allot 13.6 m equity shares at a premium of Rs. 1,013.49 per share on a preferential basis to parent HDFC with a view to maintain the latter’s shareholding in the bank at 23% of the enhanced capital base. The said allotment to HDFC was done on June 29, 2007. We have factored in the additional capital raising in our estimates for the bank. The enhanced book value will poise it attractively against its peers in terms of forward valuations, despite the fact that the issue will entail a dilution of 15% of the current share capital base.

What to expect?
At the current price of Rs 1,150, the stock is valued at 2.8 times our estimated FY10 adjusted book value (after factoring in the capital dilution). The bank’s overall performance continues to remain largely in line with our estimates including our stance with regards to the sustenance of NIMs. Having said that, the slowdown in retail assets and higher provisioning requirements for treasury as well as NPAs are our lingering concerns with regard to the bank (as is with the sector). We maintain our view on the stock.

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