HDFC Bank Strong Fundamentals stay amidst uncertainty Stock Update Stock

HDFC Bank posted a decent earnings show for Q4FY2020 with strong Sector: Banks & Finance operational growth (healthy advances growth) and fall in GNPAs. For the Result Update quarter, NII rose by 29.2% y-o-y driven by a 21.3% growth in advances and deposits growth of 24.3% y-o-y. Net interest margin (NIM) for the quarter was up by 10 bps q-o-q to 4.3% helped by lower cost of funds and recoveries. Change Total provisions for Q4 included credit reserves (contingent provision for Reco: Buy COVID-19) of Rs. 1,550 crore. The bank holds floating provisions of Rs 1,451  crore and contingent provisions of Rs. 2,996 crore (total 45 bps of advances) CMP: Rs. 910 and the management indicated that the provisions held were sufficient in their assessment for COVID-19 related stress. The core credit cost ratio at 0.77% (was Price Target: Rs. 1,400 â 0.92% in Q3 FY20; 0.69% in Q4 FY19) was helped by regulatory forbearance. Asset quality wise, the bank is fairly well-placed with average rating of its á Upgrade  No change â Downgrade wholesale loans above investment grade. As per the bank’s stress assessment, while ~9% of their SME loans may be vulnerable, it may result in a ~0.5% higher than usual delinquency run-rate, which appears manageable. Company details Operating performance was in line with estimates, but higher provision cost Market cap: Rs. 4,99,198 cr resulted in a PAT growth of 17.7% (as against our estimates of a 22% y-o-y growth). The bank has finalised three candidates for the position of the MD & 52-week high/low: Rs. 1304/739 CEO (to succeed Mr Aditya Puri who retires in October 2020). Going forward, we expect segments such as agri, rural and SME and some segments of NSE volume: (No of unsecured loans to face challenges on the credit cost front. Moreover, we 78.9 lakh expect slower credit growth for H1FY21E may also impact profitability due to shares) lower fee income, etc. We believe that the medium term may be uncertain for the banking sector, including HDFC Bank as implications of the COVID-19 are BSE code: 500180 still in progress. However, HDFC Bank’s business quality and franchise strength will help it tide over near-term challenges. We have fine-tuned our estimates NSE code: HDFCBANK and target multiples for the bank factoring in lower growth and the economic impact of the lockdown. We retain our Buy rating on the stock with revised price Sharekhan code: HDFCBANK target (PT) of Rs. 1,400. Key positives Free float: (No of 431.9 cr shares) Š Net interest margin (NIM) rose by 10 bps q-o-q to 4.3% helped by a lower cost of funds and recoveries. Š Healthy fee income growth of 27.5% y-o-y despite the lockdown impacted Shareholding (%) volumes and collection. The lockdown resulted in /other income coming lower by Rs 450 crore. Promoters 26.1 Key negatives Š Slippage ratio would have been higher by 40 bps if the moratorium due to FII 36.7 COVID-19 impact was not taken into consideration Our Call DII 21.8 Valuation: HDFC Bank currently trades at a reasonable 2.6x FY2021E and 2.3x its FY2022E book value per share (BVPS). Due to market weakness, the price has Others 15.4 corrected significantly and at present, the stock is available at below its long term average 1-yr forward PBV multiple of 3.7x. HDFC Bank consistency is buoyed by its strong underwriting capability and risk measurement standards and thus we expect it to recover faster once business environment normalises. We opine that Price chart any further weakness in the stock could be an opportunity for investors to add it 1400 to their long-term portfolio. We have fine-tuned our estimates and target multiples for the bank, factoring in lower growth and the economic impact of the lockdown. 1200 We retain our Buy rating on the stock with revised price target (PT) of Rs. 1,400. 1000 Key Risks 800 A rise in NPAs in unsecured and other retail segments can pose risks to profitability. 600 19 19 20 19 - - - - Valuation Rs cr Apr Apr Dec Aug Particulars FY18 FY19 FY20 FY21E FY22E Net interest income 40,095 48,243 56,186 69,271 80,787 Price performance Net profit 17,487 21,070 26,257 30,955 40,245 (%) 1m 3m 6m 12m EPS (Rs) 33.7 38.7 48.0 56.6 73.6 PE (x) 27.0 23.5 19.0 16.1 12.4 Absolute 1.6 -27.5 -26.5 -19.7 Book value (Rs/share) 204.8 272.3 310.9 348.4 403.6 P/BV (x) 4.4 3.3 2.9 2.6 2.3 Relative to -7.8 -2.8 -6.9 -0.4 RoE (%) 17.9 16.5 16.4 17.1 19.5 Sensex RoA (%) 1.8 1.8 1.9 1.9 2.1 Sharekhan Research, Bloomberg Source: Company; Sharekhan estimates

April 17, 2020 2 Stock Update Stock

Concall Key Highlights Š Operational comments due to lockdown: Most employees are working from home. New paradigm in operational parameters, two-factor authentication, etc. Around 95% of branches and ATMs are operational too. While productivity has improved in the wholesale segment, other segments are still evolving. The client engagement is maintained at same levels. The wholesale business is now completely working on a work-from-home (WFH) model and is able to maintain TAT in disbursal and client management. Š Anywhere working model developed: Capability development model, which Includes customer safety is making 200,000 customer engagements daily. Š Balance Sheet strength: HDFC Bank is well placed to gain market share. Its Liquidity Coverage Ratio (LCR) indicates strong liquidity and the bank focuses on deposits and bringing in new customers. Average credit-deposit (C/D) ratio is at 78%, while the CRAR is at 18.5% and CET-1 at 16.4% (over the 7.5% regulatory minimum). Maintains Rs 4447 crore of Provision buffer. Have Rs. 50,000 crore is the surplus liquidity, and deposit growth are outpacing the advances growth Š Steps in tightening of credit which is why seeing a higher rejection ratio Š Net Interest Margins: NIMs stable at 4.1-4.5% range, now at 4.3%. Building on deposit to maintain liquidity. Excess liquidity impacts current NIMs by 10 bps, offset by some trading income. Š Fee income impact: The lockdown saw impact on loan origination, third-party products sales, collections etc, waiving off certain fees all of which impacted the fee income growth during Q4FY2020. This should normalise in due time. Of the fees income, 93% of fee income arose from the retail segment, while the rest was from the wholesale segment. Š Credit card spends dropped by 35% in the second half of Q4. Š Network additions: Added 313/74 banking outlets during FY20/Q4. Around 250 branches are getting ready to be functional shortly. Š Credit cost: Annualized core slippage ratio has been lower by 40 bps, GNPA by 10 bps NNPA by 6 bps due to the moratorium benefit. Specific limited liability provision (LLP) Rs. 1,918 crore in Q4FY20 as against Rs1,430 crore in Q4FY19. PCR is at 72%. There are no technical write-offs. Core credit cost, specific loan loss was 77 bps (92 bps in Q3 FY20, 69 BOPS in Q4 FY19). Total credit cost for quarter was 151 bps ( 129 bps for Q3 FY20, 92 bps for Q4 FY19) Š HDFC Bank has a great distribution network, de-risked the balance sheet. S&P has re-affirmed the bank’s rating, two notches above Sovereign grade. Š The bank is not chasing growth as it has a great distribution platform for SME, wholesale, retail, segments, etc. Large part of growth come from wholesale, retail has been muted and would be tepid in the coming quarters. Š Corp baking: Bank has refocused on business have strong liquidity (government business, access to strong parents, etc). Over 92% of incremental loans are to clients from top 30% of the rating scale, rest are to clients who are lower rated but have a higher-rated parent backing, etc. Over 80% disbursement was for assets with <1yr maturity. Š SME loans have granularity (2/3rd of SME loans have a ticket size of less than Rs. 1 crore), also Geography spread, strong own contribution by promoters are comfort factors. Š Wholesale may see market share gains: The bank continues to benefit from flight to safety, so growth will better industry. The bank expects several large corporates to become clients, as they will likely choose to conserve cash and approach HDFC Bank for funding. Corporate loans form 75% of book to clients with an ‘AA’ and above rating.

April 17, 2020 3 Stock Update Stock

Š Retail portfolio: o Delinquency levels will be 40-60% of credit risk below market. Even in the low CIBIL band, the bank has 30% less delinquency compared to market. o Even self-employed borrowers are of better with lower risk as compared to the market. Sourced from Bureaus form very a small proportion of the loan disbursed. o Lending is based on score card system, Geography spread, etc which provides a “Composite score called “P27” of the borrower. This has performed 2.5-3x better than other tools for screening in the market and has been in use for well over a year. o 10-second loans: The bank is still extending these loans. However, the selection criteria has been tightened, to reduce risk of default. o Not only ~80% loans are to salaried employees, of which 67% are to employees from strong entities. The remainder is also strong with ~0.09% delinquencies. This is achieved by strong risk management and client filters. o Regarding credit growth, assuming zero efficiency in April, smaller in May and in June, the bank has done enough provisioning for events as per their risk assessment. Š Self-employed segment: Admit there will be greater impact from Covid-19. However, HDFC Bank’s entry point is to higher quality. Level of delinquency is largely similar to the regular business. Š Internal rating system (1 safest and 10 being riskiest): Worst rated acceptable is HDB-7, which is roughly equivalent of an A rating as per rating agencies). Hence the investment grade has been fairly high. Weighted average rating of the overall book is March 2019 was HDB 4.6, December had a rating of HDB 4.56 and March 2020 stood at HDB 4.43. Š SME segment: The bank is looking at self funding (liquid assets held by borrowers / promoters and families in HDFC Bank). This is not collateral, but indicates their liquidity. Currently, the bank sees a mid- level scenario which can see ~9% slippage on the SME portfolio, if moratorium and other relief measures. However, while in the SME segment ~9% of book is vulnerable, it is high risk without a moratorium, etc. However, the bank expects the segment to slip by ~0.5% more than the usual run-rate of the delinquencies from SME. Š Clients opting for moratorium: Only low-single digit customers have opted for the moratorium. Around 95-98% of customers who had applied for a moratorium were not in default, but the moratorium was taken out of caution rather than stress. Š Credit tightening: The bank has been already doing credit tightening for every product and offering since 12 months earlier, so entered the lockdown with fairly good quality book. The products thresholds are being filtered further. Š Have floating provision and contingent provision buffer which will help cushion the provision requirement of the future. Š HDB Financial: The subsidiary saw its AUM growth of a modest 6% y-o-y. They also created contingent provision, but amount was not shared. HDB’s results were released before the RBI gave the moratorium benefit to NBFCs. HDB has given an Opt-out of the moratorium to their clients. This is because their client rating is two notches below that of HDFC Bank. Š CoD has come down by 15-20 bps. The bank has already cut savings deposit rate by 25 bps. Š HDFC Bank expects in Medium to long term the C/I will reduce. The bank is exploring options for increasing WFH. Š Expecting tepid topline in the medium term due to slower retail growth. Š Q4 slippage ratio is benign due to the April 17 circular, without which slippages would have been higher by 40 bps (annualized). There were Rs. 3150 crore of slippages in Q4FY2020. Š Rural and Agri: Agri NPAs may be high as Kharif crop and problems of lockdown may impact farmer’s readiness to repay moratorium etc outstanding. MFI exposure is at Rs. 8500 crore April 17, 2020 4 Stock Update Stock

Results Rs cr Particulars Q4FY20 Q4FY19 y-o-y % Q3FY20 QoQ % Interest income 29,885.1 26,333.3 13.5 29,369.7 1.8 Interest expense 14,681.7 13,243.8 10.9 15,196.8 -3.4 Net interest income 15,203.4 13,089.5 16.1 14,172.9 7.3 Non-interest income 6,032.6 4,871.2 23.8 6,669.0 -9.5 Net total income 21,236.0 17,960.7 18.2 20,841.9 1.9 Operating expenses 8,277.8 7,117.1 16.3 7,896.8 4.8 Pre-provisioning profit 12,958.2 10,843.6 19.5 12,945.1 0.1 Provisions 3,784.5 1,889.2 100.3 3,043.0 24.4 Profit before tax 9,173.7 8,954.4 2.4 9,902.1 -7.4 Tax 2,246.6 3,069.3 -26.8 2,485.4 -9.6 Profit after tax 6,927.0 5,885.1 17.7 7,416.8 -6.6 Asset Quality Gross NPAs 12,650.0 11,224.2 12.7 13,427.3 -5.8 -Gross NPA (%) 1.3 1.4 -10 bps 1.4 -16 bps Net NPAs 3,542.4 3,214.5 10.2 4,468.4 -20.7 -Net NPA (%) 0.4 0.4 -3 bps 0.5 -12 bps Key reported ratios (%) NIM (%) 4.3 4.4 -10 bps 4.2 10 bps CASA (%) 42.0 42.4 -40 bps 39.5 150 bps Source: Company; Sharekhan Research

April 17, 2020 5 Stock Update Stock

Outlook We believe that structural drivers are well in place for HDFC Bank, helping it gain market share, aided by operational efficiencies and best-in-class asset quality. The bank has already finalized three candidates, for the position of the MD & CEO (to succeed Mr Aditya Puri whose term ends in October 2020). Business disruption has resulted in cost-to-income (C/I) ratio of 39%, which the bank expects to ease in the medium term. Going forward, we expect segments like Agri, Rural and SME and some segments of unsecured loans may see challenges on credit cost. However, the bank has built some provision buffer, which we believe will be useful. The bank’s operating performance remains strong, but we expect growth to return largely in FY22E, as the economy the demand environment improve. Notably, the franchise continues to be one of the best-managed and strongest business models and needs to be seen from a long-term perspective. Overall, the asset-quality picture looks sanguine, with its calibrated growth and strong underwriting and assessment capabilities and healthy digitalisation benefits adding to the moat of its business strength. HDFC Bank’s floating provision cushion of Rs. 1,450 crore and contingent provisions of Rs 2,996 crore along with comfortable capitalization levels (Tier 1 at 17.2%) which are additional positives. We believe HDFC Bank’s business quality and franchise strength will help it tide over near-term challenges. Valuation HDFC Bank currently trades at a reasonable 2.6x FY2021E and 2.3x its FY2022E book value per share (BVPS). Due to market weakness, the price has corrected significantly and at present, the stock is available at below its long term average 1-yr forward PBV multiple of 3.7x. HDFC Bank consistency is buoyed by its strong underwriting capability and risk measurement standards and thus we expect it to recover faster once business environment normalises. We opine that any further weakness in the stock could be an opportunity for investors to add it to their long-term portfolio. We have fine-tuned our estimates and target multiples for the bank, factoring in lower growth and the economic impact of the lockdown. We retain our Buy rating on the stock with revised price target (PT) of Rs. 1,400.

One year forward P/BV (x) band

7.0

5.5

4.0

2.5

1.0 15 16 17 18 19 20 ------Apr Apr Apr Apr Apr Apr

PBV +1 sd 3-yr Avg -1 sd

Source: Sharekhan Research

Peer Comparison CMP P/BV(x) P/E (x) RoA (%) RoE (%) Particulars Rs/Share FY21E FY22E FY21E FY22E FY21E FY22E FY21E FY22E HDFC Bank 910 2.6 2.3 16.1 12.4 1.9 2.1 17.1 19.5 ICICI Bank 376 1.9 1.6 13.2 10.8 1.6 1.7 14.9 16.0 Axis Bank 480 1.4 1.2 10.1 7.9 1.4 1.5 14.5 16.3 Source: Sharekhan Research; Bloomberg estimates

April 17, 2020 6 Stock Update Stock

About company HDFC Bank is the largest private sector bank with a pan-India presence. The bank has been designated by the Reserve Bank of India (RBI) as a domestic systemically important bank (D-SIB), underlining its importance in the financial system. HDFC Bank caters to a wide range of banking services covering commercial and investment banking on the wholesale side and transactional / branch banking on the retail side. Its loan book is well balance between retail and wholesale loans. As a business entity, HDFC Bank continues to deliver steady performance with well-maintained margins and conservative asset-quality performance.

Investment theme HDFC Bank is among the top performing banks in the country having strong presence in the retail segment with strong asset quality and best in class margins. Not only the bank, but its strong and marquee parentage enjoy arguably the strongest brand recall in the country which is a significant competitive advantage in the Indian banking space. Buoyed by a strong brand appeal, impressive corporate governance and strong management team (consistency in performance and best-in-class granular clientele) has enabled HDFC bank to be a long term wealth creator for investors, and the above factors still hold true. The bank continues to report consistent margins and advances growth over the years across various credit / interest rate cycles, and has been able to maintain its asset quality too indicative of the strong business franchise strength and leadership qualities. We believe the Bank has a strong business model, and is relatively well placed to tide over near term challenges.

Key Risks A rise in NPAs in unsecured and other retail segments can pose risks to profitability.

Additional Data

Key management personnel Mr Aditya Puri Managing Director Mr Jimmy Tata Chief Risk Officer Mr Srinivasan Vaidyanathan Group Chief Financial Officer Mr Arvind Vohra Group Head, Retail Branch Banking at HDFC Bank Mr Arvind Kapil Group Head - Unsecured Loans, Home, and Mortgage Loans Ms Ashima Bhat Group Head - Finance, Administration & Infrastructure Source: Company Website

Top 10 shareholders Sr. No. Holder Name Holding (%) 1 Capital Group Cos Inc/The 7.11 2 EUROPACIFIC GROWTH FUND 4.42 3 SBI Funds Management Pvt Ltd 2.81 4 50 SBI-ETF NIFTY 2.35 5 Life Insurance Corp of India 3.04 6 FIL Ltd 1.22 7 ICICI Prudential Life Insurance Co 1.07 8 HDFC Asset Management Co Ltd 1.05 9 Republic of Singapore 1.01 10 Schroders PLC 0.99 Source: Bloomberg, BSE Website

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April 17, 2020 7 Know more about our products and services

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