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HDFC Bank: Bearing fruits of merger - Views on News from Equitymaster

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HDFC Bank: Bearing fruits of merger
Jul 28, 2008

Performance summary
  • Interest income grows by 75% YoY in 1QFY09 on the back of 79.8% growth in advances due to the integration with CBoP.

  • NIMs drop to 4.1% in 1QFY09; CASA level lower at 45%.

  • Operating expenses grow by 66.5% YoY due to the merger; cost to income ratio at 56%.

  • Fee income growth at 37% YoY.

  • Net NPA to advances move up from 0.2% in FY08 to 0.5% in 1QFY09.

  • Capital adequacy ratio (CAR) comfortable at 12.2%.



Rs (m) 1QFY08 1QFY09 Change
Interest Income 20,692 36,217 75.0%
Interest Expense 10,836 18,983 75.2%
Net Interest Income 9,856 17,234 74.9%
Net interest margin (%) 4.4% 4.1%  
Other Income 5,725 5,934 3.7%
Other Expense 7,744 12,894 66.5%
Provisions and contingencies 3,071 3,445 12.2%
Profit before tax 4,766 6,829 43.3%
Tax 1,553 2,187 40.8%
Profit after tax/ (loss) 3,213 4,642 44.5%
Net profit margin (%) 15.5% 12.8%  
No. of shares (m) 333.1 424.6  
Book value per share* (Rs)   321.7  
P/BV* (x)   3.5  
* Book value as on 1st April 2008

What has driven performance in 1QFY09?
CBoP camouflages the ‘slowdown’: While the overall banking sector’s growth slowed down to about 24% YoY in 1QFY09, HDFC Bank’s advances grew by nearly 80% YoY on the back of integration with Centurion Bank of Punjab (CBoP). While the bank has not divulged the mix of retail and corporate assets (earlier 60:40), HDFC Bank’s balance sheet showed very little signs of slowdown in incremental lending at the end of 1QFY09. Nonetheless, in line with our expectations, the proportion of low cost deposits (CASA) dropped to 44.9% from 54.5% in 1QFY08. This led to a marginal decline in the net interest margins, which are one of the best in the sector.

CASA bears the brunt of merger…
(Rs m) 1QFY08 % of total 1QFY09 % of total Change
Advances 538,359   967,970   79.8%
Retail 283,270 52.6% 392,612 40.6% 38.6%
Corporate 186,178 34.6% 242,031 25.0% 30.0%
Deposits 816,197   1,309,180   60.4%
CASA 444,827 54.5% 587,822 44.9% 32.1%
Term deposits 371,370 45.5% 721,358 55.1% 94.2%
Credit deposit ratio 66.0%   73.9%    

Investment jerks: HDFC Bank has been able to grow its fee income base by 37% YoY in 1QFY09. However, the proportion of fee to total income has dropped to 22%, against 25% in 1QFY08. Also, the gains on the fee income side has been eroded by the losses on revaluation and sale of investments, the absence of which would have otherwise aided the bank’s other income. The bank’s other income has also been impacted by the higher amortisation of available-for-sale (AFS) securities in its investment book. We expect lower forex revenue to continue to impact the bank’s fee income in FY09.

Quality shows red: Due to the merger with CBoP, the quality of HDFC Bank’s asset book has been slightly tarnished. The net NPA to advance ratio for the bank has moved up from 0.2% in FY08 to 0.5% in 1QFY09. We however draw comfort from the fact that the bank has made adequate provisioning for possible delinquencies in the event of unexpected hardening in interest rates.

Expensive merger: With the integration of HDFC Bank branches and employees with that of CBoP, the cost to income ratio has increased to 50% from 56% in FY07. Given the bank’s plan to continue to expand its franchise, we expect the ratio to be marginally higher in the medium term.

What to expect?
At the current price of Rs 1,126, the stock is valued at 2.1 times our estimated FY11 adjusted book value (after factoring in the merger with CBoP). The bank’s overall performance continues to remain largely in line with our estimates including our stance with regard to the drop in NIMs. Although the merger with CBoP has partially impacted the bank’s fundamentals, we see these as temporary blips and expect the bank to correct the same by the end of this fiscal.

The time and cost of setting up branches that HDFC Bank has managed to save with the merger with CBoP is certainly something that will stand in good stead for the bank in the longer term. With its conservative approach towards growth and the necessity of acquiring size and scale prior to FY09, this is one of the best options that the bank could have opted for.

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