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HDFC Bank: Stability is growth - Views on News from Equitymaster
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HDFC Bank: Stability is growth
Jul 14, 2006

Performance summary
HDFC Bank has announced its results for 1QFY07, delivering no surprises yet again. The bank’s stability in terms of sustenance of profit growth, net interest margins, asset book expansion and asset quality by themselves accentuates its operating efficiency and growth prospects. The excessive provisioning despite a good asset quality and well-hedged treasury book are indicative of the bank’s practice of providing for the future.

Rs (m) 1QFY06 1QFY07 Change
Income from operations 8,941 15,043 68.2%
Other Income 2,636 3,508 33.1%
Interest Expense 3,704 6,867 85.4%
Net Interest Income 5,237 8,176 56.1%
Net interest margin (%)      
Other Expense 3,580 5,527 54.4%
Provisions and contingencies 1,659 2,639 59.1%
Profit before tax 2,634 3,518 33.6%
Tax 799 1,125 40.9%
Profit after tax/ (loss) 1,835 2,393 30.4%
Net profit margin (%) 20.5% 15.9%  
No. of shares (m) 311.2 313.7  
Diluted earnings per share (Rs) 23.6 29.5  
P/E (x)*   24.7  
* 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 FY06, the bank had a franchise of 535 branches and 1,323 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. Despite having raised capital in the form of ADS issue during 4QFY05 the capital adequacy ratio stands at 11.7% at the end of 1QFY07.

What has driven performance in 1QFY07?
Mortgages don’t disappoint… Against the general belief that the frequent rises in interest rates would paralyse the incremental offtakes in mortgage loans, which comprise nearly 50% of HDFC Bank’s advances, the bank has witnessed a robust 67% YoY growth in advances in 1QFY07. In absolute terms the growth in retail credit was also impressive, bringing the proportion of retail credit to total credit to 56%. Although the deposit growth was at a slower 37% YoY, a high proportion of low cost deposits (67% in 1QFY07) enabled the bank sustain its net interest margins. However, given that the bank has recently raised subordinated debt of Rs 4.5 bn for its Tier II funding, we see its cost of funds escalating in the coming quarters, which will pressurise its margins. The subordinated bonds (having maturity of 9.5 years) carry an interest rate of 7.5% p.a., which is approximately 300 basis points higher than the bank’s average cost of funds.

CD firms up…
(Rs m) 1QFY06 % of total 1QFY07 % of total Change
Advances 274,694   405,653   47.7%
Retail 138,720 50.5% 231,210 55.9% 66.7%
Corporate 135,973 49.5% 178,893 44.1% 31.6%
Deposits 374,290   511,950   36.8%
CASA 232,450 62.1% 319,180 62.3% 37.3%
Term deposits 141,840 37.9% 192,770 37.7% 35.9%
Credit deposit ratio 73.4%   79.2%    

Other income–On a weak footing: The bank’s other income growth of 33% YoY, although lower than that seen in the past few quarters, gives comfort of low impact of interest rate hikes on the treasury book. With 85% of its investments in the HTM basket and duration of less than 2 years in the AFS portfolio, the bank is reasonably well hedged in terms of treasury risk. Fee income growth (12% YoY) has, however, shown some signs of slow down in this quarter. Also, fee income comprised 83% of other income and 25% of total income at the end of 1QFY07. The bank has been facing some competition in its market share in cash management services, vending third party products and POS (point of sales) terminals. 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 excessively: 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 1QFY07 against 0.2% in 1QFY06), although very trivial when compared to its peers in the sector. Although we also draw comfort from the fact that the bank has made more-than-adequate provisioning for the delinquencies, the same may no longer prove benign for the future. In a very important development, the RBI has disallowed banks from writing back the excess provisions made earlier. The excess provision may thus prove to be costly for the bank going forward.

High capital costs: The National Housing Bank (NHB) has increased the risk weightage for loans to the commercial real estate sector from 100% to 125%, to which HDFC Bank has an exposure due to alliance with parent HDFC. Also, the investment in mortgage-backed-securities (MBS) will attract risk weightage of 125%. This is expected to weigh heavy on the bank’s capital adequacy ratio of 11.7%, especially in the wake of the upcoming Basel-II norms. Also, the bank’s cost to income ratio continues to inflate (47% in 1QFY07) due to a larger franchise and higher operational costs.

What to expect?
At the current price of Rs 728, HDFC Bank’s stock is trading at 3.3 times our estimated FY08 adjusted book value. The bank continues to outperform our estimates in term of asset growth. Also, despite the rising interest rates, negative surprises on the treasury side are not foreseen. Nonetheless, the net interest margins seem to have peaked for the time being and a downside is inevitable. Having said that, proactive provisioning will stand the bank in good stead in the longer term.

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