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1 HDFC Bank

Analyst: Anand Dama [email protected]

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 re‐rating, 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 AccumulateTarget Price Rs1940CMP Rs1713Upside 13%Sensex 17,189

Key Data Bloomberg Code HDFCB IN Reuters Code HDBK.BONSE Code HDFCBANKCurrent Share o/s (mn) 429.0MktCap (Rsbn/USDmn) 734.9/16089.852 Wk H/L (Rs) 1839/774Daily Vol.(3M NSE Avg) 0.8mnFace Value (Rs) 10Beta 0.991USD/INR 46.7

Shareholding Pattern (%)Promoters 23.9FII 27.5Others 48.7

Price Performance (%) 1m 6m 1yr

HDFCB ‐8.1 ‐3.5 ‐7.6NIFTY 3.9 5.6 80.2Source: Bloomberg;*As on 7th Jan, 2010

INDIA

Institutional Research

BANKING

Initiating Coverage

HDFC Bank

Innate resilience; enduring growth…

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

Networth Research is also available on Bloomberg and Thomson Reuters

2 HDFC Bank

4.41.8 2.8

0.90.8

1.7

10.7

18.1

0

2

4

6

8

10

12

14

16

18

20

NII Non‐

Interest

Income

Opex Provisions Taxes RoA Avg.

Asset/Avg.

Eq

RoE

(%)


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 micro‐lending, distribution and collection business.

Exhibit 2: Key events

1994 Incorporate by HDFC1995 IPO @Rs102000 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

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


Exhibit 1: DuPont analysis (FY09)

3 HDFC Bank

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 sector‐beating 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 low‐cost liability franchise, robust but qualitative growth oriented bank will emerge as sustainable winners in long run.

Exhibit 4: Consistent PAT growth above 30% Exhibit 5: Better RoE vis‐à‐vis industry

‐20

0

20

40

60

80

100

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09

%

HDFCB (adj for merger) HDFCBPrivate PSUSCB

0

5

10

15

20

25

30


%

HDFC Private PSU SCB

Source: Company, RBI, Networth Research Source: Company, RBI, Networth Research

Exhibit 6: Credit growth well above industry (YoY) Exhibit 7: Gained market share even in tougher times

‐20

0

20

40

60

80

100

120

140

160

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 Q2FY10

%

HDFC (adj for merger) HDFCB Private SCB

0

1

2

3

4

5

6


%

0

5

10

15

20

25

30

Share in industry credit Share in industry CASA

Share in pvt banks credit Share in pvt banks CASA

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

4 HDFC Bank

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

Despite economic slowdown, HDFC Bank registered consistent ~30% PAT growth, maintaining its sector‐beating 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

0

10

20

30

40

50

60

Q4FY07

Q1FY08

Q2FY08

Q3FY08

Q4FY08

Q1FY09

Q2FY09

Q3FY09

Q4FY09

Q1FY10

Q2FY10

%

3.7

3.8

3.9

4.0

4.1

4.2

4.3

4.4

4.5

4.6

Loan growth (YoY) PAT growth (YoY) NIM


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 G‐Sec 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 under‐productive 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 hands‐on 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.

5 HDFC Bank

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

Business Metrics (%)

Branches (Q2FY10) 1506 916 1520

Asset (3 yr CAGR) 36.0 44.0 15.0

Credit growth (3 yr CAGR) 41.0 54.0 14.0

Retail Portfolio (%) 55.0 22.0 45.0

C‐I ratio 51.7 43.4 44.1

CASA ratio (Q2FY10) 50.0 43.0 37.0

CASA per branch 50.0 54.0 48.0

International/Global business 0.4 6.3 28.0

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

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

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

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

RoA 1.3 1.4 1.0

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

Lower international exposure saved the bank from sub‐prime effect

Phenomenal growth but with quality. We estimate credit growth at 24%

on high base over FY09‐12E.

Branch expansion and merger synergies to help sustain industry best

CASA ratio.

Recent warrant conversion will lead to 250bps improvement in Tier‐I

capital. Expect CAR at comfortable level of about 15.6%, with Tier‐I

capital at about 11.6% by FY12E without further capital infusion

RoEs to improve further, but to remain below historical averages. RoA

set to improve with improving NII/Assets and fee income

Commentary

HDFC bank commands sector beating margins owing to strong low‐cost

franchise to fund higher yielding assets. Despite slowdown, banks NIM's

remained nearly stable. We expect NIM's to remain range bound at

about 4.4‐4.5% over FY09‐12E

Plans to add about 200‐250 branches every year

Higher retail portfolio but lower NPA's

Post merger, C‐I ratio coming‐off

Best asset quality with one of the lowest stressed assets.

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

6 HDFC Bank

Growth set to return, but with quality

After adopting go‐slow 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 macro‐ economic 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 Exhibit 11: Better loan growth v/s peers & industry(1HFY10)

22.3

5.6

‐3.4

0.1

5.0

9.5

‐5

0

5

10

15

20

25

Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10

%

15.0

‐12.6

‐0.6

5.54.3

‐1.4

‐15

‐10

‐5

0

5

10

15

20

HDFC ICICI Axis SBI SCB Pvt

%

Source: Company, Networth Research 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 run‐off 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.

7 HDFC Bank

Exhibit 12: Loan composition shifting towards corporates

38.4 43.2 38.2 41.0 44.9

0%

20%

40%

60%

80%

100%

Q4FY08 Q1FY09 Q4FY09 Q1FY10 Q2FY10

Corporate PV CV2W Personal Credit CardLAS Business banking Housing & others


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 Exhibit 14: Lowest stressed assets amongst peers (Q2FY10)

1.3 1.3

1.51.6

1.92.0

2.1

1.8

2.1 2.1

1.9

0.0

0.5

1.0

1.5

2.0

2.5

FY07

FY08

Q1FY09

Q2FY09

Q3FY09

Q4FY09

Q1FY10

Q2FY10

FY10E

FY11E

FY12E

GNPA NNPA

0

1

2

3

4

5

6

7

8

9

HDFC Axis KMB UBI ICICI SBI PNB BOI

%

GNPA Restructured loans


(%)

8 HDFC Bank

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%

83.8

91.7

86.2

69.5 69.267.1

68.6

75.8 74.576.1

50

55

60

65

70

75

80

85

90

95

FY03 FY04 FY05 FY06 FY07 FY08 FY09E FY10E FY11E FY12E

%


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 Exhibit. 17: HDFC Bank has higher share of metro+urban branches

North

30%

South

26%

West

25%

East

9%

Central

10%

29%39%

32%

16%

28%

34%40%

25%

33%

23% 24%

53%

10% 5% 4% 6%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

ICICI Bank HDFC Bank Axis Bank Federal Bank

Metro Urban Semi‐urban Rural


9 HDFC Bank

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

684 761

1412 15061686 1836

2036419

0

500

1000

1500

2000

2500

FY07 FY08 FY09 Q2FY10 FY10E FY11E FY12E

Nos


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 wide‐spread 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% pre‐merger. 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 well‐integrated CBoP branches should help bank maintain CASA ratio in the range of about 50% and thus sustain its sector‐beating margins (>4%).

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

29%25% 24%

30%

21%

12%19% 8%

16%

19%

‐2%

13%

0%

10%

20%

30%

40%

50%

60%

HDFC ICICI Axis PNB

‐8%

‐3%

2%

7%

12%

17%

22%

Savings Current CASA mobilisation during 1HFY10


10 HDFC Bank

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

4.4

4.9

4.5

4.4

4.5 4.5

4.1

4.2

4.3

4.4

4.5

4.6

4.7

4.8

4.9

5.0

FY07 FY08 FY09 FY10E FY11E FY12E

2.2

2.6

3.0

3.4

3.8

4.2

4.6

Q3FY09 Q4FY09 Q1FY10 Q2FY10

HDFC ICICI Axis SBI PNB


Strong, non‐volatile and well‐diversified source of non‐interest 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 fee‐based 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

-20%

0%

20%

40%

60%

80%

100%

FY05 FY06 FY07 FY08 FY09 1HFY10 FY10 FY11E FY12E

Fees & Commission Trading income Forex & derivatives


(%) (%)

11 HDFC Bank

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 fee‐based third party product distribution, remittance, forex & derivative business) was one such strategic move to enrich its fee‐based 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

0

10

20

30

40

50

60

70

80

FY05 FY06 FY07 FY08 FY09 FY10E FY11E FY12E

%

0

10

20

30

40

50

60

70

80

90

100

Non-interest income growth Fee income Loan growth


Cost‐income ratio improves with synergies kicking‐in

Post CBoP merger, HDFC banks (merged) cost‐income 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 C‐I 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 C‐I ratio to about 45% by FY12E.

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

50.3

55.7 55.3

50.047.1 47.6 46.2 46.2 45.2 45.1

0

10

20

30

40

50

60

Q4FY08

Q1FY09

Q2FY09

Q3FY09

Q4FY09

Q1FY10

Q2FY10

FY10E

FY11E

FY12E

%


12 HDFC Bank

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

19.517.7

16.1 16.1 16.5 18.1

1.7

1.4 1.41.3

1.51.6

0

5

10

15

20

25

FY07 FY08 FY09 FY10E FY11E FY12E

%

0.0

0.4

0.8

1.2

1.6

2.0

RoE-LHS RoA-RHS


Warrant conversion further enhances capital adequacy

Bank has decent capital adequacy at about 15.7%, including Tier‐I 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 Tier‐I capital at about 11.6% by FY12E without further capital infusion.

13 HDFC Bank

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%, sector‐leading NIMs (>4%), robust asset quality, sound management and all‐in‐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

0200400600800

100012001400160018002000220024002600

31‐Mar‐02

18‐Aug‐02

05‐Jan‐03

25‐May‐03

12‐Oct‐03

29‐Feb‐04

18‐Jul‐04

05‐Dec‐04

24‐Apr‐05

11‐Sep‐05

29‐Jan‐06

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25‐Mar‐07

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30‐Dec‐07

18‐May‐08

05‐Oct‐08

22‐Feb‐09

12‐Jul‐09

29‐Nov‐09

Rs

02000400060008000100001200014000160001800020000220002400026000

Index

HDFC Bank 2.0 2.5 3.03.5 4.0 4.5 Sensex (RHS)


Exhibit 27: HDFCB sustains premium over Axis & ICICI Exhibit 28: P/BV chart cycle – HDFC Bank v/s Axis & ICICI

‐0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Apr‐05

Aug‐05

Dec‐05

Apr‐06

Aug‐06

Dec‐06

Apr‐07

Aug‐07

Dec‐07

Apr‐08

Aug‐08

Dec‐08

Apr‐09

Aug‐09

HDFCB over Axis HDFC over ICICI

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

1‐Apr‐05

1‐Aug‐05

1‐Dec‐05

1‐Apr‐06

1‐Aug‐06

1‐Dec‐06

1‐Apr‐07

1‐Aug‐07

1‐Dec‐07

1‐Apr‐08

1‐Aug‐08

1‐Dec‐08

1‐Apr‐09

1‐Aug‐09

HDFC Bank Axis ICICI

Source: Bloomberg, Networth Research Source: Bloomberg, Networth Research

(%)

14 HDFC Bank

Under‐performed broad indices and peers, but to recover

Stock has underperformed the broad indices and its peers since Mar 09 market recovery, due to concern on banks growth and asset quality. However, with growth coming back to fore, asset quality stabilising and earnings gaining traction leading to improvement in its RoE, we believe that bank should perform better.

Exhibit 29: Under‐performed its peers since Mar 09 recovery Exhibit 30: Under‐performed broad indices

0

50

100

150

200

250

300

350

3‐Mar‐09

12‐Mar‐09

21‐Mar‐09

30‐Mar‐09

8‐Apr‐09

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14‐May‐09

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1‐Jun‐09

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7‐Jul‐09

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25‐Jul‐09

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30‐Aug‐09

8‐Sep‐09

17‐Sep‐09

26‐Sep‐09

5‐Oct‐09

14‐Oct‐09

23‐Oct‐09

1‐Nov‐09

10‐Nov‐09

19‐Nov‐09

28‐Nov‐09

7‐Dec‐09

Axis ICICI HDFC Bank

40

80

120

160

200

240

280

320

360

3‐Mar‐09

12‐Mar‐09

21‐Mar‐09

30‐Mar‐09

8‐Apr‐09

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5‐May‐09

14‐May‐09

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1‐Jun‐09

10‐Jun‐09

19‐Jun‐09

28‐Jun‐09

7‐Jul‐09

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25‐Jul‐09

3‐Aug‐09

12‐Aug‐09

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30‐Aug‐09

8‐Sep‐09

17‐Sep‐09

26‐Sep‐09

5‐Oct‐09

14‐Oct‐09

23‐Oct‐09

1‐Nov‐09

10‐Nov‐09

19‐Nov‐09

28‐Nov‐09

7‐Dec‐09

16‐Dec‐09

25‐Dec‐09

3‐Jan‐10

HDFC Bank Sensex

Bankex Large Pvt bank index

Source: Bloomberg, Networth Research Source: Bloomberg, Networth Research

Key risks and concerns

Higher delinquencies: Though retail NPA’s have nearly peaked, corporate NPA’s could still bring in pain. Further overall systemic risk still remains though moderated, posing risk to its overall loan portfolio and thus higher delinquencies.

Slowdown in branch expansion: Bank has unveiled significant branch expansion plan, which if scaled down or not timely executed could affect CASA & business growth assumptions.

Retracement of fiscal stimuli: Government has taken various fiscal measures, which has helped speedy economic recovery, including supporting credit growth and in particular automobile segment. However, fiscal stimulus is likely to be retraced sooner, which could affect recovery process and overall credit growth of banking industry.

(%) (%)

15 HDFC Bank

Financial Summary

Income Statement (Rs.mn) Ratios

Y/E March FY08 FY09 FY10E FY11E FY12E Y/E March FY08 FY09 FY10E FY11E FY12E

Interest Earned 101,150 163,323 169,202 199,863 248,131 Bal Sheet Ratios (%)

Interest Expended 48,871 89,111 85,723 98,431 121,932 Loans/Deposits 62.9 69.2 75.4 75.4 75.4

Net Interest Income 52,279 74,212 83,479 101,432 126,199 CASA Ratio 54.5 44.4 50.5 50.0 50.0

Growth (%) 50.7 42.0 12.5 21.5 24.4 Loan Growth 35.1 24.2 22.5 25.0 25.0

Non Interest Income 22,832 32,906 40,663 44,956 50,667 Deposit Growth 47.5 16.5 12.5 25.0 25.0

Growth (%) 50.6 44.1 23.6 10.6 12.7 Operating Ratios (%)

Fee, forex and other inc 21,191 29,081 34,663 40,456 46,167 NIM 4.9 4.5 4.4 4.5 4.5

Net Income 75,110 107,118 124,142 146,388 176,866 Non‐int inc/Net inc 30.4 30.7 32.8 30.7 28.6

Growth (%) 50.7 42.6 15.9 17.9 20.8 Empl Costs/ Op Costs 34.7 40.5 41.0 41.1 41.7

Operating Expenses 37,456 55,328 57,390 66,116 79,822 Cost/Income 49.9 51.7 46.2 45.2 45.1

Growth (%) 54.7 47.7 3.7 15.2 20.7 Operating cost growth 54.7 47.7 3.7 15.2 20.7

Employee expenses 13,014 22,382 23,519 27,181 33,250 Total prov/avg. loans 1.9 1.8 2.1 1.7 1.4

Other expenses 24,443 32,946 33,871 38,935 46,572 Asset Quality Ratios (%)

Pre‐Prov Profits 37,654 51,790 66,752 80,271 97,044 Gross NPA 1.3 2.0 2.1 2.1 1.9

Prov & Contingencies 14,843 18,797 24,084 24,974 26,053 Net NPA 0.5 0.6 0.5 0.5 0.5

Loan loss provisions 10,264 16,058 23,351 23,079 24,031 Slippage 1.9 3.5 1.9 1.6 1.3

PBT 22,811 32,993 42,668 55,297 70,991 NPL coverage ratio 67.1 68.6 75.8 74.5 76.1

Provision for taxes 6,909 10,543 13,227 17,142 22,362 Capital Ad. Ratios (%)

PAT 15,902 22,450 29,441 38,155 48,629 Total CAR 13.6 15.7 17.4 16.4 15.6

Growth (%) 39.3 41.2 31.1 29.6 27.5 Tier 1 CAR 10.3 10.6 12.7 12.0 11.6

Profitability Ratios (%)

RoAE 17.7 16.1 16.1 16.5 18.1

RoAA 1.4 1.3 1.5 1.6 1.7

Valuations Ratios

BVPS (Rs) 324.4 344.3 471.2 543.1 637.9

Price/BV (x) 5.3 5.0 3.6 3.2 2.7

Adjusted BVPS (Rs) 316.0 329.6 457.4 524.8 618.4

Price/Adj. BV (x) 5.4 5.2 3.7 3.3 2.8

Balance Sheet (Rs. mn) EPS (Rs) 44.9 52.8 64.7 83.8 106.8

Y/E March FY08 FY09 FY10E FY11E FY12E P/E (x) 38.2 32.5 26.5 20.6 16.0

Cash and bal with RBI 125,532 135,272 139,572 156,442 186,566 Dividend Yield 0.5 0.5 0.4 0.4 0.4

Inter‐bank balance 22,252 39,794 24,099 36,149 45,186

Loans 634,269 988,831 1,211,317 1,514,147 1,892,683 Dupont Analysis

Investments 493,935 588,175 634,619 783,232 941,385 Y/E March FY08 FY09 FY10E FY11E FY12E

Total int earning assets 1,275,988 1,752,072 2,009,608 2,489,970 3,065,821 % of Average assets

Fixed Assets 11,751 17,067 20,419 21,660 23,278 Net‐Interest Income 4.7 4.3 4.2 4.3 4.4

Other Assets 44,026 63,568 77,559 80,285 89,977 Non‐Interest Income 2.0 1.9 2.1 1.9 1.8

Total Assets 1,331,766 1,832,708 2,107,586 2,591,916 3,179,076 Net Income 6.7 6.3 6.3 6.2 6.1

Deposits 1,007,686 1,428,116 1,606,630 2,008,288 2,510,360 Operating Expenses (3.3) (3.2) (2.9) (2.8) (2.8)

Other Int bearing Liab 78,440 91,636 127,152 145,008 161,031 Operating Profit 3.4 3.0 3.4 3.4 3.4

Total Int. bearing liab 1,086,126 1,519,752 1,733,782 2,153,296 2,671,391 Provisions (1.3) (1.1) (1.2) (1.1) (0.9)

Other non‐int. bear. liab 130,667 162,428 159,244 191,368 217,268 Taxes (0.6) (0.6) (0.7) (0.7) (0.8)

Total Liabilities 1,216,794 1,682,180 1,893,027 2,344,664 2,888,658 RoA (%) 1.4 1.3 1.5 1.6 1.7

Equity 114,972 150,527 214,559 247,252 290,418 Avg.assets/avg eq. (x) 12.5 12.3 10.8 10.2 10.7

Total Liab & Equity 1,331,766 1,832,708 2,107,586 2,591,916 3,179,076 RoE (%) 17.7 16.1 16.1 16.5 18.1


Note: Ratios for FY09 are calculated assuming merged financials for FY08 & FY09

16 HDFC Bank

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Key to NETWORTH Investment Rankings Buy: Upside by>15, Accumulate: Upside by +5 to 15, Hold: Upside/Downside by ‐5 to +5, Reduce: Downside by 5 to 15, Sell: Downside by>15

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