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INDIA Institutional Research BANKING HDFC Bank Innate resilience; enduring growth… Initiating Coverage
INDIA
Institutional Research
BANKING
HDFC Bank
Innate resilience; enduring growth…
Initiating Coverage

Analyst:

Anand Dama

anand.dama@networthdirect.com

91 22 3028 6391 Date: 8 th January, 2010

Strong, consistent and resilient private banking player: HDFC bank is one of the best banking franchises among Indian banks with an unparalleled liability network, strong & consistent financial performance and sound risk management systems in place resulting in best asset quality even during trying times.

Growth set to return, but with quality: We estimate bank to deliver better than system credit expansion at about 24% CAGR over FY09 12E, well supported by improving economic conditions and sufficient low cost funds to generate better margins at lower risk. We believe that the banks revived growth phase will also be qualitative, bringing in more stability, comfort and resilience during tough times.

Impeccable asset quality with one of the lowest stressed assets : HDFC Bank has maintained robust asset quality with one of the lowest stressed assets amongst peers at about 2.3%, including GNPA at about 1.8%, despite higher retail exposure and economic slowdown, primarily due to its prudent lending practices and conservative provisioning policies (provision coverage at above 70%).

Return ratios to improve, but remain below historical averages : Bank has registered average RoE of about 20% over past 10 years, however, off late has come down to about 16%, primarily impacted due to significant equity dilution post merger. However, going forward, we estimate RoE to improve to about 18% by FY12E, as the bank productively deploys the infused capital and earnings gain traction with 29%CAGR over FY09 12E.We expect improved NII and fee income contribution to drive RoA at about 1.7% by FY12E.

Rich valuations to stay; recommend accumulate: With profitable and qualitative growth set to return and adverse impact of the expensive CBoP merger waning, bank would continue to enjoy premium. However, after significant rerating, stock is richly valued at 20.4x EPS and 3.3x FY11E adj.BV leaving limited upside. We value bank assigning a P/adj BV of 3.7x on FY11E adj.BV to arrive at a target price of Rs1938, providing an upside of 13% from current levels. Hence, recommend an accumulate rating on the stock.

Key risks: Higher delinquencies and slower branch expansion

Rating

Accumulate

Target Price

Rs1940

CMP

Rs1713

Upside

13%

Sensex

17,189

Key Data

Bloomberg Code Reuters Code NSE Code Current Share o/s (mn)

HDFCB IN

HDBK.BO

HDFCBANK

429.0

MktCap (Rsbn/USDmn) 734.9/16089.8

52 Wk H/L (Rs) Daily Vol.(3M NSE Avg) Face Value (Rs) Beta

1839/774

 

0.8mn

10

0.99

1USD/INR

46.7

Shareholding Pattern

 

(%)

Promoters

23.9

FII

27.5

Others

48.7

Price Performance (%)

 
 

1m

6m

1yr

HDFCB

8.1

3.5 7.6

NIFTY

3.9

5.6

80.2

Source: Bloomberg;*As on 7 th Jan, 2010

Y/E Mar (Rs mn)

NII

YoY (%)

Net Income

YoY (%)

Adj PAT

YoY (%)

EPS (Rs)

Adj BV (Rs)

RoE (%)

RoA (%)

P/E (x)

P/ABV (x)

FY08

52,279

50.7

75,110

50.7

15,902

39.3

44.9

316.0

17.7

1.4

38.2

5.4

FY09

74,212

42.0

107,118

42.6

22,450

41.2

52.8

329.6

16.1

1.3

32.5

5.2

FY10E

83,479

12.5

124,142

15.9

29,441

31.1

64.7

457.4

16.1

1.5

26.5

3.7

FY11E

101,432

21.5

123,313

17.9

38,155

29.6

83.8

524.8

16.5

1.6

20.4

3.3

FY12E

126,199

24.4

141,916

20.8

48,629

27.5

106.8

618.4

18.1

1.7

16.0

2.8

Source: Company, Networth Research

Exhibit 1: DuPont analysis (FY09)

(%) 20 18.1 18 16 10.7 14 12 10 8 1.8 2.8 6 4.4 0.9
(%)
20
18.1
18
16
10.7
14
12
10
8
1.8
2.8
6
4.4
0.9
4
0.8
1.7
2
0
NII
Non ‐
Opex Provisions Taxes
RoA
Avg.
RoE
Interest
Asset/Avg.
Income
Eq

Source: Company, Networth Research

Asset/Avg. Income Eq Source: Company, Networth Research Company Background HDFC Bank, incorporated in 1994 by the
Asset/Avg. Income Eq Source: Company, Networth Research Company Background HDFC Bank, incorporated in 1994 by the

Company Background

HDFC Bank, incorporated in 1994 by the Housing Development Finance Corporation (HDFC), is amongst the leading and relatively consistent private sector banks in the country today. The bank has pursued both organic and inorganic growth strategies to emerge as a strong player in private banking space. It acquired Times Bank in Feb 2000 and Centurion Bank of Punjab (CBoP) in year 2008. Bank has extensive network of more than 1500 branches and balance sheet size of about Rs1939bn. Bank has limited international exposure and is not aggressively pursuing building an huge international book, which made it more resilient during global crisis. The integration process of erstwhile CBOP branch is complete and will be brought to HDFC Bank productivity standards within next 12 15 months. The bank’s strengths include its strong brand image, proficient management, strong earnings traction, high CASA ratio and relatively better asset quality. Bank also has two non banking subsidiaries – HDFC Securities, which is primarily into broking business and HDB Financial services, which is in to microlending, distribution and collection business.

Exhibit 2: Key events

1994

Incorporate by HDFC

1995

IPO @Rs10

2000

Acquisition of Times bank in a share swap deal (1:5.75)

2008

Acquisition of Centurion Bank of Punjab in a share swap deal (1:29)

Exhibit 3: Key management personnel

Source: Company, Networth Research

Name

Position

Profile

Mr. Jagdish Capoor Chairman He took over as Bank’s chairman since July 2001. He holds a Masters Degree in Commerce and is a Fellow of Indian Institute of Banking & Finance. Prior to joining HDFC Bank, he was Deputy Governor of RBI. He also served on the boards of EXIM Bank, NHB, NABARD and SBI.

Mr. Aditya Puri

MD

He is MD of the bank since Sept 1994 and has more than 25 years of experience in banking industry. He holds a Bachelors Degree in Commerce from Punjab University and is an associate member of the ICAI. Prior to HDFC Bank, he was heading Citibank’s Malaysia operations.

Mr.Paresh Sukthankar ED He was appointed on 12 Oct 2007 for a three year term. He has been associated with the bank from 1994 in various senior capacities and has over 22 years of experience in finance and banking. Prior to joining the bank, he worked with Citibank for nearly 9 years.

Mr. Harish Engineer ED He has been associated with the bank since 1994 in various capacities and is currently responsible for wholesale banking division. He has over 38 years of experience in banking & finance and has prior experience working with Bank of America for 26 years in various areas, including operations and corporate credit management

Source: Company, Networth Research

Investment Rationale Strong, consistent and resilient private banking player HDFC bank is one of the
Investment Rationale Strong, consistent and resilient private banking player HDFC bank is one of the

Investment Rationale

Strong, consistent and resilient private banking player

HDFC bank is one of the best banking franchises among Indian banks with an unparalleled liability network, strong & consistent financial performance and sound risk management systems in place resulting in best asset quality even during the trying times. Bank characterises a combination of private aggression with a positive flavor of PSU (strong liability franchise and conservatism). Since inception, bank has adopted liability driven growth strategy with clear focus on margins, profitability and sound asset quality. During the recent sub prime crisis, when many banks were affected, HDFC bank remained a safe harbor as it had virtually no exposure to these toxic assets nor any material international exposure.

The bank has consistently outperformed the broad industry with 52% asset CAGR, 61% credit growth and delivering average PAT growth of 40% and RoE of 20% over past 10 years. Bank has gained significant market share in industry credit and CASA deposits, which is a mainstay for the banks sectorbeating margins (>4%). To gain scale and emerge as a stronger private banking player, bank has even adopted in organic growth strategy acquiring two banks (Times bank and CBoP) through its journey till now. Going forward, we estimate earnings trajectory to remain strong and consistent with 29% PAT CAGR, RoE at 18% and RoA at 1.7% over FY09 12E. We believe that banks such as HDFC bank with strong lowcost liability franchise, robust but qualitative growth oriented bank will emerge as sustainable winners in long run. Exhibit 5: Better RoE visàvis industry

Exhibit 4: Consistent PAT growth above 30% % 100 80 60 40 20 0 ‐20
Exhibit 4: Consistent PAT growth above 30%
%
100
80
60
40
20
0
‐20
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
HDFCB (adj for merger)
HDFCB
Private
PSU

SCBFY08 FY09 HDFCB (adj for merger) HDFCB Private PSU Source: Company, RBI, Networth Research % 30

Source: Company, RBI, Networth Research

%

30 25 20 15 10 5 0 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07
30
25
20
15
10
5
0
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
HDFC
Private
PSU
SCB
Source : Company, RBI, Networth Research
Exhibit 6: Credit growth well above industry (YoY) % 160 140 120 100 80 60
Exhibit 6: Credit growth well above industry (YoY)
%
160
140
120
100
80
60
40
20
0
‐20
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09 Q2FY10
HDFC (adj for merger)
HDFCB
Private
SCB

Source: Company, RBI, Networth Research (SCB – Scheduled Commercial banks)

Exhibit 7: Gained market share even in tougher times % 6 30 5 25 4
Exhibit 7: Gained market share even in tougher times
%
6
30
5
25
4
20
3
15
2
10
1
5
0
0
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
Share in industry credit
Share in industry CASA
Share in pvt banks credit
Share in pvt banks CASA

Source: Company, RBI, Networth Research

Out ‐ performance during recent quarters also indicates banks inherent strength and strong resilience Despite
Out ‐ performance during recent quarters also indicates banks inherent strength and strong resilience Despite

Outperformance during recent quarters also indicates banks inherent strength and strong resilience

Despite economic slowdown, HDFC Bank registered consistent ~30% PAT growth, maintaining its sectorbeating margins above 4% and sound asset quality, courtesy its inherent strength and resilience. Recent quarterly performance indicates that bank is back in growth phase, outperforming industry. We believe that the bank’s strategy to maintain strong but consistent performance is the key to the banks success, justifying its premium valuation and making it a bell weather bank.

Exhibit 8: Smart post merger recovery evident

%

60

50

40

30

20

10

0

Loan growth (YoY) PAT growth (YoY) NIM Q4FY07 Q1FY08 Q2FY08 Q3FY08 Q4FY08 Q1FY09 Q2FY09 Q3FY09
Loan growth (YoY)
PAT growth (YoY)
NIM
Q4FY07
Q1FY08
Q2FY08
Q3FY08
Q4FY08
Q1FY09
Q2FY09
Q3FY09
Q4FY09
Q1FY10
Q2FY10

4.6

4.5

4.4

4.3

4.2

4.1

4.0

3.9

3.8

3.7

Source: Company, Networth Research

Resilient investment book

HDFC Bank does not have any international investment book and hence remains relatively better insulated to global turbulence as compared to its peers. Further, it has a reasonably lower proportion of book in to AFS category (at about 25%), which in a way secures the bank from any significant adverse moment in GSec yields, but at the same time restricts higher trading gains in case of declining yields scenario.

CBoP merger pain waning…

As a strategic decision to enhance branch network (which otherwise would have taken at least 2 3 years through organic expansion) and gain business scale, bank acquired retail focused Centurion bank of Punjab (CBoP) at a relatively higher cost. Though merger gave bank a needed scale, but adversely impacted banks financials and to make it worst followed by global slowdown due to sub prime crisis. The merger brought with it elevated cost structure, high risk loans and underproductive though potential, branch network and biggest challenge in form of integration process. However, bank has timely completed the integration process backed by strong management band width and handson experience and merger benefits are already evident well ahead of expectation supported by economic recovery. Approximately 40% of the GNPA’s as on during FY09, were contributed by CBoP. However, erstwhile CBoP’s high risk loan portfolio has almost run off except for personal loans, which will take another 12 15 months and thus do not pose significant risk anymore. We expect the full benefits of the merger to flow in, leading to improved financial ratios and better valuations for the bank.

HDFC Bank scores well on most of the parameters… We believe the key positives of
HDFC Bank scores well on most of the parameters… We believe the key positives of

HDFC Bank scores well on most of the parameters…

We believe the key positives of HDFC bank are its strong liability franchise with higher CASA deposits leading to sector beating NIM’s, strong fee income, consistent financial performance with impeccable asset quality, strong & dynamic management and parental support from HDFC. As indicated in below table, HDFC bank scores well on most of the parameters and has emerged as a consistent and seasoned private banking player over the years, justifying the premium it commands.

Exhibit 9: Key business and financial summary of peer banks

Comparative Parameters

HDFC

Axis

ICICI

Commentary

Business Metrics (%)

Branches (Q2FY10)

1506

916

1520

Plans to add about 200250 branches every year

Asset (3 yr CAGR)

36.0

44.0

15.0

Phenomenal growth but with quality. We estimate credit growth at 24% on high base over FY0912E.

Credit growth (3 yr CAGR)

41.0

54.0

14.0

Retail Portfolio (%)

55.0

22.0

45.0

Higher retail portfolio but lower NPA's

CI ratio

51.7

43.4

44.1

Post merger, CI ratio coming off

CASA ratio (Q2FY10)

50.0

43.0

37.0

Branch expansion and merger synergies to help sustain industry best CASA ratio.

CASA per branch

50.0

54.0

48.0

International/Global business

0.4

6.3

28.0

Lower international exposure saved the bank from sub prime effect Recent warrant conversion will lead to 250bps improvement in TierI capital. Expect CAR at comfortable level of about 15.6%, with TierI capital at about 11.6% by FY12E without further capital infusion

Capital Adequacy (Q2FY10)

15.7

16.5

17.7

Tier I (Q2FY10)

10.9

11.4

13.4

Margins (%)

NIM FY09

4.5

3.0

2.3

NIM Q2FY10

4.2

3.5

2.5

HDFC bank commands sector beating margins owing to strong lowcost franchise to fund higher yielding assets. Despite slowdown, banks NIM's remained nearly stable. We expect NIM's to remain range bound at about 4.44.5% over FY0912E

Yield on advances

13.6

10.6

10.1

Cost of deposits

6.0

6.1

6.8

Interest spread

7.6

4.5

3.3

NII/Assets

4.3

2.9

2.1

Asset quality (%)

GNPA (Q2FY10)

1.8

1.2

4.7

 

Best asset quality with one of the lowest stressed assets.

Stressed Assets (Q2FY10)

2.4

4.1

7.2

Provision coverage (exc. Tech w/offs)

70.0

63.0

51.1

Provision coverage well within RBI's prescribed levels

Capital Market exposure

4.4

2.8

2.9

Commercial Real estate exposure

7.2

6.5

7.5

 

Qualitative asset profile leading to lower NPA's and capital requirement.

High risk industry exposure

7.5

18.1

22.1

RWA/Total Assets

71.0

74.0

94.0

Profitability (%)

RoE

16.1

19.1

7.8

RoEs to improve further, but to remain below historical averages. RoA set to improve with improving NII/Assets and fee income

RoA

1.3

1.4

1.0

Source: Networth Research Note: Primarily FY09 figures; but used Q2FY10 numbers as well wherever available and relevant

Growth set to return, but with quality

Growth set to return, but with quality After adopting go ‐ slow strategy considering economic slowdown
Growth set to return, but with quality After adopting go ‐ slow strategy considering economic slowdown

After adopting goslow strategy considering economic slowdown and expensive CBoP acquisition, bank is gearing up to get back on growth path, which is evident during past 2 quarters. Bank has registered about 11%YoY and 10%QoQ growth during Q2FY10, after negative sequential growth in Q3FY09 and flat growth in Q4F09. The growth has come despite run off on CBoP portfolio, primarily driven by corporate (35% in 1HFY10) and car loans (10% in 1HFY10). As a strategy, bank will continue to focus on corporate loan growth, but with macroeconomic risks retreating, bank is also likely to register significant revival in retail loan growth. Systemic demand for retail loans (especially auto and housing loans) has improved. HDFC bank has been a dominant player in auto financing with more than 30% market share amongst banks and with auto sales reviving, bank is likely to register better growth in this segment. We estimate bank to register better than system credit expansion at about 24% CAGR over FY09 12E, well supported by improving economic conditions and sufficient low cost funds to fund higher credit growth at better margins. The bank is still not looking aggressively at building international loan book, which should further insulate bank from any near term shocks in international markets.

Exhibit 10: QoQ loan growth reviving % 25 22.3 20 15 9.5 10 5.6 5.0
Exhibit 10: QoQ loan growth reviving
%
25
22.3
20
15
9.5
10
5.6
5.0
5
0.1
0
‐5
‐3.4
Q1FY09
Q2FY09
Q3FY09
Q4FY09
Q1FY10
Q2FY10

Source : Company, Networth Research

Exhibit 11: Better loan growth v/s peers & industry(1HFY10) % 20 15.0 15 10 5.5
Exhibit 11: Better loan growth v/s peers & industry(1HFY10)
%
20
15.0
15
10
5.5
4.3
5
0
‐0.6
‐1.4
‐5
‐10
‐15
‐12.6
HDFC
ICICI
Axis
SBI
SCB
Pvt

Source: Company, Networth Research

Loan mix tilting towards corporate, secured and high duration assets…

Traditionally bank has been a preferred working capital financier rather than long term financier and leveraging upon the same during downturn, bank has consciously build up its relatively low risk corporate loan book. Bank has indicated that it will like to further explore opportunities in mid to long term infrastructure financing, which would increase the duration of its loan portolio, subject to appropriate pricing. Within retail portfolio also bank has consciously allowed high risk 2W and LAS portfolio to runoff and has kept its CV, personal loan, business banking and credit card portfolio nearly stable. As per management, CBoP’s high risk 2W portfolio has virtually run off, while personal loan portfolio would take another 12 15 months.

Bank has been retaining home loans originated by it for HDFC limited (in contrast to earlier practice of transferring the loans to HDFC), along with acquired home loan portfolio from erstwhile CBoP, which should make the retail portfolio more secured, help fulfill its priority sector lending target and also improve the duration of the portfolio. We believe that banks revived growth phase will also be qualitative, bringing in more stability, comfort and resilience during tough times.

Exhibit 12: Loan composition shifting towards corporates 100%              
Exhibit 12: Loan composition shifting towards corporates 100%              

Exhibit 12: Loan composition shifting towards corporates

100%

 
100%        
100%        
100%        
 
100%        
 
100%        
 
     

80%

 

60%

40%

 

43.2

 

41.0

 

44.9

 

20%

 

38.4

 

38.2

 

0%

 

Q4FY08

Q1FY09

Q4FY09

Q1FY10

 

Q2FY10

CorporatePV CV

PVCorporate CV

Corporate PV CV

CV

2W  Personal Credit Card  

 

Personal2W   Credit Card  

2W   Personal Credit Card  
2W   Personal Credit Card  

Credit Card

 

LASBusiness banking Housing & others  

BusinessLAS banking Housing & others  

banking

Housing & others

 

Source : Company, Networth Research

Impeccable asset quality with one of the lowest stressed assets

HDFC Bank has maintained robust asset quality despite higher retail exposure and economic slowdown, primarily due to its prudent lending practices and conservative provisioning policies. Considering stressful economic environment, higher share of retail book, high risk loan portfolio (2W’s and personal loans) acquired from CBoP, serious concerns were raised about banks asset quality. However sensing the stress, the bank consciously allowed CBoP high risk loan portfolio to run off and also somber down its credit growth machine to arrest incremental NPL’s. Bank has once again emerged as one of the best bank in terms of asset quality with one of the lowest stressed assets in Indian banking industry.

GNPAs declined 6%QoQ during Q2FY10 to 1.8%, indicating likely peaking of delinquencies in near term. Further, overall stressed assets including restructured assets stood at about 2.3%, which is one of the lowest in the industry. However, factoring in higher retail portfolio including CBoP portfolio, we conservatively estimate GNPA at about 1.9% and NNPA at 0.5% by FY12E.

Exhibit 13: Asset quality risks nearly peaked (%) 2.5 2.1 2.1 2.1 2.0 1.9 1.9
Exhibit 13: Asset quality risks nearly peaked
(%)
2.5
2.1
2.1
2.1
2.0
1.9
1.9
2.0
1.8
1.6
1.5
1.5
1.3
1.3
1.0
0.5
0.0
GNPA
NNPA
FY07
FY08
Q1FY09
Q2FY09
Q3FY09
Q4FY09
Q1FY10
Q2FY10
FY10E
FY11E
FY12E

Source: Company, Networth Research

Exhibit 14 : Lowest stressed assets amongst peers (Q2FY10)

% 9 8 7 6 5 4 3 2 1 0 HDFC Axis KMB UBI
%
9
8
7
6
5
4
3
2
1
0
HDFC
Axis
KMB
UBI
ICICI
SBI
PNB
BOI
GNPA
Restructured loans

Source: Company, Networth Research

Higher provision coverage comforting HDFC Bank has traditionally maintained a NPA coverage ratio above 67%
Higher provision coverage comforting HDFC Bank has traditionally maintained a NPA coverage ratio above 67%

Higher provision coverage comforting

HDFC Bank has traditionally maintained a NPA coverage ratio above 67% (well above 100% including general provisions) driven by consistently higher operating profitability (higher operating income/average assets at about 3%). We estimate operating profits to grow at 23% CAGR over FY09 12E, providing enough cushion for higher NPA provisioning, if required. We expect NPA coverage to be in the range of about 74 76%, which is well above RBI’s prescribed level of 70%, keeping its net NPA well below 1% over FY09 12E.

Exhibit 15: Adequate provision coverage above 70%

%

95

90

85

80

75

70

65

60

55

50

91.7 86.2 83.8 75.8 76.1 74.5 69.5 69.2 68.6 67.1 FY03 FY04 FY05 FY06 FY07
91.7
86.2
83.8
75.8
76.1
74.5
69.5
69.2
68.6
67.1
FY03
FY04
FY05
FY06
FY07
FY08
FY09E FY10E FY11E FY12E

Source: Company, Networth Research

One of the best liability franchises and further building muscle

HDFC bank has one of the best liability franchises with more than 70% of branches located in the CASA rich metro and urban regions of the country. Traditionally, bank had strong presence in North, West and southern region, which has been further amplified with acquisition of CBoP. Most of the banks have realised importance of maintaining adequate branch network, which helps in procuring low cost CASA deposits and thus control cost of funding in long run to maintain margins. HDFC bank has been aggressive on this front since its inception and has even acquired banks to bolster its branch network. Historically, bank has maintained higher CASA ratio in the range of about 40%55%, which provides the flexibility to lend at competitive rates to customers and still maintain one of the best margins in the industry.

Exhibit 16: Well spread CASA rich branch network

Central

East 10% North 9% 30% West 25%
East
10%
North
9%
30%
West
25%

South

26%

Source : Company, Networth Research

Exhibit. 17: HDFC Bank has higher share of metro+urban branches 100% 5% 4% 6% 10%
Exhibit. 17: HDFC Bank has higher share of metro+urban branches
100%
5%
4%
6%
10%
90%
23%
24%
80%
33%
70%
53%
60%
34%
40%
50%
28%
40%
30%
25%
20%
39%
32%
29%
10%
16%
0%
ICICI Bank
HDFC Bank
Axis Bank
Federal Bank
Metro
Urban
Semi ‐urban
Rural

Source : Company, Networth Research

Branch expansion back on track after a lull Post merger, bank had consciously slowed down
Branch expansion back on track after a lull Post merger, bank had consciously slowed down

Branch expansion back on track after a lull

Post merger, bank had consciously slowed down branch expansion for about 3 quarters till Q1FY10. However, off late with integration process of CBoP branches over and economy back on track, bank has revived its organic branch expansion plan opening about 90 branches in Q2FY10. It plans to open about 200 250 branches every year, majority of which will be stripped down version of branches.

Exhibit 18: Bank to add about 200 250 branches every year

Nos

2500

2000

1500

1000

500

0

2036 419 1836 1686 1506 1412 761 684 FY07 FY08 FY09 Q2FY10 FY10E FY11E FY12E
2036
419
1836
1686
1506
1412
761
684
FY07
FY08
FY09
Q2FY10
FY10E
FY11E
FY12E

Source: Company, Networth Research

Superlative CASA ratio in the industry…

Bank has one of the best CASA ratio in the industry at about 50% with higher share of stable savings deposits and retail deposits. Higher savings deposits has been due to banks widespread branch network and its focus on corporate salary a/cs. Post merger with CBoP and owing to industry wide phenomenon of cannibalization of savings accounts due to increased rate differential between savings and term deposits, banks CASA ratio had fallen to about 40% during Q3FY09 from a high of 54% premerger. However, with falling term deposit rates, integration of erstwhile CBOP branches and continued branch expansion supported by float arising from improved transactional banking and IPO’s, CASA ratio has already started shown signs of improvement to about 50% in Q2FY10 (Core CASA ratio – 47%). We believe that significant branch expansion, reducing spread between term and saving deposit rates and incremental CASA from wellintegrated CBoP branches should help bank maintain CASA ratio in the range of about 50% and thus sustain its sectorbeating margins (>4%).

Exhibit 19: One of the highest CASA ratio with higher share of savings deposits

60%

50%

40%

30%

20%

10%

0%

19% 16% 13% 21% 19% 8% 12% 30% 29% 25% 24% ‐2% HDFC ICICI Axis
19%
16%
13%
21%
19%
8%
12%
30%
29%
25%
24%
‐2%
HDFC
ICICI
Axis
PNB
Savings
Current
CASA mobilisation during 1HFY10

22%

17%

12%

7%

2%

3%

8%

Source: Company, Networth Research

…helped maintain best in class margins above 4% despite industry ‐ wide pressure HDFC Bank
…helped maintain best in class margins above 4% despite industry ‐ wide pressure HDFC Bank

…helped maintain best in class margins above 4% despite industrywide pressure

HDFC Bank commands best in class NIM’s in the banking industry (only after Kotak Mahindra Bank), primarily on account of lower cost of funds (led by higher CASA) and better yields (higher retail exposure). NIM’s were under pressure owing to falling interest rates and higher cost of funds since the onset of slowdown. However, HDFC Bank managed to maintain its margin at about 4.2% during past 3 quarters with marginal compression courtesy its astounding ability to control cost of funds. Going forward, with credit growth back on track including revival in retail loans and improvement in CASA ratio, we expect banks NIM to settle around 4.5%.

Exhibit 20: NIM’s to settle around 4.5%

Exhibit 21: NIM’s sustained despite industry wide pressure

(%) (%) 4.6 5.0 4.9 4.9 4.2 4.8 3.8 4.7 3.4 4.6 4.5 4.5 4.5
(%)
(%)
4.6
5.0
4.9
4.9
4.2
4.8
3.8
4.7
3.4
4.6
4.5
4.5
4.5
4.5
4.4
3.0
4.4
4.4
2.6
4.3
2.2
4.2
4.1
FY07
FY08
FY09
FY10E
FY11E
FY12E
Q3FY09 Q4FY09 Q1FY10 Q2FY10 HDFC ICICI Axis SBI PNB
Q3FY09
Q4FY09
Q1FY10
Q2FY10
HDFC
ICICI
Axis
SBI
PNB

Source: Company, Networth Research

Source : Company, Networth Research

Strong, nonvolatile and welldiversified source of noninterest income

Non interest income contribution to net income for HDFC bank has been lower as compared to its peers at about ~30%, but is relatively strong and less volatile with non trading income contributing about 88% of other income. Core fee income excluding forex & derivative gains contributes about 75% of the non interest income, of which nearly 75% is from retail operations. The bank has well diversified feebased product portfolio for both retail (viz loan processing, credit card, depository, third party and other fee based products) and corporate clients (viz core banking, trade finance, CMS), which endows stability and sustainability to its fee income.

Exhibit 22: Non interest income less volatile with higher share of non trading income

100% 80% 60% 40% 20% 0% -20% FY05 FY06 FY07 FY08 FY09 1HFY10 FY10 FY11E
100%
80%
60%
40%
20%
0%
-20%
FY05
FY06
FY07
FY08
FY09 1HFY10 FY10
FY11E FY12E
Fees & Commission
Trading income
Forex & derivatives

Source : Company, Networth Research

Bank has identified improving fee income as one of the key focus area and is
Bank has identified improving fee income as one of the key focus area and is

Bank has identified improving fee income as one of the key focus area and is taking various measures to enhance the same. CBoP’s acquisition (strong in feebased third party product distribution, remittance, forex & derivative business) was one such strategic move to enrich its feebased product basket, increase its reach and customer base. As a result, share of forex & derivative income has significantly improved in banks non interest income. Bank has strong presence in retail segment; however, off late share of corporate loans too has increased in bank’s loan portfolio, indicating increased activity on corporate side, which should further boost banks fee income. During 1HFY10, non interest income growth has been robust, driven by higher treasury and fee income. With rising bond yields, treasury income outlook remains weak during 2HFY10, however, fee income growth is likely to remain robust with management expecting it to track loan growth. We expect bank’s non interest income to register 15% CAGR over FY09 12E, with core fee income at 17% CAGR.

Exhibit 23: Fee income to trail loan growth

%

80

70

60

50

40

30

20

10

0

FY05 FY06 FY07 FY08 FY09 FY10E FY11E FY12E Non-interest income growth Fee income Loan growth
FY05
FY06
FY07
FY08
FY09
FY10E
FY11E FY12E
Non-interest income growth
Fee income
Loan growth

100

90

80

70

60

50

40

30

20

10

0

Source : Company, Networth Research

Costincome ratio improves with synergies kicking in

Post CBoP merger, HDFC banks (merged) costincome ratio had increased to about 56% owing to high cost operating structure of CBoP and integration related expenses, which has now come off with synergies kicking in. Bank has managed to control the CI ratio well ahead of expectation, led by significant improvement in overall productivity, better treasury gains and pick up in fee income from CBoP branches, which had been badly affected post merger. With integration nearly over, expenses are expected to be under control and with merger benefit sinking in, we believe that there is further scope, though not significant for improvement in CI ratio to about 45% by FY12E.

Exhibit 24: Post merger cost efficiency showing definitive signs of improvement

%

60

50

40

30

20

10

0

55.7 55.3 50.3 50.0 47.1 47.6 46.2 46.2 45.2 45.1 Q4FY08 Q1FY09 Q2FY09 Q3FY09 Q4FY09
55.7
55.3
50.3
50.0
47.1 47.6
46.2
46.2
45.2
45.1
Q4FY08
Q1FY09
Q2FY09
Q3FY09
Q4FY09
Q1FY10
Q2FY10
FY10E
FY11E
FY12E

Source : Company, Networth Research

Better earnings visibility emerging; however RoE’s to remain below historical averages Bank had consciously
Better earnings visibility emerging; however RoE’s to remain below historical averages Bank had consciously

Better earnings visibility emerging; however RoE’s to remain below historical averages

Bank had consciously slowed down the pace of loan growth resulting in relatively moderate core earnings. However, with economy well on revival and dampening impact of CBoP merger retreating, credit and earnings growth momentum has recently picked up. We expect the bank to deliver strong and consistent 29% PAT CAGR over FY09 12E, on the back of steady NIM’s, better fee income and asset quality.

Bank has registered average RoE of about 20% over past 10 years, which has come down to about 16%, primarily impacted due to significant equity dilution post merger. However, going forward, we estimate RoE to improve to about 18% by FY12E, as bank gets back to high growth phase and productively deploys the infused capital. We expect better NII growth and higher fee income contribution to overall income to improve leading to better RoA at about 1.7% by FY12E.

Exhibit 25: Return ratios likely to improve but remain below historical average

%

25

20

15

10

5

0

1.7 1.6 1.5 1.4 1.4 1.3 19.5 17.7 18.1 16.1 16.1 16.5 FY07 FY08 FY09
1.7
1.6
1.5
1.4
1.4
1.3
19.5
17.7
18.1
16.1
16.1
16.5
FY07
FY08
FY09
FY10E
FY11E
FY12E
RoE-LHS
RoA-RHS

2.0

1.6

1.2

0.8

0.4

0.0

Source: Company, Networth Research

Warrant conversion further enhances capital adequacy

Bank has decent capital adequacy at about 15.7%, including TierI capital at about 10.9% during Q2FY10. Parent HDFC has subscribed to 26.2mn warrants (at issue price of Rs1530), which bank had issued to HDFC post CBoP merger to retain latter’s holding in the bank. Concerns were raised about subscription of these warrants as the stock price of HDFC bank had declined well below issue price, however, the same has been put to rest with market recovery and continued support from parent, which is also a major comforting factor for the bank. Warrant conversion led to more than 200bps increase in Tier I capital and is book value accretive as it enhanced book value by Rs87.5 i.e 23% against equity dilution of mere 6%. We estimate overall CAR at comfortable level of about 15.6%, with TierI capital at about 11.6% by FY12E without further capital infusion.

Valuation Analysis Rich valuations to stay; recommend accumulate Over the years, bank has build strong
Valuation Analysis Rich valuations to stay; recommend accumulate Over the years, bank has build strong

Valuation Analysis

Rich valuations to stay; recommend accumulate

Over the years, bank has build strong asset and liability base with sound business practices, which has helped it sail through double hit of expensive merger and economic slowdown. Bank commands premium valuation primarily due to its consistent earnings growth of above 30%, sectorleading NIMs (>4%), robust asset quality, sound management and allin all its ability to emerge as a strong and resilient private banking player. With profitable and qualitative growth well set to return and merger benefits sinking in, we believe that bank would continue to enjoy premium valuations.

The stock is currently richly valued at 20.4x EPS and 3.3x FY11E adjusted BV. It has primarily been trading in the one year forward P/Adj BV range of 2 4x with max P/Adj BV of 5.5x and min of 1.8x in past 10 years with a significant premium over sector. We value HDFC Bank assigning a P/adj BV of 3.7x on FY11E adj. BV of Rs525 to arrive at a value of Rs1940, providing an upside of 13% from current levels. Hence recommend accumulate on the stock.

Exhibit 26: One year forward P/Adj BV

Rs Index 2600 26000 2400 24000 2200 22000 2000 20000 1800 18000 1600 16000 1400
Rs
Index
2600
26000
2400
24000
2200
22000
2000
20000
1800
18000
1600
16000
1400
14000
1200
12000
1000
10000
800
8000
600
6000
400
4000
200
2000
0
0
HDFC Bank