Does HDFC Bank really deserve the hype it receives?

By VS Fernando

OF late, a lot of hype has been created around the ‘new generation’ HDFC Bank Ltd (HBL).

The reason is not far to fetch. First, HBL completed a $150 million American Depositary Shares (ADS) offer and listed the shares on the New York Stock Exchange (NYSE) last month.

Next, a few days ago, in a glittering ceremony, the bank bagged the ‘Emerging Company of the Year’ award by The Economic Times, whose masters incidentally own 8.4 per cent of the bank’s equity. But, does the bank deserve the steep valuation or the hype it receives?

The HBL’s scrip is currently traded on the BSE at about Rs 235 discounting the earnings of trailing 12 months up to June 2001 about 29.4 times, whereas the country’s largest bank, SBI, commands a valuation of just 4.1 PE. Corporation Bank, widely regarded as the most progressive PSU Bank, could get only 6.1.

Amongst private ‘old’ generation banks, Vysya Bank, Federal Bank and Karur Vysya Bank, which are perceived to be reasonably efficient, command PEs of 5.8, 1.4 and 2.1 respectively.

Even ICICI Bank, HBL’s new generation competitor, could barely claim a PE of under 13.3. In terms of price-to-book-value ratio too, HBL’s valuation is astronomical at 6.9 as compared to SBI’s 0.8, Corporation Bank’s 1.3, Vysya Bank’s 0.5, Federal Bank’s 0.2, Karur Vysya Bank’s 0.4 or even ICICI Bank’s 2.1.

Unless HBL possesses something unique and does business radically different from others, there is no way such a disparity could be justified. While HBL was able to comfortably surpass the deposit targets set at the time of its IPO, its failure to add quality assets has somewhat impaired its bottom line. In fiscal 1998, despite more than doubling its target of number of branches (from 15 to 37) and a quantum jump (74 per cent) over its deposits target, the bank’s advances and net profit dropped 10 per cent below their targets.

Consequently, the bank had to prune the dividend by 2 per cent from the promised 12 per cent. They say, HBL is a technology-driven bank. But, what use is technology if the attitude of the people implementing it leaves a lot to be desired.

For instance, on its NYSE listing, when this writer tried to contact HBL’s company secretary for a copy of the ADS Document and FY 2001 annual report, the personnel at HBL were so ‘progressive’ that they kept on passing the telephone call to one another almost endlessly.

Even the personal assistants of the senior executives invariably put the phone in the voice-mail mode! If you are lucky enough to reach the secretaries over the phone, you will only get a standard reply that the officials were in a meeting.

What’s more, even after our six phone calls, the busy company secretary did not respond. When we tried to send him a fax recording the turn of events, we were told that the “fax machine was not working”!

After enduring a frustrating period, during which one was enlightened that “as a policy, the bank personnel were under instructions not to talk to the press”, this writer was directed not to any corporate communications-in-charge but to the “head, credit and market risk,” who informed that though the ADS was listed and traded, the ‘printed copy’ of the offer document was not readily available at the registered office!

Though HBL did send a copy of the ADS document later, the culture, or the lack of it, on display at HBL was positively repulsive. Whats more, when we sent out an elaborate questionnaire seeking replies on issues of interest to investors, the bank didn’t reply even after four working days. When insisted on a written reply, in an era of transparency and disclosure, the bank chose to hide behind the veil of ‘secrecy and confidentiality of operations’.

Many of HBL’s decisions do not appear to put investor interest upfront. If not anything else, the lack of transparency is evident in many instances. For example, in 1995, HBL made a firm allotment of 90,79,930 shares to Jarrington Pte Ltd (JPL), Singapore. HBL had justified the firm allotment claiming that JPL would contribute materially to the bank’s business efforts in the Far East markets particularly on the deposit mobilization and trade services front.

But, at the end of fiscal 2000, the bank’s global NRI deposits stood at only Rs 332 cr (that is a paltry 4 per cent of its total deposits). Not only had JPL failed to procure the much promised business for the bank but appeared to have, very significantly, sold its holding. For, JPL does not find a mention (as it ought to have if it had held its nearly 4 per cent stake) in the list of principal shareholders featured in the ADS document. Indeed, if JPL had exited the bank, it must have made a phenomenal profit on its original investment.

Also, HBL had made a firm allotment of 4 crore shares at par to Nat West Markets, who were to provide technical assistance in relation to HBL’s banking business. In successive annual reports till fiscal 1998, the investment by Nat West was classified as the holding of ‘strategic alliance partner’.

In fiscal 1999, Nat West decided to exit India and HBL decided to replace Nat West with Chase Manhattan Bank which acquired about 15 per cent stake in HBL.

Significantly, neither the Nat West group in the beginning nor the Chase group seem to have contributed to the betterment of HBL in any worthwhile manner. Even the ADS document has been conspicuously silent on the role/association of the Chase group with the bank. There is no evidence to suggest that the bank could not have achieved its present position in the Industry without the association with Nat West/Chase.

The least the bank’s promoters could have done in 1999 was to buyback the holding of Nat West instead of letting Chase in with a chance to make easy profits without a matching contribution.
Easy money Chase appears to have made when it reportedly sold some 40 lakh shares in HBL at around Rs 250 a share, thereby making a cool profit of Rs 60 crore.

Another questionable decision of HBL’s management is the takeover of Times Bank (TB). If HBL’s idea was to add critical mass to its operations, it could have targeted small to medium-sized well-run private sector banks, which would have complemented its business model. TB had many negatives going for it at the time of its IPO in July 1999. Post-merger, HBL blames TB for the increasing incidence of NPAs.

HBL’s ADS offer document categorically states: “After acquiring TB in February 2000, our gross NP loans increased by 150.4 per cent while our total loan portfolio increased by 54.7 per cent.”

It goes on to say that out of its ten largest NP loans, five were originally made by TB!

In the ultimate analysis, the merger has benefited the promoters of TB more than anyone else. Indeed, looking at the speed with which the merger was carried through - TB made its IPO in July 1999, its shares were listed in September 1999 and the merger was announced in November 1999 - it appears that the decision to merge the two banks had been taken even before TB’s IPO!

Another factor that is shrouded in mystery is the quantum of holding of the Bennett Coleman (BC) group in HBL. Based on its Rs 100 crore holding out of Rs 135 crore equity of TB and considering an exchange ratio of 1 share of HBL for every 5.75 shares of TB, BC grup should have been allotted 1,73,91,304 shares in HBL.

But as per the ADS document, BC group is said to hold 2,05,82,404 shares in the bank. How was this possible?

Also, how come a group which is holding a sizeable chunk of shares in the bank is giving an award to the bank? Is the share price not influenced by such awards which are highly subjective?

And, if the share price goes up on the award-hype, who would be the ultimate major beneficiary? If a part-owner can award the bank and indirectly enhance his net worth, what corporate governance are we talking about?

The bank has few more questions to answer. How can the bank permit its full time employees to promote a company and use it to provide services to the bank itself? Does the bank think that there is no conflict of interest in the above arrangement? Is the Reserve Bank of India aware of this arrangement?

To sum up, some of HBL’s business decisions are shrouded in a thick film of unexplained secrecy. It is unfortunate that a bank, which prefers to call itself professional, forward-looking and progressive, fails to appreciate that its business decisions must not only be above board but seen to be transparent by all classes of investors.

(Arranged by Investar - The Aarthik News & Research Group) feedback@ investaronline.com.