team f

IAIP Student ResearchThis report is published for educational purposes only by students competing in the Investment Research ChallengeTM.

Important disclosures appear at the back of this report Indian Association of Investment Professionals TM Investment Research Challenge is a trademark of the New York Society of Security Analysts

Housing Development Finance Corporation

Industry – Financial Services

STERN Student ResearchLeonard N. Stern School of Business at New York UniversityA student generated report for informational purposes only

Ticker: NSE HDFC Recommendation: BUY

Price: INR 1628.10 Price Target: INR 2250

Earnings/ShareMar. Jun. Sept. Dec. Year P/E

Ratio2007A 14.7 23.78 23.02 27.02 85.77 25.22008A 16.4 18.8 22.79 24.68 84.32 20.62009E 0.00 0.00 0.00 0.00 98.10 18.3

Highlights Sailing through the liquidity storm: HDFC appears to have ridden out the liquidity storm of

October 2008 with resilience, despite its theoretical vulnerability as a wholesale funded, non‐bank lender. Most non‐bank lenders have seen a severe crisis of resources, as banks have almost stopped lending to this category. HDFC has bucked that trend, with retail deposits, insurance companies and its status as a priority sector borrower (refinancing for its sub‐Rs2mln home loans is part of the banks’ directed lending targets) serving it well.

Team F

9th January, 2009

IAIP 9th January 2009

Asset quality improves, despite challenging environment: HDFC’s solid performance in each successive quarter keeps us surprised positively, particularly given the deteriorating environment. The fact that they reported their lowest NPL ratio this quarter for the last 10 second‐quarter earnings seasons while maintaining growth and profitability is a revelation of their superior management and operations.

High Tier 1 Ratios make for a good cushion: In the current environment characterised by a significant degree of risk aversion, with access to capital markets virtually frozen due to fears of a potentially unprecedented level of capital calls, HDFC Ltd’s strong Tier 1 ratio of 14% affords a measure of protection. A sound Tier 1 position & AAA credit rating provides capital leverage potential as well as the flexibility to tap Tier 2 capital raising options in the event the company is obliged to shore up capital.

PSB Special Package - Temporary erosion in market share but limited bottom line impact: The steep concession in housing loan rates offered by PSBs (for new home up to June 09) will put HDFC at a disadvantage. Loans up to Rs20 lakh forms more than 50% of HDFC’s advances book implying likely competition in this target customer segment. Despite the steep concession rates under the package, we believe the manner of execution of the scheme by PSBs will decide the extent of damage to HDFC.

INVESTMENT RESEARCH CHALLENGE STUDENT RESEARCH 3

IAIP 9th January, 2008

Investment SummaryHDFC is the strongest and the most venerable play on Indian mortgages over the long term. We expect the company, with its strong brand recall, superior real estate knowledge, and revamped distribution strategy, to attain 23% CAGR in loan disbursement over FY08-10E. Consequently, we expect HDFC to deliver growth of 25% CAGR in loan book. HDFC has differentiated itself from its peers with its diversified network and revamped distribution strategy. Of the total individual loans disbursed during FY08, 65% were routed through third party channels viz., HDFC Bank, DSAs, and distribution subsidiaries. The company has been highly proactive in passing on the cost and benefit to customers. With strong pricing power in the housing finance space, we believe it will be able to pass on any increased funding cost to customers. Its recent de rating was driven by fears of higher-than-expected loan losses resulting from exposure to the commercial real estate segment, potential hikes in home loan delinquencies, and a great degree of risk aversion. Despite these headwinds, HDFC Ltd has done well. It has an admirable underwriting track-record, with gross NPA of 1.04% (0.62% on a 180-day scale), best–in-class cost-income ratios (around 10%), and high capital adequacy levels (Tier 1 of 14%).. We do not anticipate a surge in credit costs but we are raising our loan loss provision estimate, from 0.05% to 1%, to factor in the effect on valuations. Considering the adverse operating environment and its low valuations from an historical perspective, HDFC Ltd is a bargain, in our opinion, and we initiate a buy rating on the stock.

Standing amid the rubble & delivering consistentlyHDFC Ltd. has an excellent track record of achieving its growth rate without compromising its asset quality. The Company’s core expertise in mortgage lending, coupled with three decades of experience, has helped it in maintaining the position of market leader in its domain. However, the domestic economy is presently witnessing several macroeconomic disturbances in the shape of slowing down GDP growth, tightening liquidity, and high inflation. Thus, we expect growth in advances to fall below the management’s guidance of 25% for a couple of years. At the same time, we do not expect the Company to reduce its lending rate without observing any fall in the cost of funds. This will help it to minimise the expected fall in its spreads.

We believe that HDFC had followed sound risk-management practices – when banks were growing mortgages at 40-50% YoY between 2002 and 2007, HDFC gave up market share and grew at around 20-25%. Moreover, its reliance on mortgage brokers was very low (only 3% of loans originated by outside agents). This gives us the comfort that HDFC’s asset quality will behave much better than that of the other Indian banks in the coming slowdown.

Figure 1: HDFC Ltd vs. Nifty

INVESTMENT RESEARCH CHALLENGE STUDENT RESEARCH 4

Source: NSE website and company sources

HDFC’s near-term stock performance may be hampered by adverse headlines from to its wholesale funding profile and developer exposure to special loan package by public sector banks. The actual balance sheet, however, remains in immaculate condition and we think the valuations are more than justified by the high quality of the business.

Valuation We have valued HDFC Ltd. using Sum of the parts approach. The main HDFC mortgage Business has been valued using Price/Book Value Multiple.

Assumptions: We calculated Cost of Equity as 14.68% using CAPM model. Growth Rate is dependent on India’s GDP growth. Return on New equity has been assumed based on past records & expected returns. Present values have been calculated by considering Income & Change in Equity Value (Liability & Assets). The no. of outstanding shares is 284.04 Cr. For further details please refer Appendix for calculations.

Sensitivity Analysis:ROE

19% 20% 21% 22% 23% 24% 25%

COE

12% 1824 1839 1858 1870 1884 1896 191713% 1941 1957 1976 1989 2005 2019 203914% 2056 2073 2089 2106 2123 2139 215615% 2195 2211 2233 2250 2267 2283 230616% 2272 2294 2311 2328 2350 2367 238917% 2400 2416 2439 2461 2477 2500 251618% 2538 2561 2577 2599 2622 2644 2660

The drivers for price for HDFC Ltd. are ROE & Growth. HDFC has historically quoted at a premium over its peers because of: ROE in the mid 20s & NPAs in 1-1.5% band. Fall in ROE to sub 20 levels, given the macro economic conditions can lead to a 8-10% downside from the estimated target price of INR 2250 per share.HDFC has consistently grown at 17-18%+ even in times of economic turmoil with its focus on maintaining credit quality, low NPAs & high ROE. Any decline in the growth rate subject to the global scenario can affect the target price to the tune of 12-15%.Cost of Equity – Increase in interest rates, fiscal & monetary tightening, increased market risk can lead to higher cost of borrowing & cost of equity. This along with decrease in growth & ROE can lead to downside of 20 – 25% from the estimated target price.

Growth Rate 15% 16% 17% 18% 19% 20% 21%COE 12% 2222 2339 2466 2599 2744 2899 3071

Business Method Value Stake HDFC Interest

Share Value

Holding Discount

Unit INR Mn % INR Mn INR INRMortgage business 2.69x P/BV 423,616 100% 423,616 1,491.6 1,491.6HDFC Bank 2.21x P/BV 441,593 19% 83,903 295.4 265.9Asset Management 7.36 % AUM 46,919 60% 28,151 99.1 89.2Venture Capital 15 % AUM 7,810 100% 7,810 27.5 24.7Life Insurance 16xNBAP+Embed 154,493 74% 114,325 402.6 362.3Gruh Finance 2.27x P/BV 5514 62% 3391 11.9 10.7General insurance 2.24x P/BV 2,395 74% 1,772 6.2 5.6Total 662,967 2,334 2,250

13% 2111 2217 2333 2461 2594 2738 288814% 2012 2111 2217 2328 2455 2583 272715% 1945 2039 2139 2250 2367 2489 262216% 1834 1929 2012 2106 2211 2322 244417% 1757 1834 1929 2006 2106 2206 231718% 1690 1762 1840 1929 2006 2100 2206

Business Description Housing Development Finance Corporation Ltd. (HDFC), established in 1977, is India’s largest provider of housing finance, primarily focusing on retail housing. HDFC has 254 outlets in India including 4 regional offices and over 90 locations are covered through its outreach programme. The strong distribution network has helped the corporation disburse housing loans in more than 2,400 towns and cities in India. HDFC has a customer base of 3.2 million. It has a stable and

experienced management with an average tenor of senior management of over 15 years.

HDFC is among the better-diversified players in the Indian financial services space with leadership position in mortgage market and strong presence in other financial services (life insurance, asset management and banking). Operationally, HDFC’s fund mobilisation abilities and operational efficiency should help maintain healthy earnings momentum in a tough operating environment.

Industry Overview: HDFC stands out in the crowd… Additional demand for housing forecasted by the 11th Planning Commission for 2012-13 is around 6.79Mn. By using scenarios depending upon various loan growth rates (2.35%, 2.50% & 3.30%) projected housing demand for 2012-13 viz. 5.97, 6.35 and 7.62 million respectively (‘Report on Trends and Progress of Housing in India’,

2005 by National Housing Bank )

Demographic Drivers for Housing DemandA typical borrower would most likely to be a male in the age group of 40 to 50 having an average monthly income of Rs.10,000 who prefers to buy a house of the size of 100 square meters. Though most of the borrowers are in the age group of 40-50, a significant 25% are below 35 years of age. There is a falling trend in average age profile of the housing demand. It is also found that income and price elasticity of demand is less than unity.

An increase in house price by 10% results in a 4.6% decrease in housing demand as affordability comes down, while a 10% increase in the monthly income of the borrower leads to increase in housing demand area by 5.96%. Greater number of dependents also reduce housing demand as serving more number of

dependents in a family reduces the affordability and hence the size of the house. The demand for bigger house is greater in urban areas than suburban areas, which in turn is greater than demand in rural areas; access to housing loan, capacity/affordability might be reasons driving the same.

Factors affecting default rates on home loansBigger the size/value of house, higher the monthly income, presence or more number of co borrowers, lower the chance of default. This collateral margin is also a significant determinant of rate of recovery of defaulted loans. A 10% increase in the ratio leads to 0.38% increase in the recovery rate. Further, due to the presence of guarantee, bank’s likelihood of recovery is more. EMI to Income ratio is positively associated with the estimated likelihood of default. A 10% increase in EMI to Income ratio is estimated to increase the likelihood of default by 4.52%

Customers in rural, semi urban and urban areas are not equally riskyRural and semi urban people are riskier than the urban borrowers. However, borrowers located in big cities are riskier than medium and smaller cities. This may be because with the activation of personal loan segment by commercial banks and easy access to such loans especially in the metro area prompted the existing home loan borrowers to overstretch their financial commitments with a consequential deleterious effect on home loan default rate in this segment.

Tremendous Potential in Mortgage Sector The mortgage penetration continues to remain abysmally low – in India the mortgage to GDP ratio is at around 6% (in FY08) against over 51% in the USA. Even if one were to benchmark against more comparable counterparts, the ratio ranges between 15% to 20% for most South East Asian nations. Also, mortgage credit accounted for merely 12% of total non-food credit in FY08, despite the meteoric rise in incremental lending to this segment. With changing demographics and fiscal incentives, the mortgage sector is envisaged to witness a healthy growth (at about 20% - 25% YoY) over the next couple of fiscals. Nevertheless, the spiralling property prices may prove to be a dampener. On similar lines, the yawning gap in infrastructure facilities calls for additional contribution from the private sector players.

Conducive regulatory measuresNon-banking finance companies (NBFCs) and housing finance companies (HFCs) that were banned from accessing the overseas market for resources by the Finance Ministry a few years back will now be able to access low cost funds through the FCCB route. This will not only ease pressure on their fund mobilisation but also help improve their net interest margins (NIMs). Increasing the risk weight on the home loan portfolios of HFCs is expected to enforce a cautious stance on their part with respect to real estate lending and encourage better risk appraisal. The same, however, also calls for higher capital adequacy for the housing finance companies from the current minimum requirement of 12% CAR for NBFCs.

Once the amendment to the Solvency Capital Requirements for the inclusion of mortgage backed securities (MBS) is passed, banks and housing finance companies (HFCs) can sell MBS in the market and raise additional funds at lower rates, which in turn would enable them to lower the home loan rates. Through MBS, banks and HFCs can also reduce their reinvestment risk besides shoring up their capital to meet the capital adequacy requirements and improve their balance sheets.

Competitive PositioningMajor Players in Housing Finance are Commercial banks followed by Housing Finance Companies. The Major Groups are ICICI, HDFC, SBI & LIC. They form more than half of the Housing finance market. The share of public sector housing finance companies has

dipped from 10.19 percent in 2001-02 to 2.63 percent in 2005-06, says India’s official auditor. the share of private housing finance companies registered a fall to 29.23 percent in 2005-06, from 51.06 per cent in 2001-02.In the process, scheduled commercial banks increased their share from 35.90% to 68.14%- a factor that has come as a blow to traditional housing finance companies.

NBFC’s amount to 35% of housing finance market share. The housing finance market, the largest retail finance segment, is estimated at around Rs 963 billion in 2007-08 with average yield of 11.5% and average NPM of 1.25%. It is growing at 13.3% (3 yr CAGR) and will continue to grow at 14%. Credit losses have been estimated at 0.1% with finance penetration of 35%. The average ticket size is 0.67 Mn. 90-95% of loans are floating rate. HDFC is the market leader among NBFC’s accounting for 14% of total market. Please refer to Appendix for Peer Analysis of HFCs & Competitor Scorecard Analysis.

Competitive EdgePros: HDFC is the strongest and most venerable play on Indian mortgages over the long term. The management of the bank is termed to be one of the best in the country. HDFC has differentiated itself from its peers with its diversified network and revamped distribution strategy and has been highly proactive in passing on the cost and benefit to customers. Due to strong credit appraisal & recovery system, HDFC has the lowest NPL ratio of 1.04%. Besides the core business, HDFC’s insurance, AMC, banking, BPO, and real estate private equity businesses are also growing at a rapid pace and the estimated value of its investments/subsidiaries explains ~30% of HDFC’s market capitalization.Cons: There is a high dependence on individual loans portfolio. A major stake is held by American financial groups which are under stress due to economic slowdown.

Opportunities for Sector: Fast growing insurance business in the country and untapped rural markets. Possible merger with HDFC bank may reduce cost of funds. Threats for Sector: Loss of market share to commercial banks & HFCs and higher than expected increase in funding cost could affect long term profits. Risk of fraud and NPA accretion due to increasing interest rates and fall in property prices is inherent to the mortgage business.

OutlookPublic Sector Banks Special Home Loan Package – Limited ImpactPublic sector banks (PSBs) have announced a special package for home loan borrowers, as part of the stimulus package, to spur demand for residential property. Importantly, the special package will be available only for new home purchases and not for refinancing existing borrowers. While there exists a significant gap between the current rates, we believe that HDFC’s cost of funds is likely to ease off going forward as 10-year g-sec yields have come off sharply. The potential decline in HDFC’s cost of funds will allow it to bridge the interest rate gap. In addition, Reserve Bank of India’s announcement to treat refinancing to housing finance companies by banks as priority sector advances (for loans up to Rs20 lakh) should result in lower cost of funds for HFCs including those for HDFC. Additionally, benefits from the release of capital after revision in capital adequacy norms by National Housing Board will partially mitigate the pressure.

Increased focus on retail deposits to fund growth Deposits grew 13% QoQ (after rising 15% in the previous quarter) and the proportion in total interest-bearing liabilities increased by around 300bp in the past two quarters to 19.2%. We think this is commendable in the current liquidity environment and given that HDFC does not have an extensive branch network like banks. Almost 45% of incremental borrowing was through deposits. Given that it is primarily wholesale funded, this shift towards deposits will help HDFC to manage funding costs and margins. Moreover, HDFC is growing deposits at competitive rates relative to banks, highlighting HDFC’s strength as a deposit franchisee. Its borrowing cost is 10.7% (including distribution expenses). In comparison, banks are borrowing at 10.5%. However, banks have to maintain a 6.5% cash reserve ratio and 25% in bonds – HDFC does not have any CRR and has to keep only 12.5% of retail deposits in bonds. Therefore, the incremental funding cost for HDFC is still lower than at most banks.

Concerns on commercial real estate related loan losses overdone:HDFC Ltd has the highest gearing to non-mortgage loans, at 33% of total loans, which could result in earnings disappointment. That said, with a third of these loans linked to pure project related loans, the risk to earnings is low in our view. 12% of HDFC’s loan book (Rs812bn) comprises loans to property developers. These are collateralised by land with very comfortable margins, and there has been no stress on this portfolio yet, despite the difficult situation that many developers find themselves in. HDFC is confident of this portfolio behaving well, having managed this business through the ‘crisis of the early 1990s.

Potential lending rate cuts and a likely easing of property rates may forestall mortgage delinquencies:With the central bank cutting the repo rate by 150bp, to 7.5%, and the cash reserve ratio by 350bp, to 5.5%, and now hinting at cutting policy rates, it would be reasonable to conclude the bank is in a rate cutting mode. Should this turn out to be the case, there may soon be some alleviation of the pressures on wholesale funding, we believe. In this event, we would expect HDFC Ltd to pass on some of the benefits of funding cost savings to customers through lending rate reductions, a move that would go a long way to bringing down average loan durations, while also preventing incremental delinquencies.

Financial AnalysisIncome Statement Analysis:Net Interest Income will form approx 33% of Interest Income. Non Interest Income would not see growth due to added price based competition. Efficiency would lead to reduction in operating expense/Income ratio. Profits would be taxed at approx. 27%. Going forward Spreads would drive Profits

A DuPont Analysis using actual numbers for FY08 and projected numbers for FY09-11 shows that HDFC has consistently maintained its Return on Assets (ROA) at above 3%, which is significantly greater than the industry average of 2.2%. The Return on Equity (ROE) is also quite high in the range of 20%-21%. With the low interest rate environment expected to remain for next few years to revive the economy, the average yield on assets and cost of assets, both will continue to fall and spread will remain constant at around 2.3%.

Value drivers are growth in Loan Book and Spreads. Historically NIMs are stable between 2.1-2.2%. We have assumed fall in NIM in 2009 due to current economic crisis

followed by NIMs stabilising again.We have assumed Loan book will continue to grow 22% and above in following years.

We have ignored Exceptional One off items as they do not drive value in long term. Remaining FCCBs will be bought back & 25 lac shares will be newly issued.

Balance Sheet:Non Convertible debentures form the highest portion of funds in 2008. 76% FCCBs were redeemed in 2008 and remaining may be done this year. Deposits have been steadily growing and will continue to grow at 17%. Retail loans form majority of loans and are expected to grow owing to demand in lower middle class.

Disbursements in individual loan segment will continue to be strong:HDFC seems to be focusing more on individual loan segment, which grew at a faster pace of 31% Y-o-Y in Q2FY09 compared to overall disbursement growth of 23%. The company is deliberately going slow in commercial and developer’s space, sensing the risk in this segment. Real estate lending is becoming more challenging due to high interest rates background and weak property prices. However, HDFC has a strong track record of consistent growth with relatively stable spreads and robust asset quality across business cycles. HDFC’s pricing power and market share is improving, which will help it report growth of 20% plus and spreads of 2% plus.

Asset quality maintained – Very low NPLsDespite a scenario of increasing interest rates and a tight liquidity situation, asset quality of HDFC remained strong even in Q2FY09. NPL (90 dpd) declined 12bps YoY to 1.04% in Q2FY09 (compared to 1.09% in Q1FY09) and loan spread decreased to 2.24%. HDFC’s NPL has been consistently maintained at 1% level across business cycles. But an underperforming real estate sector might potentially hit the asset quality and increase NPLs.

Investment RisksIncrease in competition and sustained slack in the mortgage market can lead to lower growth than our estimates. Higher-than-expected increase in funding cost and inability to pass the cost to customers in the current tightening monetary environment will adversely affect margins and profitability. Risk of fraud and NPA accretion due to increase in interest rates and fall in property prices is inherent to the mortgage business. The key risks to our price target are -

Temporary erosion in market shareThe steep concession in housing loan rates offered by PSBs will put housing finance companies (HFCs) including HDFC at a disadvantage, albeit up to June 30, 2009. Loans up to Rs20 lakh form more than 50% of HDFC’s advances book with an average ticket size of ~15 lakh, implying likely competition in this target customer segment. Consequently for the next six months HDFC is likely to see erosion in its market share. We have already factored in a slower growth in our estimates for HDFC, but any further package from the government & the PSBs will lead to a further downside.

Moderation in DisbursementsWe expect disbursement growth to moderate initially as property prices correct, and then recover eventually as volumes pickup driven by declining interest rates and property prices. We are building in a 20% disbursement growth over the next 6 quarters on a rolling basis. Failure to achieve this growth would hurt the valuations significantly

Asset Quality & Commercial Real Estate loansWhile HDFC has maintained its asset quality well so far, as reflected in its gross NPAs, we cannot rule out slippages in asset quality in the future. HDFC Ltd has the highest gearing to non-mortgage loans, at 33% of total loans, which could result in earnings disappointment (an erosion of 88% of FY2009 earnings, assuming a 25% write-off in real estate and lease rental loans of c. 20% of aggregate loans. That said, with a third of these loans linked to pure project related loans, the risk to earnings is low in our view.

Unrealized gains down 20.6% YoYHDFC's unrealized gains on listed investments stood at Rs 9,022.4 crore at the end of Q2FY2009, indicating a decrease of 20.6% YoY. However the same was 23.5% above the unrealized gains of Rs7,305.1 crore at the end of Q1FY2009. The ongoing deterioration in the equity markets may make it difficult for the company to realize attractive gains from its investments.

HDFC Bank WarrantsFull subscription to HDFC Bank’s warrant at INR 1530/share would dilute our target price to the tune of 8-10%. We have not factored this downside in our base case as the current prevailing market price is in the band INR 1000 – INR 1050.

HDFC Bank

Even as the redemption of investments helped the bank to raise resource during the quarter, the term deposits still grew by 75% YoY and 3.7% QoQ. In coming quarter, the growth in advances will be difficult to achieve without raising more of term deposits which will entail higher funding cost.

The cost/asset ratio for the bank has not come down. As compared to an average 2.8% between September 2005 and September 2007, the ratio has shot up to 3.3% on account of CBOP merger and as bank continues to invest in branch network.

Higher cost/asset ratio has eaten up 30-32bps from RoA. We believe that the ratio will continue to remain high for at least next two quarters. Although the bank has been able to contain provisioning for the quarter due some write backs, going forward the provisioning requirement may go up to prop up provision coverage.

HDFC Life Insurance Ltd.Lower than expected growth rates in new business life insurance premium will adversely impact the valuation of HDFC Standard Life and consequently the parent's stock price. The fundamental drivers deciding the risk for investing in HDFC Life Insurance are policyholders guarantee, operational leverage, interest rate, asset backing regulatory issues and demographics.

Explosive growth going forward is reinforced by the macro variables of a low social security cover, untapped and rising household savings as also an encouraging demographic profile. While believe the sector will deliver about 31% CAGR over FY07-10 (45% for private sector), the growth could come at the expense of margins and believe that the NBAP (New Business achieved profit) margins will moderate by 150-200bps over the next three years. A strong brand, deep pockets and an aggressive posture on distribution will be the key differentiators.

HDFC Ergo General InsuranceSlow reform: Much of this growth prediction is based upon the liberalization agenda set out by the government and the regulator, the IRDA. Due to a number of competing interests, it should be noted that there is significant potential for delay in this liberalization program.

Poor customer perception: Due to the poor levels of customer service provided by PSU insurers and their failure to pay claims promptly, Indian assureds tend to perceive insurance to be a tax (i.e. with no returns) rather than a product of genuine economic value.

HDFC Mutual FundMutual funds have been facing a lot of redemption pressure in the last few months. Unlike banks which have a provision where they can take losses on the asset side, the only resort that mutual funds have in such situation is to repay the unit holders by selling assets. Mutual funds cannot even borrow in such a case, a borrowing for redemption will expose the remaining unit holders to leveraged losses. Though equity markets have started rising again, the volatility is still there and uncertainty in the near term continues to dominate. Though a significant portion of HDFC mutual fund is under debt schemes, the yield in debt markets have fallen to all time lows and hence reduced new profitable investment opportunities.

Table 1: Income Statement (All Values in INR)Source: Company Documents, Student Estimates

INR Cr 2007 2008 2009E 2010E 2011EInterest Income 5,314 7,784 10,453 11,623 13,633Interest Expense 3,667 5,143 7,172 7,687 8,823Net Interest Income 1,647 2,641 3,280 3,936 4,810Non Interest Income 582 1,048 889 968 1,096-Fee 69 63 59 55 51-Investment 190 817 184 197 208-Others 324 168 647 717 838Net Revenue 2,229 3,689 4,170 4,904 5,906Operating Expense 237 284 317 354 393-Employee Expense 91 118 125 133 141-Depreciation 17 17 17 17 17-Other 128 150 175 204 235Pre Provision profit 1,993 3,406 3,852 4,550 5,514Provisions 25 32 35 43 53PBT 1,968 3,374 3,817 4,507 5,460Taxes 397 937 1,031 1,217 1,474PAT 1,570 2,436 2,786 3,290 3,986Basic No. Of shares 25.0 27.1 28.5 28.7 28.7Basic EPS 62.8 90.1 97.7 114.8 139.1Diluted No. Of shares 26.9 28.5 29.7 29.6 29.6Diluted EPS 58.4 85.5 93.7 111.1 134.6 DPS 22.00 25.00 28.20 33.30 40.34Dividend Payout 35% 29% 29% 29% 29%

Figure 1: Shareholding PatternSource: Company Documents

Table 2: Balance Sheet (All Values in INR)Source: Company Documents, Student Estimates

INR Cr 2007 2008 2009E 2010E 2011E

Equity Capital 253 284 287 287 287

R&S 5,298 11,663 14,254 16,458 19,122 Net Worth 5,551 11,947 14,541 16,745 19,408 Total Deposits 10,369 11,278 13,139 15,767 18,920 Secured loans 39,669 51,737 61,021 74,395 92,239 Unsecured Loans 7,155 6,136 7,372 8,500 10,710 Total Liabilities 62,749 81,099 96,073 115,408 141,278 Loans 56,512 72,998 87,782 107,166 132,766 Investments 3,665 6,915 6,392 6,762 6,997 Net Current Assets 2,235 830 1,516 1,065 1,063 - Current Assets 5,062 4,152 5,256 5,184 5,692 - Current Liabilities 2,827 3,322 3,740 4,119 4,630

Net Fixed Assets 213 208 208 206 204

Other Assets 123 147 175 208 247

Total Assets 62,749 81,099 96,073 115,408 141,278

Table 3: DuPont Analysis (All Values in Percentage Terms)Source: Company Documents

Feature FY08 FY09E FY10E FY11ENIM/Average Assets 3.7 3.7 3.7 3.7Non-IR/Average Assets 1.5 1.0 0.9 0.9Non-Int Rev/Revenues 28.4 21.3 19.7 18.6Revenues/Assets 5.1 4.7 4.6 4.6Cost/Income 8.6 8.5 8.1 7.5Cost/Assets 0.4 0.4 0.4 0.3Pre-Provision ROA 4.7 4.3 4.3 4.3Provisions/Assets 0.0 0.0 0.0 0.0Loans/Assets 90.0 91.4 92.9 94.0Pre-Tax ROA 4.7 4.3 4.3 4.3Tax Rate 27 27 27 27ROA 3.4 3.1 3.1 3.1Equity/Assets 14.7 15.1 14.5 13.7ROE 20.4 19.2 19.7 20.5

Table 4: Ratio Analysis (All Values in INR)Source: Company Documents, Student Estimates

Ratios 31-Mar-08 31-Mar-09 31-Mar-10 31-Mar-11Growth Metrics NII 60% 24% 20% 22%Non Interest Income 80.1% -15.2% 8.9% 13.2%Op Ex 20% 12% 11% 11%Provisions 28% 10% 22% 24%PAT 55% 14% 18% 21%Loans 29% 20% 22% 24%Deposits 9% 17% 20% 20%Loan Sanctions & Disbursements Approvals 425,200 518,744 643,243 810,486 Disbursements 328,750 394,500 481,290 596,800 Disbursement/Approval Ratio 77.3% 76.0% 74.8% 73.6%Approvals Growth 27.6% 22.0% 24.0% 26.0%Disbursements Growth 25.6% 20.0% 22.0% 24%Valuation EPS 90.1 97.7 114.8 139.1EPS growth 43% 8% 18% 21%BV per Share 442 510 584 677ROE 20% 19% 20% 21%ROA 3.0% 2.9% 2.9% 2.8%P/E 26.5 18.4 20.8 17.2

P/BV 5.4

3.5

4.1

3.5

Adj P/E 27.9 19.2 21.5 17.7 Dividend Yield 1.0% 1.6% 1.4% 1.7%Spread Analysis Avg Yield on Assets 10.7% 11.9% 10.8% 10.3%Cost of Assets 8.2% 9.7% 8.5% 7.9%Spread 2.50% 2.24% 2.32% 2.33%NIM 2.30% 2.04% 2.12% 2.13%Efficiency Cost Income Ratio 8.6% 8.5% 8.1% 7.5%Expense/Average assets 0.4% 0.4% 0.3% 0.3%Tier 1 Ratio 14.7% 15.1% 14.5% 13.7%

Table 5: Competitor Analysis (All Values in INR Mn)Source: Company Annual Reports

No Feature HDFC LIC Dewan Housing Gruh Finance General1 Start Year 1977 1989 1984 19862 No. Of branches 203 113 175 23

3 Key StrengthSeparate Sales

Team 2nd Largest Niche Strategy Rural Finance4 Market Share 21 7 NA NA Shareholding5 Foreign (%) 75.9 31.6 0 8.76 Institutional (%) 10.7 8.8 22.8 4.37 Non-Institutional (%) 13.4 18.7 23.3 25.58 Promoter (%) 0 48.8 53.9 61.5 Efficiency9 Non performing (%) 0.2 0.6 1.6 0

10 Income/Employee ('000) 55,564 21,212 9,248 6,225

11 Profit/Employee ('000) 18,774 3,974 1,459 1,34612 Net Profit Margin (%) 33.8 18.7 15.8 21.6 Financial

13 CAR (%) 16.8 13.3 20.8 18.214 Net Worth 128,014 18,542 4,451 1,90215 Credit/Deposit Ratio 651.8 NA 148.0 948.816 PAT 27,129 3,915 826 424 Ratios

17 P/E 24.4 5.8 5.28 14.818 EPS 95.5 46.1 7.4 12.219 ROE (%) 21.2 21.1 13.8 22.320 ROA (%) 2.8 1.7 1.2 2.121 Book Value 450.7 218.3 60.8 54.922 Market Cap 660,961 22,719 4,957 6,254 Spreads

23 Advances 747,735 219,364 17,610 17,69624 Deposits 114,711 0 119 1,86525 Yield on Advance (%) 9.9 9.3 9.4 10.626 Cost of Deposits (%) 8.9 NA 8.3 727 NIM (%) 3.1 2.6 3.0 4.4

As on March 2008. All figures are in Rs. Million

Table 6: Peers Analysis (All Values in INR)Source: Stock Exchange

12th Dec 08 P/E B/V EPS Market Cap

Housing Development Finance Corporation Limited 19.22 420.34 85.12 46,491.00

L I C Housing Finance Limited 3.92 215.65 54.67 1,822.23

Shristi Infrastructure Development conrporation 103.72 14.07 3.76 865.80

Dewan Housing Finance Corporation Limited 5.33 73.28 15.52 500.22

Gruh Finance Limited 7.16 54.91 13.45 333.83

G I C Housing Finance Limited 3.36 58.74 10.65 192.79

Ganesh Housing Corporation Limited 2.90 127.95 17.56 166.54

Sharyans Resources 22.24 105.30 3.52 116.43

Can Fin Homes Limited 3.02 107.28 15.08 93.21

Ashiana Housing Limited 1.93 34.11 20.49 74.10

Sahara Housingfina Corporation Limited 36.45 27.03 2.14 54.60

Coral India Finance & Housing 1.90 22.50 3.99 7.56

Saya Housing Finance Company Limited 66.67 10.42 0.06 4.00

Asahi Infrastructure & Projects Limited 5.57 1.29 0.01 2.90

Parshwanath Housing Finance Corporation Limited 2.74 9.69 2.43 2.00

Warden Construction & Finance Limited

Not Traded

Usha Housing Development Company Limited

S B I Home Finance Limited

Residency Projects & Infratech Limited

Mehta Housing Finance Limited

MFL Housing Finance Limited

Sylph Technologies Limited

Manoj Housing Finance Company Limited

Manraj Housing Finance Limited

International Housing Finance Corporation Limited

Happy Home Profin Limited

Indbank Housing

Table 7: Property Ventures ValuationSource: News Reports

Sr. No. Scheme/Fund Name Fund Type Corpus (INR Cr)

1 HDFC India Real Estate Fund Domestic, 7 year close ended fund 1,0002 HDFC IT Corridor Fund Investments in IT infrastructure in India 4463 HDFC International Fund International, 9 year close ended fund 3,760

Total 5,206Value of HDFC Property Funds: % of

AUM 15%

Value of HDFC Property Funds (INR Cr) 780.96Number of Shares (Cr) 284

Value per Share 2.75

Table 8: Asset Management Company ValuationSource: Stock Exchange

MF Bidder Stake Deal (USD Mn)

AUM Equity (USD mn)

% AUM

JM Financial Hedge Funds 12.00% 28 2,791 216 8.36%Standard Chartered IDFC 100% 205 3,256 205 6.30%Reliance Eton Park 5.00% 127 20,000 2,540 12.70%Canara Bank Robeco Groep NV 49.00% 27 512 55 10.76%Sundaram BNP Paribas 49.90% 25 695 50 7.21%SBI Societe Generale 37.00% 43 1,535 116 7.57%

Mean 7.36%

Valuation using average of % of AUM of above 4 deals ignoring the overvalued dealsAUM of HDFC MF as at the end of Dec-2008 (Rs in Cr) 63757.45….AUM as at the end of Dec-2008 (Source: AMFI) 46757.45….Portfolio management and advisory services (Source: Investor Presentation HDFC, Sep 08) 17000Valuation: % of AUM 7.36%Valuation of AUM (Rs in Cr) 4692Value of 60% Holding of HDFC Ltd. 2815Number of Shares (Cr.) 28.4Value per Share (Rs.) 99.12

Table 9: HDFC Bank ValuationSource: Student Estimates

Net income EPS P/E BVPS P/BV Dividend

Yield ROA ROE

March 2006 8,816 27.62 39.4 170 6.4 5.5 0.50% 1.41% 17.90% March 2007 11,510 34.93 31.2 203 5.4 7 0.60% 1.40% 19.51% March 2008 15,951 45.5 23.9 326 3.3 8.94 0.80% 1.42% 17.72% March 2009E 21,580 50.55 21.5 393 2.8 9.72 0.90% 1.27% 17.68% March 2010E 29,499 60.72 17.9 470 2.2 11.86 1.10% 1.27% 17.94%

PBV based valuationBVPS 2010E 470PBV multiple 2.21

Price target (INR) 1038Shares outstanding (Mn) 425.14Market Cap (INR Mn) 441,593

Table 10: Gruh Finance ValuationSource: Student Estimates

PBV based valuationBVPS 2010E 70PBV multiple 2.27

Price target (INR) 159Shares outstanding (Mn) 33.7Market Cap (INR Mn) 5514

Table 11: HDFC Standard Life Insurance ValuationSource: Student Estimates

Valuation (INR Mn) 2008-09EPremium Collection 41040

NBAP margin 20%NBAP 8208

Multiple at 16x 131328Holding of HDFC Ltd 74%Share of HDFC Ltd 97183

No of shares of HDFC Ltd (Mn) 284Structural Value 342.1Embedded Value 60.4

TOTAL: (INR/Share) 402.5Value 154493

Table 12: P/BV Calculation FormulaSource: Aswath Damodaran, Professor NYU

Table 13: HDFC Mortgage business P/BV ValuationSource: Student Estimates

High Growth (10 years) StableROE 22.0% 18.0%

Payout 28.0% 67.0%Growth (expected) 18.0% 6.0%

COE 14.7% 14.65%P/BV Calculation 0.72 1.97

Total 2.69

Table 14: HDFC Bank P/BV ValuationSource: Student Estimates




Total 2.21

Table 15: Gruh Finance P/BV ValuationSource: Student Estimates




Total 2.27Table 16: Market Values (All Values in INR)Source: Student Estimates

Code = 500010 Company = HDFC

No Month Close Price % Return BSE 500 % Return2

1 Dec-03 644.35 2,366.36

2 Jan-04 649.80 0.85% 2,246.83 -5.05%

3 Feb-04 609.90 -6.14% 2,228.41 -0.82%

4 Mar-04 644.10 5.61% 2,243.60 0.68%

5 Apr-04 594.80 -7.65% 2,321.25 3.46%

6 May-04 578.85 -2.68% 1,891.75 -18.50%

7 Jun-04 517.15 -10.66% 1,923.78 1.69%

8 Jul-04 575.05 11.20% 2,081.26 8.19%

9 Aug-04 556.45 -3.23% 2,125.65 2.13%

10 Sep-04 609.80 9.59% 2,276.87 7.11%

11 Oct-04 639.50 4.87% 2,319.30 1.86%

12 Nov-04 800.55 25.18% 2,548.36 9.88%

13 Dec-04 766.10 -4.30% 2,779.65 9.08%

14 Jan-05 777.80 1.53% 2,726.49 -1.91%

15 Feb-05 777.50 -0.04% 2,825.65 3.64%

16 Mar-05 726.60 -6.55% 2,734.66 -3.22%

17 Apr-05 730.85 0.58% 2,610.50 -4.54%

18 May-05 762.15 4.28% 2,829.20 8.38%

19 Jun-05 883.95 15.98% 2,928.31 3.50%

20 Jul-05 925.70 4.72% 3,124.78 6.71%

21 Aug-05 904.85 -2.25% 3,273.00 4.74%

22 Sep-05 1,039.65 14.90% 3,521.83 7.60%

23 Oct-05 968.30 -6.86% 3,198.69 -9.18%

24 Nov-05 1,127.20 16.41% 3,568.37 11.56%

25 Dec-05 1,205.35 6.93% 3,795.96 6.38%

26 Jan-06 1,340.00 11.17% 4,004.96 5.51%

27 Feb-06 1,355.85 1.18% 4,130.07 3.12%

28 Mar-06 1,336.05 -1.46% 4,516.73 9.36%

29 Apr-06 1,311.90 -1.81% 4,829.73 6.93%

30 May-06 1,125.95 -14.17% 4,157.93 -13.91%

31 Jun-06 1,130.00 0.36% 4,029.97 -3.08%

32 Jul-06 1,174.80 3.96% 4,029.43 -0.01%

33 Aug-06 1,308.35 11.37% 4,423.88 9.79%

34 Sep-06 1,534.30 17.27% 4,739.67 7.14%

35 Oct-06 1,470.50 -4.16% 4,957.37 4.59%

36 Nov-06 1,647.95 12.07% 5,227.73 5.45%

37 Dec-06 1,624.55 -1.42% 5,270.76 0.82%

38 Jan-07 1,670.75 2.84% 5,408.71 2.62%

39 Feb-07 1,501.90 -10.11% 4,938.08 -8.70%

40 Mar-07 1,520.35 1.23% 4,955.39 0.35%

41 Apr-07 1,659.70 9.17% 5,311.03 7.18%

42 May-07 1,870.80 12.72% 5,646.90 6.32%

43 Jun-07 2,030.20 8.52% 5,781.37 2.38%

44 Jul-07 2,016.50 -0.67% 6,063.20 4.87%

45 Aug-07 1,976.00 -2.01% 5,950.11 -1.87%

46 Sep-07 2,527.25 27.90% 6,773.54 13.84%

47 Oct-07 2,773.20 9.73% 7,785.22 14.94%

48 Nov-07 2,784.45 0.41% 7,865.98 1.04%

49 Dec-07 2,872.45 3.16% 8,592.43 9.24%

50 Jan-08 2,843.50 -1.01% 7,160.03 -16.67%

51 Feb-08 2,802.70 -1.43% 7,108.12 -0.72%

52 Mar-08 2,383.75 -14.95% 6,157.27 -13.38%

53 Apr-08 2,804.80 17.66% 6,885.03 11.82%

54 May-08 2,569.15 -8.40% 6,474.97 -5.96%

55 Jun-08 1,962.40 -23.62% 5,215.37 -19.45%

56 Jul-08 2,276.70 16.02% 5,525.77 5.95%

57 Aug-08 2,343.65 2.94% 5,631.51 1.91%

58 Sep-08 2,141.15 -8.64% 4,897.59 -13.03%

59 Oct-08 1,764.55 -17.59% 3,570.07 -27.11%

60 Nov-08 1,463.90 -17.04% 3,295.60 -7.69%

Disclosures:Ownership and material conflicts of interest:The authors or a member of their household, of this report does not hold a financial interest in the securities of this company. The authors or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation:Compensation of the authors of this report is not based on investment banking revenue.Position as a officer or director:The authors or a member of their household, does not serves as an officer, director or advisory board member of the subject company.Market making:The authors do not act as a market maker in the subject company’s securities.Ratings guide:Banks rate companies as BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the security’s weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months.Disclaimer:The information set forth herein has been obtained or derived from sources generally available to the public and believed by the authors to be reliable, but the authors does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with the Investment Research Challenge with regard to this company’s stock