Robust loan growth coupled with healthy asset quality
Over the last ten years, total deposits with HDFC Bank (“HDFC” or the “Company“) have grown at a CAGR of 27.13 %. For the same period profit after tax grew at a CAGR of ~ 30 %. For financial year 2013, HDFC reported a healthy 20.08 % loan growth (compared to 18.28 % for financial year 2012) despite sluggish economy and lower loan off-take in both wholesale and retail segments. The chart below shows growth in the total deposits for HDFC over the last 10 year period.
The asset quality for HDFC is the healthiest in the industry. Gross Non-Performing Assets (“GNPAs”) at the end of financial year 2013 stood at 0.95 % of gross advances, and Net Non-Performing Assets (“NNPAs”) came at just 0.20 % of customer assets. Over the last few years, there have been many challenges with respect to NPAs for the indian banking system due to bad economic and business environment.
Despite this, HDFC has been able to pick up the right quality of assets. As the chart below indicates, HDFC fared far better on the asset quality front in comparison to its peer group. This healthy asset quality has been achieved primarily due to a combination of strong risk management practices and nominal exposure to the troubled sectors like aviation, infrastructure and textile.
Consistently high Net Interest Margins (“NIMs”); Market leader in mobilising CASA deposits
For financial year 2013, HDFC reported a healthy 22.7 % jump in its net interest income over the previous year despite worsening economic conditions for most part of the year.
Net interest margin for financial year 2013 stood at 4.47 % compared to 4.22 % for financial year 2012 and 4.25 % for financial year 2011. We believe that in the next few quarters HDFC will continue to enjoy this advantage of having wide spread on its interest income given its large low cost deposit base coming from its CASA accounts.
HDFC is the market leader in mobilising CASA (current account and savings accounts) deposits. Interest rate paid on CASA deposits is much lower compared to other deposits like term deposits or recurring deposits. While banks do not pay any interest on current account, interest paid on savings account deposit is set by RBI at 4%. Banks therefore make maximum effort to increase the share of CASA on their books to reduce their overall cost of deposits and increase their Net Interest Margins (NIMs).
At the end of FY 2013, 47.4% of total deposits with HDFC were in the form of low cost CASA deposits which has helped it in maintaining a high rate of NIMs and strong profitability numbers. With a high proportion of its deposits coming from retail customers, HDFC is likely to continue to enjoy this advantage of high CASA ratio for many quarters. The Net Interest Margin (‘NIM”) for HDFC stood at 4.47 % for FY 2013 (4.22 % for FY 2012); substantially higher than its peer group while Non-Performing Assets (“NPAs) stood at 0.20% which is substantially lower than its peer group.
Growth from non-funded revenue stream
Non-funded revenue (i.e. other income) largely constitutes of fee income such as commission and brokerage fees and client based merchant foreign exchange trade, service charges from account maintenance, transaction banking (including cash management services), syndication and placement fees, processing fees from loans and commission on non-funded products (such as letters of credit and bank guarantees) etc. Growth in other income or non-funded revenue is good for the bottom line (i.e. net profit) as income from this stream is derived without significant mobilisation of deposits and hence the cost associated with this income is relatively lower compared to interest income. Banks in developed countries derive nearly 50% of their income from these non-funded sources.
For financial year 2013, ~ 30% of HDFC’s operating revenue came from non-funded segments such as fees and commissions for services. In percentage terms HDFC earns a lower portion of its net income from nun-funded revenue stream but we consider the non-funded revenue of ~30% extremely healthy for a bank with NIM of 4.5%.
Increasing cost of funds and high Inflation
Over the last few quarters, Indian banking sector as a whole has suffered from lower availability of loanable funds as R.B.I. has kept the interest rates high in order to control inflation. The inflation rate is still on the higher side. For April 2013, inflation was recorded at 4.69 %. RBI is likely to continue with its tight monetary policy and is unlikely to cut policy rates unless it is sure that inflation is under control. There are signs of improvement in the rate of inflation over the last 12-18 months. We expect tight monetary policy to continue until inflation is under control. At the same time R.B.I. has mandated that all banks pay a minimum of 4% interest rate on all savings accounts. This has increased the cost of funds and kept margins under pressure.
Unless inflation comes under control and R.B.I. cuts policy rates the cost of funds will continue to remain high creating margin pressures which could have a negative impact on the financial performance of HDFC.
Intense competition, threat of new entrants and stringent capital requirements as per Basel III
Many of the services that were traditionally performed by the banks are now being performed by other players such as depositories, NBFCs and brokerage houses which have intensified competition in the indian banking industry. Additionally, R.B.I. has released the new Banking License Guidelines for NBFCs and will sooner or later award new banking licenses which will create even more competition. Additionally, development of technology has resulted in availability of multiple delivery channels for customers such as ATMs and phone and internet banking. As technology develops further, some of the advantage enjoyed by larger banks such as HDFC such as a large branch network could become a drain on the revenue stream.
The Basel Committee on Banking Supervision has finalised the Basel III framework which will begin to take effect from the beginning of 2013 and will be progressively phased in by 2019. The main goal of the new framework is to make the banking sector more resilient in times of economic slowdowns. The Basel III framework sets out requirements for higher and better-quality capital and better risk coverage especially related to capital markets activities. For example, the longstanding 8.0 % minimum total capital requirement (as per Basel II norms) will increase to 10.5 %, including 2.5 % “capital conservation buffer” to be used in periods of economic stress. Further, the new norms introduce a 3% minimum leverage ratio of Tier 1 capital to total assets and two new global liquidity standards (viz. Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio) to be formally introduced from 2015 and 2018 respectively, after an initial observation period.
These new regulations would not only require the banks to maintain more stringent liquidity measures, but will also pose integration challenges for the banking sector. In August 2012, R.B.I. Governor D. Subbarao stated that “the country’s banking sector may need an additional capital of Rs. 1.60-1.75 lakh crore by March, 2018, to conform to the Basel III norms”.