HDFC Bank, India’s top private sector bank, fell 9 percent on Wednesday and continued its fall on Thursday, wiping out over Rs 1 lakh crore from its market capitalisation, amid mayhem in the broader markets.
The fall was on the back of disappointing results by the bank, which showed slow pace of growth and net interest margin concerns that spooked investors.
But why are investors spooked despite the growth numbers and is the merger with HDFC a reason for the drop?
Following its second earnings report post-merger with parent HDFC, HDFC Bank experienced an increase in its loan-to-deposit ratio (LDR), reaching a tight 110%. This marks a significant rise from its pre-merger LDR, which ranged between 85-89%. The Reserve Bank of India (RBI) generally considers LDRs between 70-75% as comfortable for banks. With its current LDR, HDFC Bank holds the highest ratio among India’s private banks, causing concerns in the market.
Analysts and investors fear that elevated levels of credit/deposit (CD) ratio, beyond the RBI’s comfort range, could lead to potential challenges. There are apprehensions that this situation might force banks, including HDFC Bank, into margin pressure if they aggressively mobilise deposits. Alternatively, a slowdown in lending growth could be observed, or a combination of both scenarios. Such developments might result in a de-rating of the banking sector.
To address the elevated LDR, analysts suggest that HDFC Bank needs to grow its deposit growth rate at a rate 3-4% higher than its credit growth. In the third quarter, the bank reported gross loan growth of 4.9% sequentially, while deposits grew at a more modest 1.9%. Management indicated plans to restore the balance, but the timeline for this adjustment is anticipated to be 3-4 years.
The bank’s strategy includes replacing non-retail deposits with retail ones to granularize the deposit base and avoid intense price competition in the non-retail space. Despite a recent crackdown by the RBI, HDFC Bank plans to grow its unsecured loans in the high-teens range, constituting 22% of its loan book post-merger. However, the pursuit of this growth without a rapid increase in deposit growth may exert pressure on net interest margins (NIMs), which remained flat for the quarter.
Challenges such as lower liquidity coverage ratio (LCR), a bottleneck in credit deposit ratio (CDR), and slower deposit growth could potentially limit NIM expansion going forward. The reported NIMs of 3.6% for interest-earning assets came in below expectations, and the lower LCR and slower deposit growth may contribute to further compression in NIMs.
Analysts keep faith
However, experts say that key player in the Indian banking sector is navigating a phase of market consolidation. The broader market has experienced a bullish trend for the past 10 months, supported by robust fundamentals in the Indian economy and corporate sector. The positive outlook is further fueled by the reduction of major macro and political risks, contributing to sustained rich valuations.
Despite concerns from some quarters, HDFC Bank remains positioned as one of the healthiest banks with a low level of non-performing assets (NPAs). The recent merger has bolstered its size to compete with global majors, and analysts anticipate synergy benefits to unfold over time. The bank’s growth prospects are underlined by an aggressive branch expansion strategy and a gradual shift in market share from public sector to private sector banks.
Notably, not all market participants share a bearish sentiment on HDFC Bank. Global brokerage firm CLSA and Axis Securities have increased their target prices, expressing confidence in the bank’s potential. Fund manager Saurabh Mukherjea goes so far as to describe the current valuations as “mouth-watering levels.”
HDFC Bank Results
While HDFC Bank’s recent quarterly results saw a dip in shares, the 34% year-on-year jump in net profit, reaching Rs 16,372.54 crore, exceeded street expectations. The bank’s deposit growth, though modest at 1.9% quarter-on-quarter, is seen as incrementally positive. Concerns about the impact of the reverse merger with parent entity HDFC Ltd have led to institutional selloff, but some experts believe institutional appetite will return as the company stabilises.
Analysts at Kotak Institutional Equities note that the valuations are attractive, although they suggest the bank needs more time to deliver best-in-class return ratios. The recent regulatory change by the Reserve Bank of India (RBI) regarding investments in Alternative Investment Funds (AIFs) has prompted HDFC Bank to make a 100% provision for its AIFs.
On the technology front, HDFC Bank acknowledges past challenges but is actively working on revamping its net and mobile banking services in-house, aiming to introduce enhanced platforms in the next two quarters.
While facing headwinds such as the recent increase in risk weight on unsecured consumer loans by the RBI, HDFC Bank remains a prominent player with a solid financial foundation. The bank’s strategic moves, growth prospects, and ongoing efforts to adapt to digital trends position it as a key contender in the dynamic banking landscape.
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