Operating leverage and forex offset investment costs: HDFC Bank reported a marginal drop in earnings growth momentum primarily due to high investment depreciation (almost the entire cost was absorbed instead of using the RBI dispensation). Strong operating leverage (opex grew 9% y-o-y, cost-income ratio declined 150 bps q-o-q) and healthy forex income (doubled y-o-y) supported the high depreciation costs. However, a few key issues persist(i) pressure on revenue growth continued with NII growth weak at 15% on the back of 16% loan growth, (ii) growth in retail is steadily shifting to unsecured loans, (iii) fee income continues to trail overall revenue growth at 11% y-o-y, and (iv) high cost for investment depreciation resulted in coverage ratio declining 200 bps to 74%.
HDFC Bank loan growth slower: Loan book grew at a moderate pace at 16% y-o-y (4% q-o-q). Growth in retail (17% y-o-y, 3% q-o-q), was driven by unsecured loans (23% y-o-y, 4% q-o-q) and business banking (20% y-o-y) as vehicle loans and gold loans saw a moderation in growth. Increasing competition and low industry growth appear to be affecting vehicle loan growth. Corporate loan growth at 15% y-o-y was lower than expectation given the surge in demand, but the management indicated that they hardly participated in it given the low appetite for this low-margin short-duration business opportunity.
HDFC Bank loan impairment ratios are broadly stable: Asset quality trends remained broadly stable though headline NPL (non-performing loan) numbers increased marginally. Gross NPLs (non-performing loans) increased 10 bps q-o-q to 1.1% (8% increase on an absolute basis) while net NPLs were stable at 0.3% of loans. Net NPLs increased 16% q-o-q on the back of lower provisions. Most of the slippages in the quarter came from the CV/CE (commercial vehicle/construction equipment) segments, and were negligible in the wholesale segment. Provisions were lower resulting in a 200 bps decline in coverage ratio to 74% as the bank had to make higher provisions for the investment portfolio. We note that the bank did not make any floating provisions in the current quarter.
HDFC Bank NIM declines 30 bps: NIM declined 30 bps q-o-q led by a rise in costs of funds by 20 bps while yield on advances declined 10 bps. While the bank raised the base rate by 20 bps in the quarter, full impact did not come through in the quarter. We note that only 25% of HDFC Banks loan book is base rate linked and competitive intensity in retail loans, combined with subdued demand, limited the banks ability to push higher rate on retail products.
We believe that NIM has scope to decline further as the ability to push interest rates would be challenging in retail products, especially with public banks cutting interest rates recently. Further, shifting to wholesale is a lot more margin dilutive activity for HDFC Bank. We broadly maintain our negative outlook on NIM, especially over the next few quarters.
Total deposits grew 14% y-o-y led by growth in saving (18% y-o-y) and term deposits (17% y-o-y). CASA ratio was stable at 45%. The management highlighted the reduction in CA balance came only towards the end of the quarter, on a daily average basis CASA (current account saving account) was only marginally lower and hence did not impact cost of funds.
HDFC Bank valuations closer to fair value: The best-in-class bank has been under-performing over the past year, reflecting the challenging business environment faced by the sector. Post the valuation correction, we find the bank closer to our fair value. NIM could drift to the lower end of 4% which combined with the slow loan growth can increase pressure on revenue growtha key medium-term risk. We maintain the Reduce rating on the bank.
Kotak Institutional Equities