HDFC Bank plunged after Q4FY22 report card; what’s next?

But the volatility may be an opportunity to buy a quality blue-chip private bank in adversity

HDFC Bank plunged almost -12% in the last two months (April/May-till date) and made a 18-months (since Nov’20) low around 1286.00 after a subdued Q4FY22 report card coupled with ‘not so exciting’ prospect of a merger between HDFC Bank and its parent/NBFC arm, housing loan giant HDFC.

HDFC Bank made a high around 1721 on 4^th April’22, almost around the lifetime high 1725 (made mid-Oct’21). On 4^th April, HDFC Bank announced the much-awaited merger with its parent HDFC (subject to all regulatory approval). HDFC Bank announced a ‘transformational combination’ of HDFC and HDFC Bank in the ratio of 1.68; i.e. holders of each 25 shares of HDFC will get 42 shares of HDFC Bank.

·         Shareholders of HDFC Limited as of the record date will receive 42 shares of HDFC Bank (each of face value of Re.1), for 25 shares held in HDFC Limited (each of face value of Rs.2), and the equity share(s) held by HDFC Limited in HDFC Bank will be extinguished as per the Scheme. As a result of this, upon the Scheme becoming effective, HDFC Bank will be 100% owned by public shareholders and existing shareholders of HDFC Limited will own 41% of HDFC Bank

·         The combined entity will bring together the strengths of both companies. Post the merger, HDFC Bank’s customers will be able to avail mortgages as a core product in a seamless manner. HDFC Bank will also leverage the long tenor mortgage relationship to offer varied credit and deposit products enabled through better insights throughout the customer life-cycle

·         The boards of HDFC and HDFC Bank believe that the merger will create long-term value for all stakeholders, including customers, employees, and shareholders. The combined entity will also provide an impetus to the government’s vision of ‘Housing for All’.

The Chairman of HDFC, Parekh said:

“This is a merger of equals. We believe that the housing finance business is poised to grow in leaps and bounds due to the implementation of RERA, the infrastructure status of the housing sector, and government initiatives like affordable housing for all, amongst others. The resulting larger balance sheet will allow underwriting of large ticket infrastructure loans, accelerate credit growth, boost affordable housing and increase the quantum of credit to the priority sector”.

The CEO & MD of HDFC Bank, Jagdishan said:

“The proposed transaction ticks all the right boxes in terms of completion of product offerings, product leadership in home loans as with other retail assets products, distribution strength across the country, and a customer base that can be leveraged to cross-sell a complete suite of financial products. It is value accretive for all the stakeholders of both the organizations, including shareholders, employees, and customers”.

Pros & cons of the merger between HDFC Bank and HDFC:

·         ·         Building a secured housing loan portfolio under the banking platform rather than too much emphasis on high-yielding unsecured credit cards and personal loans; currently, HDFC Bank sells the home loans of HDFC Ltd and earns a fee. The merged entity will not only reduce the unsecured loan exposure but also provide headroom to underwrite more loans

·         Access to low-cost funds avoiding various regulatory headwinds under NBFC

·         HDFC Bank is India's largest private sector bank and has a large base of over 68M customers. The bank platform will provide a well-diversified low-cost funding base, especially under CASA. Thus HDFC bank will be able to offer more competitive housing loan products; the housing loan market is now highly competitive

·         The HDFC merger will create a combined large balance sheet of Rs 25.61T against ICICI Bank’s Rs.17.74T and SBI’s Rs.45.34T

·         Huge cross-selling opportunity for HDFC Bank amid complementary human resources. HDFC comes with dedicated 445 offices of service centers across the country, which will be used to cross-sell the entire suite of banking products. The mortgage provider has a trained staff to do only home loans, which will provide an edge to the merged entity in the market

·         HDFC Bank may have access to HDFC customers/borrowers, 70% of which have no banking relationship with HDFC Bank

·         HDFC’s insurance, asset management, and securities subsidiaries will further diversify the combined entity’s revenue profile

·         The profitability of the combined entity may suffer in the shorter term due to higher provisions amid elevated statutory reserve requirements and priority sector lending (PSL)

·         As per some estimates, HDFC Bank will have an excess SLR/CRR asset requirement of around Rs.700-800B and will also need an incremental Rs.900B for the agriculture portfolio (based on 18% of borrowings) to meet PSL norms. These low-yielding portfolios could be a drag on the merged entity’s P&L

As per HDFC Bank’s presentation, the expected EPS of the merged entity may be around 67 vs 65 for HDFC Bank and 74 for HDFC at present. Thus HDFC Bank is expecting around a 3% increment in EPS as a result of the merger.

Highlights of Q4FY22 report card: HDFC Bank

In Q4FY22, Net Interest Income (NII) was up +2.33% sequentially and +10.24% yearly. But other operating income contracted -6.68% sequentially and +0.57% yearly. The bank said there was a loss on sale or revaluation of investments during the Q4FY22 at Rs 0.403B against income of Rs 0.6551B in Q4FY21. Total operating income was around Rs.26.509B against Rs.26.627B sequentially (-0.44%) and Rs.24.714B yearly (+7.27%). Total operating expenses were around Rs.10.152B against Rs.9.851B sequentially (+3.06%) and Rs.9.181B yearly (+10.58%). The EBTDA (core operating profit without NPA provisions) was around Rs.16.357B against Rs.16.7762B sequentially (-2.50%) and Rs.15.533B yearly (+5.31%). Eventually, core operating EPS (EBTDA/share) was at Rs.29.50 VS 30.27 sequentially (-2.55%) and 28.18 yearly (+4.68%). EBTDA margin was 39.81% against 41.27% sequentially and 40.86% yearly. The reported core NIM was at 4.00% against 4.10% sequentially and 4.20% yearly.

Overall, the report card of HDFC Bank, India’s most trusted and largest private sector bank was subdued and also below market expectations. The Bank also issued an indirect guidance warning for elevated operating expenses amid tech upgrades and branch expansions. Subsequently, HDFC Bank corrected.

The Bank said in its analyst concall:

“In summary, we remain committed to offering our customers with a comprehensive range of products and services while capitalizing on growth opportunities. We have delivered a consistent performance for years together and remain pledged towards the culture of excellence. Thus the quarter results reflect advances growth of 21%, deposits growth of 17%, and profit after tax increased by 23% delivering a consistent profit growth rate and return on asset of over 2% and ROE of over 17%. Earnings per share in the quarter of ₹ 18.1, book value per share increased in the quarter by ₹18.6 to ₹ 433, the economy is growing, businesses are robust, credit demand is high, savings growth is strong, customers have the cash to spend and are spending and we are here to serve.”

Highlights of Q4FY22 earnings concall: HDFC Bank

·         COVID crisis is almost over as the pandemic is now turned into endemic

·         High-frequency indicators showing robust economic recovery and growth

·         Inflationary pressure is high due to elevated fuel and food costs amid Russia-Ukraine geopolitical tensions and economic sanctions

·         RBI is expected to shift to a neutral stance from accommodative in the June meeting, but the overall monetary policy stance will support continued economic growth and demand for credit

·         The bank is investing heavily in HR, new branches, and digital tech for further improvement in productivity, which is the need of the day as the economy accelerates

·         In Q4FY22, 563 branches were added, while cumulatively 734 branches were added in FY22; will open another 150 branches in a short period

·         Total advance around Rs.13.69T, grew +8.6% sequentially and +20.8% yearly

·         Commercial and rural advances grew +10% sequentially and +30% yearly

·         Retail advances grew +5% sequentially and +15% yearly despite muted car loans amid lingering chip shortages

·         Wholesale loans grew +11.6% sequentially and +17.4% yearly

·         Total deposits around Rs.15.59T, up +16.8% yearly and +22% sequentially

·         CASA ratio of 48% with retail deposits constituted over 80% of total deposits

·         Total cards 16.5M; 2.18M fresh cards issued since the withdrawal of RBI restrictions in the 7-months of FY22

·         Market share of advance grew from 10% to 11% and the incremental share of credit growth in the whole economy is around 24%

·         Market share of deposits improved from 7% to 11% in the last five years

·         A strong balance sheet along with comfortable regulatory capital requirements will support future credit/business growth

·         Continue to provide loans in line with proven (strict) credit models

·         Floating and contingent NPA provision at Rs.11B, while GNPA ratio of 1.17%

·         Soft NIM was due to stress on higher-rated loans at lower yields amid COVID; i.e. the bank took precautionary steps in providing loans during COVID disruption; focused on quality loans and return of capital rather than return on capital

·         Looking ahead, as the COVID period is over and as credit card loan growth resumes, NIM is expected to improve

·         Fees on payment products remain subdued due to lower risk related fees (overdraft fees, late payment fees, etc) as banks remained cautious on the credit card based spending

·         Trading income was negative (-0.04B) against Rs.1.046 sequentially and Rs.0.655B yearly; in Q3FY22, there were opportunistic gains from the bank’s investment portfolio

·         Operating expenses were higher amid the continuous expansion of the bank’s branches, ATMs, distribution networks, and technology upgradation

·         Expanding partnerships with Airtel, India Post payment banks, and Manipal Business Solutions so that their customer's total of around 140M could be accessed

·         Cost to income ratio stands around 38%; looking ahead operating expense/cost to income ratio remains elevated due to higher sales and promotional activities, elevated technology, and other discretionary spending

·         Fresh slippage Rs.4B; recoveries and upgrade Rs.2.1B; write-offs Rs.1.7B

·         COVID restructured loans (under RBI resolution framework) were at Rs.15.7B; around 41% secured and 59% unsecured, while 84% of unsecured borrowers have good CIBIL score/credit rating/non-delinquent

·         Total NPA provisions at Rs.3.312B against Rs.2.994B sequentially and Rs.4.694B yearly; provisions for core-specific loan loss were around Rs.1.778B against Rs.1.821B sequentially and Rs.3.153B yearly; Q4 total provision included the additional provision of around Rs.1B for contingency

·         PCR was at 73%; total provisions comprising specific, floating, contingent, and generally stand around 182% of GNPA

·         Lower NIM is due to bank’s focus on high-quality lending, which is usually lower yield

·         Focus is now on risk-adjusted NIM, which bank claims improved to 3.5% from 3.1% on yearly basis (NCM=NIM-COC; i.e. net credit margin=net interest margin – cost of credit)

·         Consistent ROA around 2% and ROE around 17% amid increasing focus on secured retail lending rather than an unsecured loan

·         Average retail lending yield 5%, commercial 10%, wholesale 11%, and 9.5% agri yield

Overall, HDFC as well as India’s private banking sector suffered in the last two years on elevated COVID NPA/NPL, especially in the retail and MSME loan portfolio. Moreover, HDFC Bank’s retail loan book suffered significantly due to lower O/S of credit cards (after the RBI ban) coupled with car loans (amid chip shortages).

The NII/NIM was impacted to some extent by subdued loan growth amid the COVID tsunami/lockdowns, increased regulatory CRR (RBI) requirement, low yielding asset mix, and interest reversal (SC/loan moratorium/compound interest issue), while other income mainly boosted by FX trading. Also, operating costs declined in the previous quarter primarily due to increased online mode of operation rather than offline, which is now reversing as the bank now shifting towards an online/hybrid model of work.

In the Indian banking system, the actual level of NPA/NPL determination is very difficult, considering the ever-greening mechanism. But if we look into HDFC Bank’s GNPA with interest income, the ratio was around 16% in FY21/22 against around 14% for earlier years; i.e. it may safe to assume almost 15% of loans may be stressed or under some type3s of delinquencies. But PSU peers like SBI may have much higher NPA/NPL stress around 25% levels.

In any way, assuming HDFC Bank’s ‘robust’ recovery mechanism, prudent/quality unsecured lending policy against salary accounts of reputed companies only maybe a huge positive despite possible ‘hidden’ NPA/NPL. To make up for the loss from the credit card business, HDFC Bank was also providing revolving credit on customers’ debit cards. In H2FY22, HDFC Bank’s ‘robust’ collection was affected by COVID lockdowns. HDFC Bank sees the cost-to-income ratio to climb to 38-39% in the near term as economic activity rebounds but has maintained its long-term guidance of 35%.

HDFC Bank always provides unsecured credit only to solvent/quality borrowers and in most cases that too against existing savings/salary accounts of respectful deposits/companies. In other words, HDFC Bank takes a calculated risk in unsecured lending and also can collect from many defaulter/delinquent borrowers by various ethical/unethical means; i.e. it has a robust recovery mechanism from defaulters.

As highly expected, in early March’22, RBI withdrew the ban of new credit/debit cards/digital business on HDFC Bank after ‘due diligence’, paving the way for another trigger on the scrip. Looking ahead, HDFC bank’s stress on retail lending including secured car and home loans (through HDFC/after HDFC merger), branch expansions, digital banking, and prudent business loan policy may help the scrip despite a fall of almost -25% from the recent lifetime high levels. Thus considering all the pros & cons, HDFC Bank may be an example of a great business under temporary disruptions. Considering the professionalism of HDFC bank management, their credibility, and the brand value, it may be a great opportunity to enter the scrip at current market volatility/adversity amid the concern of faster Fed/RBI tightening and lingering geopolitical tensions (Russia-Ukraine).

The market is now concerned about synchronized global stagflation or even an outright recession. But higher bond yield may be also positive for banks and financials (lending model/NIM). In India, inflation is structurally high for a long and despite that discretionary consumer spending was not affected significantly as there are adequate regular wage hikes (both public and private companies). Thus the demand for credit is expected to be robust and private banks like HDFC usually extends credit to quality and solvent borrowers under salary class.

Despite being a private bank, HDFC bank, along with ICICI bank is categorized by the RBI as India’s systematically important bank; i.e. it’s too big to fall. RBI/Indian government will never allow a big private bank like HDFC to fall. The same is true for even Yes Bank or any other small/big private bank. During late 2018-20, repeated digital disruptions were a major headwind for the bank along with the auto loan controversy in July’20.

In any way, unlike some major/big private banks (like Yes Bank, ICICI Bank, or even Axis Bank), there were no major issues of corporate governance in HDFC Bank and the credibility of the management is impeccable. HDFC bank always maintains a high standard of corporate governance, prudent lending norms, and risk management. Apart from the stress on household/personal lending, HDFC bank will now also focus on infra and secured home loans (after the expected merger with HDFC in FY23/24).

HDFC Bank is the most profitable among all domestic scheduled commercial banks in terms of return ratios (ROA, ROE, NIM, and cost to income ratio). HDFC Bank always cares for higher-margin/yield along with safety: “We have a certain yield band that we are comfortable with. As a market leader we won’t drag the pricing down just to grow. When you don’t undercut, the market also doesn’t get corrupted or spoiled”.

Looking ahead, HDFC Bank, with around 69 M customer bases and over 6,300 branches, wants to make deeper inroads, what it calls ‘kilometer expansion’. The bank’s two main unsecured loan products are personal loans, targeted at the salaried class, where the average ticket size is Rs.0.4M, and business loans, usually in the range of Rs.1M, mainly availed by SME traders.

HDFC Bank management said: “A lot will depend on whether you have the right kind of valuer and infrastructure in place to avoid the risk of quality dilution. To ensure the quality of the book, the bank is targeting government accounts, both at the Central and state level. The government opportunity in unsecured loans is similar to the public sector versus private sector arbitrage in banking that was prevalent 25 years ago”.

Apart from stress on unsecured/secured retail/personal lending in affluent urban areas, HDFC Bank is now also prioritizing rural and agri banking. The management said: “The bank will double the coverage of villages it serves from 100,000 to 200,000 in the coming years. One of the tailwinds that the bank is riding on to grow its credit in the heartland is government schemes. With more than 25 government schemes in play, it is possible for the bank to go out and lend where the bank wants to improve its coverage to 625 districts, thanks to GST and digitization resulting in better assessment of a borrower’s creditworthiness”.

On the planned merger with parent HDFC, the bank is expecting it to fructify in FY24. The HDFC Bank management said:

“The combined entity will be an Rs.18T (loan book) behemoth----cross-selling of opportunities will increase as 70% of HDFC customers do not deal with the bank, while 80% of HDFC Bank customers do not have mortgages, indicating low penetration of the mortgage book. Of our 69 million customer base, 5 million have taken housing loans from other banks. That itself is Rs.15T----! Just imagine, if I start penetrating that, I can create another HDFC Bank. For HDFC, the gain will come from access to the bank’s low-cost funding franchise. Besides, the combined entity’s larger balance sheet will enable the bank to make larger ticket loans. Over a period of time, HDFC’s branches will be converted into full-fledged bank branches.

While the HDFC bank never had a mortgage book and is now largely sourcing for the parent (for a fee), after the merger, the mortgage business might be run as a separate unit. Mortgages will be a huge piece and there is always the option to run it as a separate business. But I cannot comment with clarity as the merger is still in the works.”

The market is concerned that the combined entity of HDFC Bank may not retain all the existing HDFC mortgage borrowers because most of the retail borrowers having salary account in one bank, tend to borrow from another bank as any default, the bank can deduct/block the exiting savings/salary account without even any prior notice or arrangement.

Fair Valuations: HDFC Bank: Rs.1735 by Dec’22 and Rs.1925 by Mar’23

For FY22, HDFC Bank reported a core operating EPS of 115.55; considering all pros & cons as discussed above, and past trends of P&L accounts, it may generate a 15% CAGR in core operating EPS growth from FY3 to FY26.

Further considering a reasonable average PE of 15 and the actual FY21 core operating EPS of 104.06, the FY21 fair value was around Rs.1734.00, which was already achieved in early April (after the merger announcement with HDFC). Now projecting core operating EPS of Rs.132.88 for FY23, Rs.152.81 for FY24, Rs.175.73 for FY25, and Rs.292.09 for FY26, the respective fair value should be around 1926, 2215, and 2547, 2929, and 3368. Apart from the HDFC merger trigger, HDFC Bank may also list its subsidiary like HDFC Sec and another NBFC- HDB Financials in the coming days to deleverage its balance sheet.

Looking ahead, whatever may be the narrative, technically, HDFC Bank has to sustain over 1290-1355 for any meaningful rally; otherwise sustaining below 1280-1250, may fall more.

P&L A/C analysis: HDFC Bank

Articles

Comments