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HDFC Bank: Cautiousness pays - Views on News from Equitymaster

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HDFC Bank: Cautiousness pays
Oct 12, 2007

Performance summary
  • Interest income grows by 49% YoY on the back of higher PLR and 33% YoY growth in advances

  • Growth in retail asset mellows to 37% YoY in 2QFY08 against 44% YoY in 2QFY07

  • Net interest margins drop to 4.0% from 4.6% in 1QFY08 on the back of HTM writeoffs.

  • Fee income growth at 25% YoY

  • Capital Adequacy Ratio comfortable at 14.9%.

Rs (m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Interest Income 15,780 23,628 49.7% 30,225 44,319 46.6%
Interest Expense 7,901 12,001 51.9% 14,767 22,837 54.6%
Net Interest Income 7,879 11,627 47.6% 15,458 21,482 39.0%
Net interest margin (%)       3.8% 4.0%  
Other Income 3,977 4,824 21.3% 7,485 10,549 40.9%
Other Expense 5,791 8,184 41.3% 11,319 15,928 40.7%
Provisions and contingencies 2,481 2,894 16.6% 4,521 5,965 31.9%
Profit before tax 3,584 5,373 49.9% 7,103 10,138 42.7%
Tax 955 1,688 76.7% 2,081 3,241 55.7%
Profit after tax/ (loss) 2,629 3,685 40.2% 5,022 6,897 37.3%
Net profit margin (%) 16.7% 15.6%   16.6% 15.6%  
No. of shares (m) 314.4 353.3   314.4 353.3  
Book value per share* (Rs)         182.1  
P/BV* (x)         7.9  
* Book value as on 30th September 2007

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 September 2007, the bank had a franchise of 754 branches and 1,800 ATMs. Strong understanding of the retail sphere (55% 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 14.9% at the end of 2QFY08 of which the Tier-1 CAR was 11.3%.

What has driven performance in 2QFY08?
Who said ‘slowdown’? Thanks to a judicious mix of retail and corporate assets, HDFC Bank’s balance sheet shows no signs of a slowdown in incremental lending at the end of 1HFY08, despite a muted growth in offtake of retail loans. While continuing to outperform the sector average in terms of incremental advances and deposit growth, the bank has kept the proportion of retail and corporate assets almost unchanged. The fact that HDFC Bank’s net interest margins (NIMs) despite a PLR hike, has dropped by nearly 0.6% in this quarter, is largely due to the impact of HTM (held to maturity) write offs in its treasury book. On a YoY basis the same have, in fact, improved by 0.2%.

Retail assets continue to enjoy dominance in HDFC Bank’s portfolio allocation (55% in 2QFY08). Having said that, given the rise in lending rates, the corresponding growth in the bank’s retail assets (37% YoY) has been lower than that clocked in the corresponding quarter of FY07 (44% 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 infact cushioned HDFC Bank’s net interest margins is the fact that it continues to enjoy the distinction of having the highest proportion of low cost deposits in its books (52.5% in 2QFY08). The sharp increase in net interest margin of the bank in the first quarter of FY08 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.

Good show…
(Rs m) 1HFY07 % of total 1HFY08 % of total Change
Advances 470,291   627,368   33.4%
Retail 252,137 53.6% 345,680 55.1% 37.1%
Corporate 218,154 46.4% 281,688 44.9% 29.1%
Deposits 634,627   910,690   43.5%
CASA 317,314 50.0% 478,112 52.5% 50.7%
Term deposits 317,314 50.0% 432,578 47.5% 36.3%
Credit deposit ratio 74.1%   68.9%    

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 leave a lot desired: Although HDFC Bank has been able to grow its fee income base by 25% YoY in 2QFY08, the fee to total income proportion has dropped to 24% against 25% in 2QFY07. Also, the loss on the treasury side has been compensated with higher forex gains which otherwise would have dented the bank’s 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: 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 2QFY08). 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.

Expensive expansion: The bank added just 1 branch in 2QFY08 as against 69 branches during the first quarter of FY08 taking the network to 754 in 320 cities. 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. However, with the cost to income ratio peaking to 50% in 2QFY08, the bank seems to have been cautious in its incremental franchise growth. It therefore has concentrated on increasing the number of ATMs (84 opened in 2QFY08) this quarter.

Comfortable with capital: 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. During the quarter ended September, 2007, the bank made an ADS offering in July 2007 of 6.6 m American Depositary Shares (ADS), each ADS representing three equity shares, at a price of US$ 92.1 per ADS. The net proceeds of the ADS issue were Rs 24 bn. As a result, the bank’s capital adequacy ratio (CAR) improved to 14.9% (Tier I CAR was at 11.3%). The enhanced book value has poised the bank attractively against its peers in terms of forward valuations, despite the fact that the issue entailed a dilution of 15% of the capital base.

What to expect?
At the current price of Rs 1,430, the stock is reasonably valued at 3.4 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 higher operating costs, increased provisioning requirements for treasury as well as shortage of fee income are our lingering concerns with regard to the bank (as is with the sector). We believe that the valuations leave little room for a substantial upside and that any investment in the stock needs to be viewed with caution.

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