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HDFC Bank: Bucking the trend!

Oct 17, 2005

Performance summary
HDFC Bank has announced strong results for the second quarter ended September 2005. The bank has reported a 31% YoY growth in its bottomline during the quarter. While most of its peers are facing margin pressures on account of higher cost of funds, the bank has managed to buck the trend by actually registering an improvement in net interest margin despite an appreciable 56% YoY growth in advances. The spurt in operating overheads has also been offset by the growth in other income. While the bank remains steady in terms of asset quality, capital crunch is a looming concern.

Rs (m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Income from operations 7,447 10,229 37.4% 14,473 19,170 32.5%
Other Income 1,227 2,602 112.1% 2,307 5,237 127.0%
Interest Expense 3,191 4,108 28.7% 6,229 7,812 25.4%
Net Interest Income 4,256 6,121 43.8% 8,244 11,358 37.8%
Net interest margin (%)       3.8% 4.0%  
Other Expense 2,473 4,016 62.4% 4,781 7,597 58.9%
Provisions and contingencies 758 1,806 138.3% 1,447 3,465 139.5%
Profit before tax 2,252 2,901 28.8% 4,323 5,533 28.0%
Tax 730 904 23.8% 1,400 1,702 21.6%
Profit after tax/ (loss) 1,522 1,997 31.2% 2,923 3,831 31.1%
Net profit margin (%) 14.9% 26.8%   20.2% 20.0%  
No. of shares (m) 286.3 311.9   286.3 311.9  
Diluted earnings per share (Rs)* 21.3 25.6   20.4 24.6  
P/E (x)         26.7  
* (annualised)            

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 FY05, the bank had a franchise of 531 branches and 1,150 ATMs. Strong understanding of the retail sphere (40% 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 10.4% at the end of 2QFY06.

What has driven performance in 2QFY06?
Margins uncompromised: HDFC Bank’s retail loan continued to grow at a faster clip (74% YoY) as compared to its corporate portfolio (40% YoY) during 2QFY06. With this, the bank’s total retail portfolio has surmounted the corporate segment to comprise 52% of the total advance portfolio. Although the bank has not divulged details about the average yields and average cost of funds, it has indicated a higher exposure in high yielding retail assets, which explains the expansion in net interest margins (NIMs at 4%). It must be noted that the bank enjoys one of the highest net interest margins in the sector. Also, higher concentration of low cost deposits (60%, again one of the highest in the sector) has helped the bank cap growth in interest costs.

Credit deposit ratio up
(Rs m) 2QFY05 % of total 2QFY06 % of total Change
Advances 215,032   334,990   55.8%
Retail 100,420 46.7% 174,530 52.1% 73.8%
Corporate 114,612 53.3% 160,460 47.9% 40.0%
Deposits 334,654   454,460   35.8%
CASA 174,478 52.1% 271,220 59.7% 55.4%
Term deposits 160,176 47.9% 183,240 40.3% 14.4%
Credit deposit ratio 64.3%   73.7%    

Treasury concerns – to be evaded: Fee income constituted 83% of the bank’s other income at the end of 2QFY06. This has complemented growth on the treasury side. It may be recalled that the bank suffered treasury losses in the corresponding quarter of FY05. As against that, profits in this quarter have bloated the figure of other income growth. The bank had 45% of its investments in the HTM category at the end of 1QFY06 and has transferred more investments to the HTM category in this quarter. The same is however, lower as compared to its peers in the private banking sector and with interest rates keeping an upward bias, negative repercussions of the same on HDFC Bank’s treasury portfolio cannot be ruled out.

Slippages to be arrested: 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 is 0.3% at the end of 2QFY06 (0.2% in 2QFY05).

Higher costs envisaged: The bank has filed a shelf prospectus for raising Rs 10 bn of Tier II borrowing in FY06. The same will mean 23% increase in borrowing costs and 50 basis points contraction in interest margins at the current cost of funds. Also, the bank’s cost to income ratio continues to inflate (31% in 2QFY06) due to a larger franchise and higher operational costs. These costs are expected to squeeze the bank’s net profit margins going forward.

What to expect?
We believe that HDFC Bank’s margins may not be sustainable in the longer term. While the bank can continue to do well in terms of asset growth and fee income, negative surprise on the treasury side may have an impact on the bottomline. The bank increased its investment in HDFC Securities from 29.5% to 55% in 2QFY06, consequently making HDFC Securities its subsidiary. Returns on the same also remain subjected to the vagaries of the capital markets.

At a current price of Rs 655, HDFC Bank’s stock is trading at 3.3 times our estimated FY08 adjusted book value. Although HDFC Bank remains amongst our top picks in the sector, we believe that the current valuations warrant caution.

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