20 June 2012 Annual Report Update | Sector: Financials

HDFC Bank
BSE SENSEX S&P CNX

16,860

5,104

CMP: INR537

TP: INR600

Neutral

FY12 Annual Report instills higher confidence in liability franchise

Branch expansion, product penetration key growth mantras

Bloomberg Equity Shares (m) 52-Week Range (INR) 1,6,12 Rel.Perf.(%) M.Cap. (INR b) M.Cap. (USD b)

HDFCB IN 2346.7 558/400 3/19/20 1,260.2 22.5

In FY12, HDFC Bank's retail loans grew 33.7% and retail deposits 27.6%. Proportion of retail business increased to 65% from 60% a year ago. Focus on India's hinterland is visible - 90% of branches opened in last 2 years are outside top 9 cities of India. Slippage ratio and credit cost are at the decade low of 1% and 0.4% respectively. Including general and floating provisions, coverage ratio is at ~200%. Outstanding floating provisions stood at INR14.35b (INR6.1/share, 4.8% of Networth) Expect operating leverage to cushion earnings. Visibility on core operating parameters and growth remains high, but rich valuations discount the same. Neutral.

Focused retail strategy; liability profile improved further

Liability customer acquisition followed by product penetration and exploitation of cross-selling opportunities remains HDFC Bank's (HDFCB) key business strength. During FY12, retail loans grew 33.7% and retail deposits 27.6% (retail term deposits grew 37% and savings 17%). Proportion of retail in overall deposits increased to 72.4% v/s 67.1% a year ago. Third party product cross-sell related fees (17% of overall fees, 24% in FY11) declined 20% YoY led by sharp 30% drop in insurance commission due to regulatory changes.

Valuation summary (INR b)

Y/E March NII OP NP EPS (INR) EPS Gr. (%) P/E (x) BV (INR) P/BV (x) ABV (INR) P/ABV (x) RoE (%) RoA (%) 2012 123.0 89.5 51.7 22.0 30.4 24.4 127.4 4.2 122.6 4.4 18.7 1.7 2013E 147.3 115.4 67.3 28.7 30.2 18.7 149.4 3.6 138.3 3.9 20.7 1.8 2014E 177.0 144.3 83.5 35.6 24.2 15.1 176.7 3.0 160.0 3.4 21.8 1.8

Aggressive franchise expansion - banking on India's hinterland

During FY12, HDFCB's number of branches rose ~28% to 2,544 and ATMs ~63% to 8,913. Presence in number of Indian cities is up ~40% YoY and 4.3x over FY08. Out of the total 820 new branches in last two years, 735 branches are outside the top 9 cities. Overall, 75% (70% in FY11) of branches are outside the top 9 cities.

Shareholding pattern % (Mar-12)

Foreign, 41.7 Others, 7.5

Customer acquisition demonstrates success of retail strategy

One of the key factors behind HDFCB's successful customer acquisition is its superior technology demonstrated by the fact that 80% of its transactions happen through non-branch channels. Total customer base increased from ~21m in FY11 to ~26m in FY12 and has more than doubled in last 4 years. The number of debit cards increased ~22% YoY to 14.1m (27% CAGR over FY08-12). Outstanding credit card base grew 11% to 5.6m.

Domestic Inst, 13.4

Promoter 37.4

Stock performance (1 year)

Strong earnings cushion, high return ratios but rich valuations

A third of HDFCB's branches are less than 24 months old; further, a large part of branch expansion happened outside top 9 cities, where breakeven period is 2430 months. Going forward, this strong expansion in hinterland will not only help customer acquisition and product penetration but also meet priority sector targets. While credit cost and slippages are at cyclical lows, higher base on account of floating provisions provides strong cushion to earnings. Visibility on HDFCB's core operating parameters and growth remains high; however, we believe rich valuations discount the same. Maintain Neutral.

Alpesh Mehta ([email protected]) +91 22 3982 5415 Sohail Halai ([email protected]) +91 22 3982 5430

HDFC Bank

Senior management commentary

HDFCB's objective is to continue building sound customer franchises across distinct businesses so as to: (1) be a preferred provider of banking services for its target retail and wholesale customer segments, and (2) achieve a healthy growth in profitability, consistent with its risk appetite. "Understanding customers across multiple segments and meeting their varied financial needs efficiently is at the heart of what we do." Many products consumed in urban markets are viewed as income generating assets by rural consumers - demonstrating management philosophy of growing in the rural areas. Over 400 branches are located in close proximity to mandis, further supplemented by dairy societies and sugarcane co-operatives acting as the bank's business correspondents.

Takeaways from management discussion and analysis

Monetary easing in response to slowing domestic demand is likely to be modest but enough to offset at least a part of the tightening over the last year. Leveraged consumer spending could thus gain some impetus. Greenfield capex could remain restricted; however, brownfield capacity expansion involving minimal regulatory hurdles could benefit from easing domestic funding and firm private consumption. Some sectors such as roads and highways that have seen considerable traction in activity over the last year are likely to remain an important support to investment momentum going ahead. While adequate capital provisioning and stringent prudential regulations largely shielded the domestic banking system from the global crisis, cyclical deterioration in asset quality remains a concern.

Other highlights

20 June 2012

Increase in savings deposit rate to 4% from 3.5% on an average daily basis, led to 10-11bp impact on margins. Retail term deposit cost increased by ~100bp. Domestic CD ratio at 77.1% v/s reported CD ratio of 79.2%. Wholesale loans grew 10.5% and deposits grew 5.4% (adjusted for one-off current account deposits of INR40b in FY11). Average monthly sourcing of home loans at INR8b (INR7b in FY11); bought-back portfolio from HDFC at INR47b (INR43b in FY11). Outstanding securitized loans on balance sheet were INR162.8b (~8% of loans) v/s INR146.9b (~9% of loans) a year ago. More than 85% of securitized assets are a part of the loan agreement with HDFC Ltd. Commission earned on housing loan sourcing was INR1.1b (INR965m a year ago). Outstanding RIDF bonds increased to INR91.2b (3.4% of average interest earnings assets) from INR65b (3% of average interest earnings assets). Investment of INR92.3b with various development banks (to meet PSL requirement) reclassified to HTM from AFS in-line with RBI guidelines. Negligible standard asset restructuring of INR1.6b v/s INR2.4b a year ago; overall asset restructuring of INR6.4b v/s INR3.7b a year ago. NPV losses on the accounts restructured during the year stood at ~15%. Exposure to real estate developers at 0.4% loans v/s 0.6% a year ago.
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HDFC Bank

Dupont analysis: Return ratios to remain healthy, led by strong core operating performance (%)
Y/E March 2007 4.2 1.9 31.4 6.1 2.9 47.9 0.9 32.1 2.0 3.2 -0.1 3.1 1.1 0.8 0.3 2.0 0.6 30.3 1.4 14.0 19.5 2008 4.7 1.8 28.1 6.5 3.3 51.5 1.2 34.7 2.2 3.1 0.2 3.4 1.3 0.9 0.4 2.0 0.6 30.3 1.4 12.5 17.7 2009# 4.7 1.8 28.2 6.5 3.5 53.6 1.4 40.5 2.1 3.0 0.2 3.3 1.2 1.0 0.2 2.1 0.7 32.0 1.4 11.9 16.9 2010 4.1 1.8 30.3 5.9 2.9 49.4 1.1 38.5 1.8 3.0 0.2 3.2 1.1 1.0 0.1 2.1 0.7 31.3 1.5 11.1 16.1 2011 4.2 1.8 29.4 6.0 2.9 47.9 1.1 39.6 1.7 3.1 0.0 3.1 0.8 0.3 0.5 2.3 0.8 32.5 1.6 10.7 16.7 2012 2013E 2014E

Strong margins and healthy fee income contribution leading to higher share of core revenue to overall revenues Higher focus on retail business and strong branch expansion leading to higher opex to average assets; expect operating leverage to kick in over next 2 years RoA and RoE expected to remain the best in the industry

Net Interest Income Core Fee Income Fee to core Income Core Revenues Operating Expenses Cost to Core Income Employee cost Employee to total exp Other operating expenses Core operating profits Trading and others Operating Profits Provisions NPA provisions Other Provisions PBT Tax Tax Rate RoA Leverage (x) RoE # Merged with CBoP

4.0 4.0 3.9 1.8 1.8 1.8 30.7 30.9 31.1 5.8 5.7 5.7 2.8 2.7 2.5 48.4 46.8 45.0 1.1 1.1 1.1 39.6 40.5 41.3 1.7 1.6 1.5 3.0 3.0 3.1 -0.1 0.1 0.1 2.9 3.1 3.2 0.5 0.5 0.5 0.2 0.4 0.4 0.3 0.1 0.1 2.4 2.6 2.7 0.8 0.8 0.8 31.2 31.3 31.3 1.7 1.8 1.8 11.1 11.5 11.8 18.7 20.7 21.8 Source: Company/MOSL

HDFCB: One year forward PE (trading at 20% discount to LPA)

HDFCB: One year forward PBV (trading at near LPA)

Source: Company/MOSL

20 June 2012

HDFC Bank

Franchise
A third of the branches are less than 2 years old
Branch addition in FY12 equal to the total branches added in the first 10 years of operations (i.e. up to FY06)

ATM/branch ratio up to 3.5x from 2.7x in FY11

ATM network up 6x in past five years, 3,400+ ATMs added in FY12

CAGR of ~25% over FY07-12

Branches outside top nine cities increase

Focused approach to India's hinterland 90% of branches opened in last two years are outside top nine cities of India

Faster penetration in hinterland

FY12 presence in number of cities in India has increased ~40% over FY11 and 4.3x over FY08

CAGR of 30% over FY07-12

Sharp increase in customer base

HDFCB's customer base increased sharply by ~5m led by expanding network and focused retail strategies (m)

Card base continues to grow

Increased customer base has led to higher debit card base; cautious approach for credit card customer growth

(m)

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HDFC Bank

Basel II and ALM profile

Proportion of risk weighted assets
The proportion of risk weighted assets to average assets stabilizes at ~70%

Break up of credit RWA (%)

More than 70% of the assets are low risk weight which remains largely stable

Top 10 funded exposure (%)

Exposure to stressed sectors significantly lower than peers

Top 10 non-funded exposure (%)

Non-fund based exposure remains diversified

ALM of FY12 (%)

Strong control over ALM led by higher proportion of granular retail deposits

ALM of FY11 (%)

Proportion of deposits maturing in one year remains stable in last three years at ~30%

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HDFC Bank

Loans, deposits and Investments

Share of Retail loans has increased (%)
Conscious strategy of staying away from wholesale loans and strong growth in retail loans across products led to improved share of retail loans in FY12 loans loans

Retail loan mix (%)

HDFCB emerged as the biggest credit card issuer in India in FY12; Moreover leadership across various retail products continued

Deposit mix (%)

Power of strong liability franchise demonstrated from higher and stable share of retail deposits

Concentration of risk remains low (%)

The concentration details (top 20) show improvement across categories #

# Top 4 NPA accounts

Investments break up (%)

Investment book largely dominated by G-sec; exposure to debentures and shares remains low

Break up of investment in HTM and AFS (INR b)

Investment of INR92.3b with various development banks reclassification to HTM from AFS in non SLR categories
48.1 17.6 23.2 30.1 13.9 8.0 1.1

70.8

67.3

10.7

21.4

16.3

0.6

* Figures in box implies percentage to overall investments

0.5

12.4

58.0

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HDFC Bank

Asset quality
Slippage ratio and credit cost lowest in the decade (%)
First mover advantage and relatively better retail loan cycle, access to database of CIBIL, healthy competition, etc are helping HDFCB report lowest slippage ratio in a decade

Proportion of sub standard assets increases (%)

The proportion of sub standard assets rose to 48% compensated by reduction in share of loss assets (23%)

# Merged with CBoP

Segment-wise NPA (%)

NPAs increased marginally in agri and allied activities, but declined across other sectors

Asset quality movement (%)

The performance on asset quality remains impeccable with GNPA at 1% and NNPA at 0.2%

Restructured loans and NPV losses (INR m)

While NPV loss on CDR cases was contained at 7%, overall NPV loss percentage stood at 15% of restructured loans

NNPA & standard restructured loans (% of loans)

Net slippages and restructured loan book remain the lowest among peers

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HDFC Bank

Earnings
Commendable performance on margins (%)
Core NIM (on average assets) remains stable - best among peers Reported NIMs 4.4

RoA at historical high (%)

Strong core operating performance and low delinquencies lead to high RoA

Fee income to average assests remains healthy (%)

Fee income growth improves (on a lower base) led by growth in forex income

Revenues from bancassurance declined ~20% YoY

Change in regulation led to moderation in income from insurance business

(INR m)

Cost to core income & cost to average assets (%)

The cost to core income increased as a result of higher infrastructure and staffing expenses

Higher trading loss a drag on profitability (INR m)

High interest rate and muted equity market led to higher trading loss in FY12 i.e. ~3% of PBT

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HDFC Bank

Financials and Valuation

Income Statement
Y/E March 2009 Interest Income 163,323 Interest Expense 89,111 Net Interest Income 74,212 Change (%) 42.0 Non Interest Income 32,906 Net Income 107,118 Change (%) 42.6 Operating Expenses 55,328 Pre Provision Profits 51,790 Change (%) 37.5 Provisions (excl tax) 18,797 PBT 32,993 Tax 10,543 Tax Rate (%) 32.0 PAT 22,449 Change (%) 41.2 Equity Dividend (Incl tax) 4,254 Core PPP* 47,964 Change (%) 36.1 *Core PPP is (NII+Fee income-Opex) 2010 161,727 77,863 83,864 13.0 39,831 123,695 15.5 59,398 64,297 24.2 21,406 42,891 13,404 31.3 29,487 31.3 6,414 60,847 26.9 2011 199,282 93,851 105,431 25.7 43,352 148,783 20.3 71,529 77,254 20.2 19,067 58,187 18,923 32.5 39,264 33.2 8,948 77,780 27.8 2012 272,864 149,896 122,968 16.6 52,437 175,405 17.9 85,901 89,504 15.9 14,373 75,132 23,461 31.2 51,671 31.6 11,806 91,463 17.6

(INR Million)
2013E 326,120 178,821 147,299 19.8 67,990 215,289 22.7 99,874 115,415 28.9 17,553 97,862 30,582 31.3 67,280 30.2 15,743 113,415 24.0 2014E 389,579 212,590 176,990 20.2 82,842 259,832 20.7 115,524 144,308 25.0 22,798 121,510 37,972 31.3 83,538 24.2 16,708 141,308 24.6

Balance Sheet
Y/E March Equity Share Capital Reserves & Surplus Net Worth Deposits Change (%) of which CASA Dep Change (%) Borrowings Other Liabilities & Prov. Total Liabilities Current Assets Investments Change (%) Loans Change (%) Fixed Assets Other Assets Total Assets 2009 4,254 146,273 150,527 1,428,116 41.7 633,597 15.4 91,636 162,428 1,832,708 175,066 588,175 19.1 988,830 55.9 17,067 63,568 1,832,708 2010 4,577 210,648 215,225 1,674,044 17.2 871,039 37.5 129,157 206,159 2,224,586 299,424 586,076 -0.4 1,258,306 27.3 21,228 59,551 2,224,586 2011 4,652 249,140 253,793 2,085,864 24.6 1,099,083 26.2 143,941 289,929 2,773,526 296,688 709,294 21.0 1,599,827 27.1 21,706 146,011 2,773,526

(INR Million)
2012 2013E 4,693 4,693 294,553 346,091 299,247 350,784 2,467,064 2,985,148 18.3 21.0 1,194,059 1,395,367 8.6 16.9 238,465 243,581 374,319 485,817 3,379,095 4,065,330 209,377 230,685 974,829 1,121,053 37.4 15.0 1,954,200 2,384,124 22.2 22.0 23,472 25,365 217,216 304,103 3,379,095 4,065,330 2014E 4,693 410,082 414,775 3,701,584 24.0 1,674,440 20.0 256,397 630,931 5,003,687 280,915 1,289,211 15.0 2,980,155 25.0 27,660 425,744 5,003,687

Asset Quality
GNPA (INR m) NNPA (INR m) GNPA Ratio NNPA Ratio PCR (Excl Tech. write off) E: MOSL Estimates 19,881 6,276 1.98 0.63 68.4 18,168 3,921 1.43 0.31 78.4 16,943 2,964 1.05 0.19 82.5 19,994 3,523 1.01 0.18 82.4 35,447 7,976 1.47 0.33 77.5

(%)
53,454 12,027 1.77 0.40 77.5

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Financials and Valuation

Ratios
Y/E March Spreads Analysis (%) Avg. Yield-Earning Assets Avg. Yield on loans Avg. Yield on Invt Avg. Cost-Int. Bear. Liab. Avg. Cost of Deposits Interest Spread Net Interest Margin 2009 11.8 15.0 7.4 6.8 6.6 5.0 5.4 2010 9.0 10.8 6.8 4.7 4.5 4.3 4.7 2011 9.2 10.6 7.2 4.7 4.3 4.5 4.9 2012 10.2 11.6 7.7 6.1 5.6 4.1 4.6 2013E 9.9 11.4 7.4 6.0 5.4 3.9 4.5 2014E 9.8 11.1 7.3 5.9 5.3 3.9 4.5

Profitability Ratios (%)

RoE RoA Int. Expense/Int.Income Fee Income/Net Income Non Int. Inc./Net Income 16.9 1.4 54.6 27.1 30.7 16.1 1.5 48.1 29.4 32.2 16.7 1.6 47.1 29.5 29.1 18.7 1.7 54.9 31.0 29.9 20.7 1.8 54.8 30.7 31.6 21.8 1.8 54.6 30.7 31.9

Efficiency Ratios (%)

Cost/Income* Empl. Cost/Op. Exps. Busi. per Empl. (INR m) NP per Empl. (INR lac) * ex treasury Asset-Liability Profile (%) Loans/Deposit CASA Ratio Investment/Deposit G-Sec/Investment CAR Tier 1 53.6 40.5 41.1 0.5 49.4 38.5 51.2 0.6 47.9 39.6 61.5 0.7 48.4 39.6 66.5 0.8 46.8 40.5 71.4 1.0 45.0 41.3 81.8 1.1

69.2 44.4 41.2 88.7 15.7 10.6

75.2 52.0 35.0 87.1 17.4 13.3

76.7 52.7 34.0 75.6 16.2 12.2

79.2 48.4 39.5 78.2 16.5 11.6

79.9 46.7 37.6 74.6 15.2 11.1

80.5 45.2 34.8 77.5 13.8 10.5

Valuation
Book Value (INR) Change (%) Price-BV (x) Adjusted BV (INR) Price-ABV (x) EPS (INR) Change (%) Price-Earnings (x) Dividend Per Sh (INR) Dividend Yield (%) E: MOSL Estimates 70.8 9.1 61.2 10.6 17.6 2.0 94.0 32.9 88.5 12.9 22.1 2.4 109.1 16.0 105.0 16.9 31.0 3.3 127.4 16.8 4.2 122.6 4.4 22.0 30.4 24.4 4.3 0.8 149.4 17.2 3.6 138.3 3.9 28.7 30.2 18.7 5.7 1.1 176.7 18.3 3.0 160.0 3.4 35.6 24.2 15.1 7.1 1.3

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HDFC Bank

N O T E S

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