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Crisis: Why HDFC Bank will not be hit
Sarath Chelluri in Mumbai
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November 24, 2008
HDFC Bank's ability to grow at over 30 per cent annually in the last nine years, along with superior credit risk management practices, which have helped it maintain asset quality, would ensure that it will be among the least affected in a slowdown.

The bank's focus on technology and superior margins with support from low-cost deposits will ensure profitable growth in the future.

The merger of retail focused-Centurion Bank of Punjab (CBOP) with HDFC Bank [Get Quote] effective May 23, 2008, will shore up revenues in the medium-term. However, the synergies from the merger with start reflecting over 12-24 months, and boost profitability. Put together, the gains from organic and inorganic initiatives will help the bank sustain growth rates in excess of its historical average of 29-30 per cent, and in a profitable manner.

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The inherent synergies of HDFC Bank and CBOP in their retail focus was the driver for the merger, which added around 400 branches to HDFC Banks' branch strength of 760 (as on March 2008) along with a 15-20 per cent increase in the asset base to more than Rs 1.7 lakh crore. While the merger has helped increase the size of HDFC Bank, it has also led to some pressure on key ratios (see Merger Effects) for the combined entity; CBoP ratios were lower than that of HDFC Bank. The next pertinent question is the pace of integration, and how fast HDFC Bank can ramp up efficiency levels of CBOP to its own benchmarks.

The integration plan is on schedule. The re-branding of CBOP was completed in May itself; training processes to assign all the employees of CBOP in their new roles is marching ahead with almost 90 per cent of the people retrained. With regards the systems, treasury, wholesale banking and retail loan segments, they have already been integrated with HDFC's platform, while the overall retail banking is expected to be completed in the next two months.



Rs crore

9 Mths

HDFC Bank**
9 Mths

FY 08

 H1 FY09

Net Int. Income





Other Income





Net Profit





Cost/income (%)





NIM (%)





CASA (%)





Net NPA (%)





CAR (%)





** Pre-merger and for nine months ended December 2007

The actual benefits will start to filter in the next 12-24 months, with improved productivity in terms of net revenue (net interest income and other income) and CASA (the ratio of low cost deposits to total deposits) growth of CBoP branches on par with HDFC outlets. But before that to happen, HDFC bank will have to shoulder the pressure in the medium-term.

For instance, on the efficiency front, the cost to income ratio has also increased from 50 per cent in March, 2008 to around 55 per cent in Q2 FY09 on the back of higher employee costs and integration costs, post the merger. The integration of the two banks' technology-based platforms is expected to be completed by the end of this fiscal, and will improve the cost efficiencies going forward.

Likewise, the capital adequacy ratio (CAR) dropped to 11.4 per cent in Q2 FY09; this can partially be attributed to the merger blues and also organic growth of loan book. However, it is comfortably above the regulatory requirement of 9 per cent. Notably, CAR will improve and provide capital for future growth, if the promoters exercise their right to convert warrants and infuse Rs 3,500 crore (warrants already issued, conversion price of Rs 1,500 per share, deadline is December 2009).


Rs crore

FY 2008

 FY 2009 E*

FY 2010 E *

Net Interest Income




Other Income




Net Profit




EPS (Rs)




P/BV (x)




E *: estimates for merged entity

Sustained growth
HDFC Banks' net revenues have grown at a CAGR of 44.5 per cent in the last five years on the back of net interest income (NII) and other income growing by 43 per cent and 47.7 per cent, respectively. Net profits grew by 33 per cent; the lower pace is due to the bank's prudent policy of higher provisioning (last three years).

Of late, HDFC Bank has been going slow on the retail loans and even CBoP's non-issuance of fresh loans (since December 2007) to the two-wheeler and personal loan segments, has ensured comfortable NPA (non-performing assets) levels for the combined entity. Gross NPA and net NPA are up 40 basis points and 20 basis points y-o-y in Q2 FY09 to 1.6 per cent and 0.6 per cent, but are comfortable in comparison to peers. Analysts say that HDFC Bank, after the merger, would provide higher provisions to the combined entity in line with its own superior provision coverage of around 67 per cent (CBOP's at 55 per cent). Although, it will add pressure on the profitability in the near term, it will help avoid slippages in asset quality in the future.

The advances haven't slowed and this is indicated from the credit-deposit ratio rising from 63 per cent (FY08) to around 75 per cent in Q2 FY09. The recent CRR cut has released additional funds of around Rs 4,500 crore that could be used for further loan disbursements and provide support to NIMs (CRR balances with RBI do not yield any returns). The higher yield on advances and investments in conjunction with high interest rates has meant that NIM is still comfortable at 4.2 per cent.

Investment rationale
The demand from the domestic corporate sector is also robust as the external doors are relatively closed in view of the global liquidity crunch. This should also help offset any slowdown in retail lending and lower concerns pertaining to retail defaults. HDFC Bank's ability to transfer its operational efficiencies to CBOP assumes importance for future growth. Considering its track record of successfully integrating Times Bank with itself in 2000, the bank will also accrue the benefits from the existing CBOP branch network through increased offerings of HDFC Bank products, which will help shore up revenues.

Superior NIMs, a high proportion of low-cost deposits (at 44 per cent) and an extensive branch network (now at over 1,400) will drive growth without appreciable cost pressures. This quality and profitable growth along with low valuations, provides an investment opportunity for long-term investors. At Rs 856.70, the stock trades at around 12.5x (traded at an average 20-25x in the last five years) and P/BV at 2.1x its FY10 earnings, and can deliver 18-20 per cent annually for the next few years.

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