Why the Stock of HDFC Bank Deserves a Closer Look than Before...

Jul 22, 2020

HDFC Bank's results' analysis.

Whenever I am asked, which aspect of my work I found least exciting, over past 16 years, this is always my answer.

All put together. I have analysed the performance numbers of the bank, for 63 quarters, so far.

Balance sheet growth and profit growth in the range of 20% year on year. Net non-performing assets (NPAs) well below 1% of loan book.

These are statements which remained a permanent fixture in HDFC Bank's results, come what may.

Be it SARS, the global financial crisis or demonetisation, it was impossible to find an aberration in HDFC Bank's numbers. Needless to say, I didn't expect Coronavirus to do the unthinkable.

I always knew that HDFC Bank keeps ample floating coverage (provisions over and above gross NPAs). Rather that's the secret of the bank's impeccable asset quality across economic cycles.

It's probably the only financial entity in the country (apart from parent HDFC) to assign higher weightage to its internal rating system. In other words, it doesn't rely on rating agencies.

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This internal rating system allows HDFC Bank to err on the side of caution. Its effectiveness is evident in HDFC sidestepping every sectoral crisis from infrastructure to real estate to telecom to aviation to NBFCs.

So, why pay attention to the bank now?

What drew my attention is the fact that HDFC Bank increased provision costs by 50% this quarter.

That too despite completely stopping new retail credit like personal loans during the Covid-19 lockdown phase.

If a bank that has floating provisions at 149% of gross NPAs needs to do this, are the others playing with fire? Let me list at least three reasons to believe so.

First, the loans under moratorium (offered due to Covid-19 crisis) may be a sitting time bomb for India's financial sector.

52% of NBFCs loans were under a moratorium as of May 2020. Even if 10% of these loans go bad, then the gross NPAs of NBFCs will double to 9.6% of loans by March 2021.

The trouble among NBFCs will spillover to banks. Just as they did post demonetisation. The bank's current exposure to NBFCs is nearly three times that post demonetisation.

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Second, rating agencies have informed RBI that they could stop rating at least 50% of the rated universe.

This is primarily for want of sufficient financial data in the post Covid-19 scenario from their reluctant clients. Banks that have lent to there entities based on the credit ratings remain most vulnerable.

Third, almost 6 m salaried individuals withdrew money from their Employees' Provident Fund account during the April to June quarter. This is significantly above normal withdrawal rates and suggests a steep fall in incomes. Such individuals may no longer be in a position to service loan EMIs once the moratoriums lapse.

So, it's fair to assume that the real impact of Covid-19 will be evident on the Indian financial sector post September. HDFC Bank's prudence in loan loss provisions only points towards it.

What's more worrying is that India isn't an isolated case in such post Covid-19 banking crisis.

Jamie Dimon, chief of one of the largest US banks, JP Morgan, believes such a catastrophe is coming the US's way too.

25.6 m Americans will lose unemployment benefits by the end of July 2020. Its unclear if the government will stop paying the US$ 600 per week payout to such households.

Almost 50% of credit card and mortgage customers in the US are under moratorium. Like their Indian counterparts, these borrowers could default first.

China usually manages to hide such widespread trouble in its financial sector... but not this time.

Just last week, the Chinese regulator took control of 9 troubled financial firms. It's worth noting the Chinese government has taken over only 12 financial entities since 1995. The number this year is therefore alarming.

Call it what you want, but this is China's version of financial contagion.

Which Indian financial entities could be the victim of such a worldwide contagion?

I will continue to dig the details and keep you informed.

Which are the entities you should consider profiting from while the Sensex is nearing its peak? I answered that in a video in December 2019.

Stay tuned for more...

Warm regards,

Tanushree Banerjee
Tanushree Banerjee
Editor, StockSelect
Equitymaster Agora Research Private Limited (Research Analyst)

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