HDFC Bank Ltd: Analysis

Background: HDFC Bank Ltd (NSE: HDFCBANK; BSE: 500180) is the largest private sector bank in terms of advances as well as deposits. The bank has presence in both segments viz. wholesale segment (commercial and transactional banking) and retail (branch banking) offering all major products business loans, vehicle loans, personal loans as well as credit cards. It was identified as Domestic Systemically Important Bank (apart from SBI & ICICI) by RBI in 2017.

Strong player in banking space: Not only the bank boasts of its strong market position with balance sheet of INR 16.54 lac cr (as on December 31, 2020), it is well-diversified with 48:52 mix of retail and wholesale loans. Loan book at the end of Q3FY21 (refers to period from April 01 to December 31) has growth consistently over the years and stood at INR 10.82 lac cr with low NPAs of INR 1.38%, showing high quality of the loan book. Nevertheless, the bank is adequately capitalized for any unforeseen losses with Capital Adequacy Ratio (CAR) and Tier-I CAR were 18.9% & 17.5% respectively.

Robust and consistent growth in loan book: The Bank has been aggressive in its expansion strategy with shifting focus on corporate segment where disbursements had actually dried up since ILFS fiasco in 2018. The total loans grew by 24% in FY19 and 21% in FY20; stood at INR 10.82 lac cr as on Dec 31, 2020, clocking YoY growth of 15.6%. As seen in below chart, the growth is largely backed by strong rise in wholesale loans (consistently more than retail).

The bank has been a strong player in the corporate segment with more than 20% growth in last three fiscals. However, the growth has not been at the cost of asset quality. The bank’s barometer to measure that i.e. average internal rating stood at 4.4 (scale of 1-10) for the corporate book as on Dec 31, 2020 which is equivalent to ‘AA’ rating by credit rating agencies.

Disbursements for the retail segment during the quarter had crossed pre-Covid levels with 20% yoy growth, meaning that the business is gaining traction for micro/small businesses. The bank’s retail book has mainly constituted of personal, auto & home loans. Interestingly, comparing the bank retail book from Mar-2020 to Dec-2020, it can be noticed that auto loans have been cut by 3.5% while home loans have grown by 5%. This further boosts the quality of loan book as houses fare better collaterals than vehicles.

Over the years, the bank has been focusing on augmenting the corporate loan book and the efforts have yielded results. The loan mix which was skewed towards retail book is now balanced.

Income: The bank has reported consistent growth in income figures during last 10 years. In fact, it has achieved at whopping 22% CAGR in operating revenue during 2010-20. In Q3FY21, the bank saw growth 15.1% growth in Net Interest Income (NII). It is difference between interest earned on loans & interest paid on borrowings/deposts; the two most important figures impacting profitability of a bank. Bank’s Net Interest Margin (NIM), measures how much spread a bank makes on a rupee lend, has remained stable at 4.2%. 

Apart from interest, a bank also earns fee-based income from writing loans, distributing 3rd party products (like insurance), commissions, treasury gains, income from investments, etc.

Deposits: These are one of the cheapest sources of money for the bank; classified into current, saving and time deposits. Of these current and savings account (commonly known as CASA) balances are most crucial for a bank as these come at lowest costs. So for a bank, higher the CASA, the lower is cost of funding. HDFC Bank has been able to maintain its CASA at 42-43% consistently. CASA grew at 30% in Q3FY21; highest in last 5 quarters.

Adequate capitalization: RBI stipulates a minimum capitalization which all banks have to maintain to provide for in case of any unforeseen increase in bad loans. Capital Adequacy Ratio measures this which is ratio of capital to risk weighted assets. Against requirement of 11.075%, bank’s CAR stood at 19.1%. Bank’s CAR for Tier-1 capital was 17% (minimum requirement: 7.575%). Being identified as a Domestic Systemically Important Bank (D-SIB), it has to maintain additional 0.20% CAR.

Robust book quality: Growth in business is tough, quality growth in even more. And the best parameter to evaluate a bank’s book quality is NPA. The bank has been able to manage the GNPA% (of advances) at less than 1.4% and NNPA% at 0.4% levels during FY18-20. In Q3FY21, the GNPA% reduced noticeably to 0.8% and NNPA% to 0.1%. Compare this with GNPA% of HDFC Bank’s peers such as SBI 4.77%, ICICI Bank at 4.38%, Axis Bank at 3.44%. Though, the low figures for Q3 were also owing to directive by Honorable Supreme Court that those accounts that had not been declared NPA till August 31, 2020 should not be declared as NPA until further orders. However, the bank has been monitoring the actual NPA levels as per their assessment model, the GNPA% (proforma) will be 1.37%.

The bank is an ideal stock in one’s portfolio with professional management team, jaw-dropping income growth, balanced segmental loan book, lowest NPA levels and huge size.

Analysing Banking Stocks

Banks are institutions which are part of our daily lives. We have been witnessing growth in the size of the industry (many new players have entered in the past 10 years) and quality of services (more branches, better cust0mer dealings, internet banking & plastic money, improved loan and deposit products). In a sense, we have known how the industry has moved from a typical sarkari sector to a globally competitive playfield.

In this article, let us just look a bit deeper to how banking sector can be used for investment, by way of stocks.  Many schedules banks are listed in India which makes it easier for us to compare their performance and know about the industry features. To begin with the analysis, it is convenient to understand the income & expenditure concepts and key ratios of banks.

CASA (Current Account Savings Account): People & institutions place money (Deposit) with a bank for a certain period and/or earn interest/avail services. Deposits can be Demand Deposits, Savings Bank Deposit & Term Deposit. Out of the total deposits that customers have kept with the bank, savings accounts cost just 3.5% to and current accounts are charged to the customers for services provided by the bank, whereas the term deposits (FD, RD, etc.) cost higher. Funds from any type of deposit are lent by bank at much higher rate. Therefore, the bank which has higher proportion of savings & current accounts money out of the total deposits is in a more profitable position from the one whose deposits consist more of term deposits. Industry measures this feature of a bank as CASA Ratio i.e. amount of savings and current accounts as a percentage of total deposits held with the bank.

NPAs (Non-Performing Assets): Banks lend to earn interest. Lending by banks is governed by regulations of RBI & its own lending policy mainly. Banks are required to do thorough due diligence before accepting the lending proposal. NPAs are such advances of a bank which have ceased to provide income to the bank. RBI stipulates a period of 90 days for identification of NPAs. NPAs could either become good entirely or partially or may result in 100% loss to the bank. Provisions are created as per RBI guidelines for NPAs. The lower the quantum of NPAs, the better.

NIM (Net Interest Margin): This is the ratio of net interest earned (Interest earned – Interest paid) by the bank as a % of interest-earning assets i.e. advances. The ratio helps us in assessing the efficiency of the bank. More NIM, better.

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Many other ratios like ROI, ROA, ROE, operating margins, etc. can’t be ignored.

Honestly, I haven’t seen banks moving up and down according to their fundamentals. Also there is no guarantee that stocks bought based on such analysis will yield green figures in your portfolio statement.  But when we are in the market to buy shares without exactly knowing which stocks will be profitable, isn’t better to buy shares with strong fundamentals. SBI being the largest bank of India by assets. This feature of SBI is enough to make it a strong stock. Now even if an investor is having a long position in SBI at a price much higher than the prevailing market price, he can be reasonable assured that he has his money in a safe bet.

Inflation, Monetary Policy & Investor

During last few months we all have seen lot of movements in the money market & also in the share market. A hike in CRR or REPO rate brought a lot of volatality in the markets. There is a sharp rise in the inflation rate which, as some say, made the FM bring structural changes in the budget because inflation in our India is not only a economic but a political subject too. No one knows where will it all land. But knowing the basics of these terms would enable us to decide our future course of action.

INFLATION: General rise in prices measured against a standard level of purchasing power.
Simply put it is the percentage of our current price that we will have to pay on the current price in order to buy a commodity after a particular period. For e.g. if price of an item is Rs 100 today & inflation rate is say 6%, then we will have to shed Rs 6 apart from the basic price of Rs 100.
Inflation is measured by comparing two sets of goods at different points of time & computing the increase in cost not affected by increase in quality and qauntity. For e.g. if cost of one two-litre Pepsi is Rs 50 as against the price 3 months before which was Rs 45 for 1.5 litre, then we will have to make adjustment for contents.

It is measured through various indices like Wholesale Price Index (WPI) or Consumer Price Index (CPI). Usually inflation shown by an index is different from inflation bear by an individual. It is because index covers several items which are given different weights & so the change in prices of these items is depicted by the index and the spending of a household will not be done in the same pattern (as of the index). Also the Education Cess is not considered by the index.
A rise in inflation rate raises the cost of production for the business people & cost of living for the common man. Corporates pass their burden of inflation on the latter by raising the prices of commodities. As far as we as ultimate consumers are concerned, we should plan our expenditure accordingly & also keep inflation in mind while making investments. It can be explained as follows. We should make our budget of household expenditure keeping in mind the average rate of inflation i.e. a reserve for it should be maintained to bear the rising prices.
As regards the investments, we have to put in our money in such places which can earn a good return over & above the inflation rate (called real rate of return). For e.g. if we invest Rs 10,000 in a Fixed Deposit at 8% p.a. & inflation rate is 5%, then we don’t get a return of Rs 800 but after providing for inflation we left with just Rs 300 i.e. a real return of 3%.
MONETARY POLICY: Policy of the Central Bank (Reserve Bank of India, in India) through which it keeps the supply of money in control thereby constraining inflation or deflation, maintaining an exchange rate, achieving full employment or economic growth.
Tools of Monetary Policy:-

$ Bank Rate: It is the rate at which RBI lends money to banks.
Increase in this raises the cost of funds obtained by banks from RBI & vice-versa, the burden of which is in-turn passed on to the consumer.

$ REPO (Repurchase Option) & REVERSE REPO Rates are the main players here. Former is the rate at which RBI lends money to banks against government securities & infuses liquidity into the system. Reverse Repo is the rate at which RBI sucks excess money supply from the system by selling government securities to banks. Recently RBI hiked the rates which positions them at REPO:7.5% & Rev Repo at 6%.
If REPO rate is hiked then it means that now banks will have to incur more cost to obtain funds from Central Bank & so they increase their PRIME LENDING RATE (PLR), this results in increase in the rate at which the bank lends money to consumers.
On the other hand if REVERSE REPO rate is hiked then it reduces the overall liquidity available for lending to borrowers as banks may find it more attractive to lend to RBI. As a result the lending rate of banks to consumers may rise as now they would expect a rate of interest above the REPO rate to forgo RBI i.e. opportunity cost is increased.

$ Cash Reverse Ratio (CRR): It is the percentage of deposits which banks are required to keep with RBI under RBI Act. This serves dual purpose – (1) RBI gets control over lending capacity of Banks (2) a portion of deposits of public is secured with RBI.
A increase in the CRR produces similar effect as is observed on hike in REPO rate. In such a situation, banks have to keep more funds with RBI & the balance loanble funds are chased by same number of borrower. This raises the interest rates of banks. But some analysts believe that a hike in CRR does not bring an immediate impact on interest rates as the demand for loans by consumers may not pick up along with a hike in CRR & banks may still witness surplus liquidity for a temporary period.

$ Statutory Liquidity Ratio (SLR) is the statutory reserve that is set aside by banks for investment in cash, gold or unencumbered approved securities valued at a price not exceeding the current market price. SLR should not be less than 25% and not exceeding 40%. Currently it is at 25%.
A rise in SLR has the same affect as CRR i.e. it reduces the funds at disposal of banks & brings a halt on rising liquidity.. As a result banks raise their lending rates to maintain their margins.

Usually it is seen that a hike in CRR %, SLR or REPO rate brings a sharp decline in the prices of bank stocks. The main reason as it seems is fear in profitabilty of banking companies due to higher costs of borrowing from RBI or their ploying of funds into less profitable investments (government securities). So any news of RBI changing the aforesaid tools shall warn us for a market reaction.

Apart from the above repurcussions, a rise in the interest rates forces some changes in the market some of which can be enumerated as follows:-
Increased interest rates affect the whole economy as it brings a rise in prices of commodities which pulls the demand down.

Direct result of rising rates is beared by corporates who now face additional financial costs. A hike in interest rates brings cost of bonds down.
The prices of stocks falls as now the investors expect a greator return from the market as compared to the yield generated by bonds as seen above.
Though the sudden fall in stock market as a whole or financial sector in particular may give us chill bites but they also bring an opportunity for the investors to enter the market at low prices (if only the companies are fundamentally strong).


Conclusion: After the above analysis we can say that Rates – inflation & Interest both – have a direct bearing on an investor’s decision. Though the market may not always behave in the aforesaid fashion but for conservative investors these are warning signals.