Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

HDFC Bank – “Demonstrating prowess in difficult times” Rating CMP Target Upside %
Buy 526.5 635.9 20.8
Promoted by HDFC, HDFC Bank is India’s leading private sector bank with an enviable asset Source: NSE, ABML Research
quality and a consistent growth record. The bank has created a strong brand name for itself in
the banking space by gaining market share and through consistent performance on the Risk Return Matrix
operating front. Post merger of CBoP, it has a strong distribution network with 2201 branches
and 7110 ATMs in 1174 cities. We initiate coverage on HDFC Bank with a BUY rating and a

Low Medium High

price target of `635.9 /share, implying an upside potential of 20.8% from current levels.

Investment Arguments

Return
 Low cost liability profile remained largely unscathed post de-regulation of savings
rate – CASA to decline moderately in the coming quarters led by migration to high Low Medium High
rate term deposits – HDFC Bank has one of the best liability profiles in the banking space Risk
with one of the highest CASA as a % of total deposits. The bank has been maintaining a Source: ABML Research
CASA of ~50.0% over the past few years, helping it in keeping its cost of funds at lower
levels. The banks aggressive expansion to semi-urban and rural areas has helped it to keep Company Data
the momentum in new savings accounts accretion despite higher term deposit rates and hike BSE Code 500180
in savings rate by some competitors post deregulation of savings rate. Going forward we NSE Code HDFCBANK
expect CASA to decline moderately from 47.6% at the end of Q3FY12 to 47.0% by FY13E. Equity Capital (` mn) 4682.6
 Impeccable asset quality with lowest restructured assets amongst the peer group - Face Value (`) 2.0
Asset quality to witness slight deterioration going forward - HDFC Bank has one of the Market Cap (` bn) 1232.7
best asset quality amongst the peer group with gross NPA at 1.0% (NNPA at 0.2%). Total Avg Daily Volume (Qtly) 3602234
restructured assets were 0.4% of the Bank’s gross advances (0.3% included in NPAs) as of 52 week H/L (`) 537.9/400.3
Q3FY12. However we believe the asset quality to witness slight deterioration going forward Source: NSE, BSE
on the back of higher slippages in the coming quarters (with stress visible in some sectors)
and normalization of recoveries and write-offs. We expect the GNPA to inch towards 1.13% Shareholding (%)
in FY12E and likely to peak at ~1.21% by FY13E.
Holders Dec 11 Sep 11 Jun 11
 Strong fee income provides diversification to the revenue stream and aides in higher
Promoters 23.20 23.23 23.28
return ratios - Growth to remain moderate going forward - HDFC Bank has a strong and
diversified source of fee based income that helps the bank to maintain higher return ratios FIIs 29.67 29.30 29.23
(ROAA at ~1.6-1.7%). We believe, the Banks strategy to cross sell wide range of financial MFs/Banks & FI’s 10.87 10.97 11.14
products and services by leveraging the existing client relationships is likely to boost profits
Public & Others 36.26 36.50 36.35
through fee and fund based income going forward. We expect the fee income to grow by
17.9% and 19.7% for FY12E and FY13E respectively. Source: BSE
 Advance book growth to moderate slightly in the current fiscal - Retail loan book to
drive the loan book growth - HDFC Bank has always maintained above industry growth in Chart: HDFC Bank vs. Sensex
credit (~24% to 27%) in the past. During the current fiscal the management has guided for 3- 130
4% above industry growth in credit. We expect credit to grow by ~ 22.0% in FY12E and 125
Relative Performance

120
24.0% in FY13E.Going forward, we believe the growth in credit will be broad based with 115
110
growth in retail book likely to be higher than the corporate loan book. 105
100
 Operating expense ratio to remain stable despite aggressive branch expansion plans 95
90
mainly led by modest NII growth and technological up gradation leading to cost 85
80
efficiency – HDFC Bank has witnessed improvement in its operating efficiency over past
Feb-11

Apr-11

Jun-11

Dec-11
Aug-11

Oct-11

two years with cost to income ratio falling to 48.1% in FY11 from 51.7% in FY09. We expect Feb-12
C/I ratio to remain fairly stable going forward despite aggressive branch expansion plans HDFC Bank Return Sensex Return
mainly driven by modest Net Interest Income (NII) growth in a challenging environment,
aggressive investment made in technological up-gradation and continuous improvement in Source: Capitaline

employee and branch productivity.

Analyst Details
 Valuations – We estimate HDFC Bank to report an EPS CAGR of 28.3% over FY11-FY14E.  
ABV is estimated to grow at 19.0% CAGR during the same period. The bank’s strong asset Sumit Jatia
quality, superior return ratios, strong asset growth and adequate capitalization bodes well for 022-42333460
its future growth. HDFC Bank has always commanded a premium valuations vis-à-vis its
sumit.jatia@adityabirla.com
peers due to its track record of consistent growth in earnings and assets. We initiate
coverage on HDFC Bank with a BUY rating and March’13 price target of `635.9 /share
(based on 3.5x March-14E ABV which is five year average one year forward multiple),
implying an upside of 20.8% from current levels.

Financial Snapshot (` mn)

YoY Operating YoY YoY EPS YoY ABV RoAE RoAA P/E P/ABV
In ` mn NII (%) Profit (%) Net Profit (%) NIM (%) (`) (%) (`) (%) (%) (x) (x)
FY11 105431 26 77254 20 39264 33 4.6 16.9 31 107.8 16.7 1.6 31.2 4.9
FY12E 122728 16 90220 17 51248 31 4.2 21.9 30 125.2 18.6 1.6 24.1 4.2
FY13E 154768 26 112796 25 65600 28 4.2 28.0 28 146.4 20.3 1.7 18.8 3.6
Source: Company, ABML Research

Page No. 1
Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

    Industry Section
Macroeconomic scenario deteriorated sharply, however, signs of improvement witnessed off-late –
The risk emanating from macroeconomic environment have increased sharply in the current fiscal on the back
of –
Weakening domestic growth - India’s GDP growth slowed to 6.9% in the July-September quarter from 7.7%
in Q1 FY12 and 8.8% YoY, on account of a sharp deceleration in industrial growth due to rising interest rates.
The first half of 2011-12 saw a slower growth of 7.3% in overall GDP compared to 8.6% in the first half of
2010-11. The set back to economic growth in the first half of the current fiscal year was on account of a
decline in mining output and weak growth in manufacturing and construction sector. RBI in its credit policy on
24 January 2012 has revised GDP growth downwards from 7.6% to 7.0% considering increase in global
uncertainty, weak industrial growth, slowdown in investment activity and deceleration in the resource flow to
the commercial sector. Index of Industrial Production - In Oct, 2011, India’s industrial production growth fell
to -5.1% sharply below expectations, as output levels contracted across all categories. For the April-
September 2011 period, IIP grew by only 5.0% as against 8.2% YoY. The cumulative impact of rising interest
rates coupled with global growth slowdown has taken a toll on IIP numbers
Chart 1 – Quarterly GDP Growth Chart 2- Slowdown in IIP growth

12 15

10 10
5
(%)

(%)
6 0

4 -5
Mar-07

Mar-10
Dec-04

Sep-05

Jun-06

Dec-07

Sep-08

Jun-09

Dec-10

Sep-11

-10
Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar
GDP Growth FY11 FY12

Source: Bloomberg, ABML Research

    Signs of improvement, however its sustainability is a serious concern – Post sharp deceleration in IIP in
October, the index rose at a better-than-expected 5.9% YoY in Nov, 2011, supported by a revival in consumer
goods & basic goods. In December the growth again moderated to 1.8% on account of contraction in capital
goods and mining sectors along with weakness in manufacturing sector which dragged the overall industrial
growth down. We believe the sustainability of IIP numbers is a concern as the growth in major sectors like
capital goods and chemicals continues to be in the negative territory (account for 25% of the manufacturing
sector).

Inflation stabilizing, however non-food manufactured inflation still at elevated levels – RBI to adopt
calibrated approach in cutting rates - Headline WPI inflation, which averaged 9.7% YoY during April-
October 2011, moderated to 9.1% in November and further to 7.5% and 6.55% in December and January
respectively. The decline in inflation was driven largely by a decline in primary food and non-food articles
inflation. Primary articles inflation, which was in double digits for over two years from September 2009 to
October 2011, moderated to 8.5% in November and further to 3.1% in December. This benefit has, however,
been offsetted to a large extent by the lower than expected moderation in non-food manufactured products
inflation and fuel inflation (led by higher global crude oil prices and rupee depreciation). The monetary easing,
we believe, going forward would be a consequence of manufacturing inflation coming down coupled with the
favourable currency. The RBI said in its credit policy statement that - “In the absence of credible fiscal
consolidation, the Reserve Bank will be constrained from lowering the policy rate in response to decelerating
private consumption and investment spending”. We believe RBI would go for a rate cut post the forthcoming
Union Budget which is expected to signal fiscal consolidation in a more sustainable way.
Chart 3 – Inflation cooling off Chart 4 – Key policy rates

12 2 10
9
10 1
8
8 0 7
(%)

6
(%)

6 -1
(%)

5
4 -2 4
3
2 -3
May-08

May-09

May-10

May-11
Jan-08

Sep-08

Jan-09

Sep-09

Jan-10

Sep-10

Jan-11

Sep-11

Jan-12

0 -4
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12
Inflation Real Rate of Return CRR Repo Rate Reverse Repo

Source: Bloomberg, ABML Research

Page No. 2
Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

    Rising fiscal deficit – Lower than expected tax revenue collection due to growth slowdown coupled with dim
prospects for disinvestment has put significant strain on the country’s fiscal deficit target for the current fiscal.
Added to this sticky oil price and increase in subsidy expenditures (primarily food, fertiliser & fuel) has further
aggravated the deficit. India’s fiscal deficit in the first eight months of FY12 touched `3.53 tn, accounting for
85.6% of the budgeted `4.13 tn for the current year (49% in the same period last year). The government has
raised its borrowing target twice in the last five months by `928.72 bn. This takes the gross market borrowing
target for 2011-12 to `5090 bn as against the earlier target of `4170 bn set out in the budget.

Bonds yields stable, heavy government borrowing and continued fight against rupee depreciation
kept liquidity under pressure – Based on the expectations of rate cuts, benchmark 10 year government
bonds yield that hit a high of 9.0% in November have cooled to ~8.2% now. In its mid quarter policy review
RBI stated on 16 December 2011 that further rate hikes might not be warranted. It stated that monetary policy
actions are likely to reverse the rate hike cycle. Added to this, OMOs, which are conducted by the RBI to
infuse liquidity in the system has further aided in bringing the bond yields lower. The apex bank has
purchased government securities worth over `820 bn from the money markets in nine instalments in the past
two months as part of efforts to infuse liquidity into the system. Increased government borrowing coupled
with continued fight against rupee depreciation has kept the liquidity under pressure. Due to the
present tightness, banks have been borrowing more than `1100 bn daily, on average, since November from
the repo window of RBI. Despite several steps by the central bank in recent times, such as reducing CRR and
infusing money via open market purchases of government bonds, the liquidity deficit continued to be much
above the comfort zone of RBI(~ `500 bn). Going forward we believe liquidity to remain under pressure for
some more time owing to factors like advance tax payment and higher government borrowings.
Chart 5 – Government bond yields – Stable after sharp fall Chart 6 – Reverse Repo Outstanding

9.0 1,500

1,000

8.5 500

-
(%)

(` bn)

8.0 (500)

(1,000)

7.5 (1,500)
Jan-11 Apr-11 Jul-11 Oct-11 Feb-12
(2,000)
GIND5YR Index GIND10YR Index Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12

Source: Bloomberg, ABML Research

  Declining corporate profitability – Corporate profits had fallen by 13.2% in the first half of 2011-12 on the
back of steep rise in raw material, fuel prices and high interest rates. Besides this sharp depreciation in rupee
since September 2011 brought MTM losses to companies which further pulled down profits. A study by
CRISIL Research reveals that the interest coverage ratio of Indian companies in the S&P CNX 500 Index has
dipped to a five-year low. The median interest coverage ratio has fallen to 4.8 times in July-Sept, FY12
quarter against average interest coverage for the past five years at 8.4 times. However, we believe corporate
profits to revive in March quarter on the back of possible reversal of the currency losses generally; robust
growth in banking profits due to lower provisioning and low base. Added to this reversal of interest rate cycle
going forward coupled with stabilizing global uncertainty is likely to revive the capex cycle which remained
sluggish in the current fiscal.
  Banking industry outlook

  Credit growth to pick up with the reversal of interest rate cycle – We expect credit growth in the current
fiscal to remain subdued on account of project delays, low capex related demand for loans and subdued retail
loan growth in the current elevated interest rate scenario. The key sectors that will be a drag on the credit
growth would be metals, gem & jewellery, infrastructure sector (led by power and telecom sector). Power
sector growth would be affected by delays in execution of projects and issues related to increasing coal
prices. However, we believe the credit growth to gain momentum in the next fiscal with the reversal of interest
rate and gradual revival of economic growth. We expect the credit to grow by ~16-17% in the current fiscal in
line with the RBI’s growth target.
 

Page No. 3
Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

Chart 7 – Credit and Deposit growth

  26
24
22
20
18

(%)
16
14
12
10
8
6

Nov-10

Nov-11
Feb-10

Apr-10

Apr-11
Jul-09

Sep-09

Dec-09

Jul-10

Sep-10

Jan-11

Jun-11

Aug-11

Jan-12
Deposit Growth Credit Growth

Source: Bloomberg, ABML Research

  Slippages near its peak - Asset quality to deteriorate further in Q4 on account of stress visible in
various sectors together with lag effect of rising interest rates and slowing growth
The primary sources of stress on asset quality include telecom, commercial real estate, state-owned utilities,
electricity boards, metals and airlines. These sectors are experiencing financial strain owing to highly-
leveraged balance sheets, inadequate cash flow from operations and changes in the regulatory landscape.
Historically it has been seen that strong credit growth was synonymous with lowering of the risk perceptions
leading to noticeable improvement in asset quality, whereas slow down in credit growth was followed by
increase in impaired assets. During March 2007 - September 2008, while the outstanding credit growth
remained relatively high at about 24%, NPAs had either decelerated or grew very modestly, as against which
during the slow down phase i.e. between December 2008 – December 2009 when the credit off-take started
declining and fell to 12-13% in December 2009, the NPAs rose sharply from about ~2.1% to ~2.6%. In the
third phase i.e. 2010-11 as the credit growth picked up to the pre crisis level, there was substantial
deceleration gross NPAs. Apart from reflecting cyclicality, the pattern was also indicative of impairment in
assets being actually initiated during phases of rapid credit growth. We believe in the current adverse
macroeconomic scenario when the credit growth is expected to slow down, we might see incremental
slippages going forward as the historical trend suggest. However, we believe the reversal of rate cycle might
trigger a fresh demand for loan post FY12 and consequently asset quality might also peak out.
Chart 8 – Historical Trend in Credit Growth and GNPA
 
35 4.0
30 Phase I 3.5
25
Phase II 3.0
20
(%)
(%)

Phase III 2.5

15
2.0
10
5 1.5

0 1.0
200609
200612
200703
200706
200709
200712
200803
200806
200809
200812
200903
200906
200909
200912
201003
201006
201009
201012
201103
201106

Credit Grow th GNPA

Source: RBI, ABML Research

   
Sector Outlook
Banks have delivered strong Q3 numbers driven by lower than expected slippages, higher other income and
modest growth in NII. Private sector banks have outpaced PSU banks during the quarter mainly led by strong
core business growth and lower slippages relatively. The gross NPA for PSBs, rose from 2.3% of advances in
Q3FY11 to 3% at the end of the Q3FY12. In contrast, private banks reduced their gross NPA ratio from 2.5%
to 2.1% over the same period. With a sharp rise in bad loans, PSBs have had to increase provisions too.
During the nine months ended December 2011, the provisions of PSBs went up by 53%, while that for private
banks fell by 25%. However improvement in margins during the quarter, offsetted the increase in provisions to
some extent.

Page No. 4
Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

  Overall we have a positive view on the banking sector as we believe the recent policy actions by the
government to resolve various contentious issues in power sector related to fuel security and linkages
coupled with change in RBI’s monetary policy stance is likely to alleviate asset quality concerns to some
extent. We prefer private sector banks over PSUs as we believe they are well placed in terms of capital
adequacy, thus removing the overhang from capital dilution which will drive return ratios going forwards. We
believe forthcoming Union budget will be a key event which might signal fiscal consolidation in a more
sustainable way and help RBI ease monetary policy. As interest rates start moving downward and monetary
conditions become easier, we will see the capex cycle gaining momentum and consequently the credit off
take.
   
Investment Rationale
Low cost liability profile remained largely unscathed post de-regulation of savings rate – CASA to
decline moderately led by migration to high rate term deposits – HDFC Bank has one of the best liability
profiles in the banking space with one of the highest CASA as a % of total deposits. The bank has been
maintaining a CASA of ~50.0% over the past few years, helping it in keeping its cost of funds at lower levels.
The deregulation of savings bank rate by RBI in October 2011 aimed at providing greater flexibility to the
banks in fixing rates for the savings account, was perceived to have negative impact on the banks with high
CASA as it might trigger flight of deposits to banks offering higher savings rates. However, the impact was
minimal as till date only three banks have increased the rate including Yes Bank, Indusind Bank and Kotak
Mahindra Bank (which are relatively smaller in size controlling 7% of the total business with major presence in
metropolitan cities) with no large banks going for a rate hike. HDFC Bank has managed to maintain its CASA
balance despite higher term deposit rates and hike in savings rate post deregulation of savings rate, on the
back of aggressive branch expansion over the last one year.
Chart 9 – Quarterly CASA movement Chart 10 – CASA ratio – Peer group comparison

100% 50% 47.6% 47.5%

80% 48 48 51 49 50 47 45% 42.2% 42.1%
51 53 51
60% 40% 36.3%
40% 30 30 29 30 32 30 31 30 30 35%
20%
21 22 20 20 19 22 18 17 18 30% 27.4%
0%
25%
Q3FY10

Q4FY10

Q1FY11

Q2FY11

Q3FY11

Q4FY11

Q1FY12

Q2FY12

Q3FY12

20%
HDFC SBI Axis ICICI PNB BoB
Current Deposits Savings Deposits Term Deposits Bank

Source: Company, ABML Research

  However, we believe in the current elevated interest rate scenario, the bank may see some flight of deposits
from savings to higher yield term deposits. On the flip side aggressive branch expansion plans of the bank is
likely to partly offset the decline in CASA going forward. The bank opened 421 branches in last 12 months the
highest ever branch addition till date. As of December 31, 2011, the Bank’s distribution network is spread
across 2201 branches and 7110 ATMs in 1174 cities. We expect the bank to take the total number of
branches to ~2600 by FY13E. In Q3FY12 the bank registered a slight improvement in CASA sequentially from
47.3% to 47.6% despite high fixed deposit rates and some flight of deposits from savings account post
deregulation of savings rate. The banks aggressive expansion to semi-urban and rural areas has helped it to
keep the momentum in new accounts accretion. Going forward we expect CASA to decline moderately from
47.6% at the end of Q3FY12 to 47.0% by FY13E.
Chart 11 – Trend in CASA Chart 12 – Trend in branches

1600 60% 3000 2606

55%
52% 53% 2500 2276
55% 1986
1200 2000 1725
50% 1412
44%
(in ` bn)

1500
800 47% 47% 45% 761
1000
40% 500
400
35% 0
FY08

FY09

FY10

FY11

FY12E

FY13E

0 30%
FY08 FY09 FY10 FY11 FY12E FY13E
CASA CASA as a % of deposits Number of Branches

Source: Company, ABML Research

Page No. 5
Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

    Impeccable asset quality with lowest restructured assets among the peer group - Asset quality to
witness slight deterioration going forward - HDFC Bank has one of the best asset quality amongst the
peer group with gross NPA at 1.0% of gross advances and net NPA at 0.2% of net advances. Total
restructured assets were 0.4% of the Bank’s gross advances (0.3% included in NPAs) as of December 31,
2011. The bank has been able to maintain its asset quality despite its strong presence in high yielding risky
segments like credit card, personal loans, etc mainly on the back of disciplined credit risk management and
focused retail strategy. The banks slippages during FY11 were lowest in the preceding 5 years at 1.13%. The
absolute addition to gross NPA has been fairly stable over the past few quarters (as can be seen from the
graph below). Besides this, higher recoveries and write-offs further eased pressure on asset quality. However
we believe the asset quality to witness slight deterioration going forward on the back of higher slippages in the
coming quarters (with stress visible in some sectors) and normalization of recoveries and write-offs. The pace
of recoveries and write-offs which has been a key reason for the bank’s improving asset quality is coming off,
with the rundown of slippages added few years back. We expect the GNPA to inch towards 1.13% in FY12E
and 1.21% by FY13E with slippages at around 1.29% and 1.17% respectively going forward.
  Chart 13 – Quarterly Gross NPA movement – Peer group comparison

  120
100
80
in ` bn

60
40
20
0
Axis Bank HDFC Bank Bank of Baroda Punjab Natl.Bank ICICI Bank
Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12

  Source: Company, ABML Research

 
The bank’s NPA is well diversified across various segments with no major single exposure to any one
segment. Besides this it has a conservative provisioning policy which provides it a cushion against any
adverse macroeconomic events. The bank has been providing for floating provision (counter cyclical buffers)
and contingency provisions (on account of MFIs) besides specific loan loss provisions over the last few
quarters. The bank’s provision coverage is comfortable at 80.3% as at December 31, 2011.

Chart 14 – Asset Quality to deteriorate slightly Chart 15 – Peer group comparison – Lowest impaired asset

2.5 90 5.0 4.6

2.0
3.8
2.0 80 4.0

1.4 1.4 3.0

1.5 70 2.4
(%)

2.2
(%)

1.2
(%)

1.1
1.0
2.0 1.5
1.0 60
0.6 1.1 1.1 1.0
0.5 0.8
1.0 0.5
0.5 50 0.4 0.2
0.3
0.2 0.2 0.2
0.0
0.0 40 SBI ICICI PNB BoB Axis Bank HDFC
FY08 FY09 FY10 FY11 FY12E FY13E Bank Bank
Gross NPA (LHS) Net NPA (LHS) Prov. Coverage (RHS) GNPA NNPA

Source: Company, ABML Research

  Margin profile largely stable – Matched funding book to keep the margins at around current levels
HDFC bank has been maintaining margin at ~ 4.0%+ over the last few years mainly driven by high CASA
base and its unique loan book positioning. The bank’s margin profile is relatively stable vis-à-vis its peer group
as ~ 80.0% of the loan book is fixed rate loan with matched funding book on the deposit side. In the retail side
~ 95.0% of the book is fixed in nature. On the other hand, in the wholesale side the bank provides working
capital loans to corporates which constitutes ~ 70.0% of the total wholesale book. Working capital loans are
short term in nature leading to faster repricing. Besides this the bank is currently focusing towards high
yielding retail loans which are likely to provide some support to the margin. The bank has run off some low
yielding short term corporate loans and consciously remained slow on the corporate book while expanding the
retail book during Q3FY12. During the current fiscal the management has indicated that the margins are likely
to move in a range of 3.9%-4.2%.
 
Page No. 6
Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

Chart 16 – NII and NIM movement Chart 17 – Peer group comparison – NIMs (TTM)

210 4.7% 4.5

4.6% 191 4.2
190 4.5% 4.6% 3.9
3.6 3.6
170 155 4.5% 3.5
4.4% 3.1
150 4.4%
(in ` bn)

130 123 4.3%

(%)
2.5
110 105 4.2% 2.0
4.2% 4.2%
84
90 4.1%
1.5
70 4.0%
50 3.9%
0.5
FY10 FY11 FY12E FY13E FY14E
HDFC PNB SBI Axis BoB ICICI
NII NIM (%) Bank Bank Bank

Source: Company, ABML Research

    Advance book growth to moderate slightly in the current elevated interest rate scenario – Retail loan
book to remain strong - HDFC Bank has always maintained above industry growth in credit (~24% to 27%)
in the past. During the current fiscal the management has guided for 3-4% above industry growth in credit. We
expect credit to grow by ~ 22.0% in FY12E and 24.0% in FY13E. The bank’s advance book is equally shared
between corporate and retail segment. Going forward, we believe the growth in credit will be broad based with
growth in retail book likely to be higher than the corporate loan book. In Q3FY12 the bank’s retail loan book
grew at a healthy ~30.0% as against the market expectation of some slowdown in the current elevated
interest rate scenario partly attributed to the rising income levels of the middle class and bank’s geographical
expansion into Tier‐2 and Tier‐3. The retail loan book is well diversified among 6-7 major segments
including auto loans, personal loans, business banking, CV/CE and housing loans. The diversified nature of
the loan book helps the bank to maintain consistent growth as slowdown in any segment is partly offsetted by
strength in others. The growth in the wholesale book stood at 15.0% YoY (-2% QoQ) at the end of Q3FY12.
The bank has run off some low yielding short term corporate loans and consciously remained slow on the
corporate book while expanding the retail book. However, the management has indicated that it has the
flexibility to grow its wholesale book to some extent in the pace at which it wants it to grow depending on the
interest rate environment and the margins that the bank earns on the marginal corporate assets.
Chart 18 – Advance book mix Chart 19 – Credit growth comparison – HDFC Bank vs Industry

100% 45 40.9
38.2
40
80%
49.8 55.4 55.9 51.3 49.9 52.2 50.7 49.7 33.1
35
60%
27.1
(%)

30
24.42
40% 25 21.9 21.42
19.9 21.0
19.15
50.2 44.6 44.1 48.7 50.1 47.8 49.3 50.3 20
20% 21.38
15 18.1
0% 15.4 15.94
10
Q4FY10

Q1FY11

Q2FY11

Q3FY11

Q4FY11

Q1FY12

Q2FY12

Q3FY12

Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12

HDFC Bank Industry
Retail Advances Wholesale Advances

Source: Company, ABML Research

Page No. 7
Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

    Adequately capitalized to support its growth plans – No capital dilution over the next two years to
keep return ratios high – HDFC Bank is well capitalized with CAR of 16.3% (Tier 1 of 11.2%). The bank has
no plan to raise capital over the next two years, thus removing the overhang of capital dilution in the current
market conditions. This would support the return ratios of the bank. The bank proposes to maintain its CAR in
the band of 13.0%-13.5% in the coming years with Tier-I between 8.0% and 8.5%. With such a strong capital
base, HDFC bank is all set to support its growth plans going forward.
Chart 20 – Quarterly movement in CAR Chart 21 – CAR – Peer group comparison

20 18.3 18.9
17.4 17.0 16.9 20
16.3 16.3 16.2 16.5 16.3
16.3
16 4.5 4.1 3.9 4.3 4.2 4.0 5.5 5.1 16
5.1 13.1 13.5
12 11.8 11.6 11.5
(%)

12 11.2
8

(%)
13.8 13.3 9.3
12.4 12.7 12.1 12.2 11.4 11.4 11.2 8.3 7.9
7.6
4 8
0
4
Q3FY10

Q4FY10

Q1FY11

Q2FY11

Q3FY11

Q4FY11

Q1FY12

Q2FY12

Q3FY12
0
ICICI HDFC BoB Axis SBI PNB
Tier 1 (%) Tier 2 (%) Bank Bank Bank
CAR (%) Tier 1 (%)

Source: Company, ABML Research

    Strong fee income provides diversification to the revenue stream and aides in higher return ratios -
Growth to remain moderate going forward - HDFC Bank has a strong and diversified source of fee based
income that helps the bank to maintain higher return ratios. The substantial contribution of non interest
income to total net income reflects the diversified revenue base of HDFC Bank. Since its inception, non
interest income contributed on an average ~30.0% to its total net income. The robust growth in other income
(CAGR growth of 31.0% over FY06-11) has helped the bank to maintain higher return ratios in the range of
~1.6% over the past few years. The bank’s principal sources of fee and commission revenue are retail
banking services, retail asset fees and charges, credit card fees, home loan sourcing commissions, cash
management services, documentary credits and bank guarantees, distribution of third party mutual funds and
insurance products and capital market services. Due to some regulatory changes that resulted in the capping
of earnings from the distribution of insurance products, the bank has seen slight moderation in income from
distribution of third party mutual funds and insurance products. However, the increase in Bank’s sales
volumes made up partly for the reduction in units commission. Going forward, the management feels the
growth to remain in the range of 15.0-19.0%. We believe, the Banks strategy to cross sell wide range of
financial products and services by leveraging the existing client relationships is likely to boost profits through
fee and fund based income going forward. We expect the fee income to grow by 17.9% and 19.7% for FY12E
and FY13E respectively.
Chart 22 – Non-interest income as a % of Net Revenue Chart 23 – Trend in Return Ratios

70 32.2% 33%
61.2 25.0 1.9
60 32% 20.3
30.7% 51.1
20.0 18.6
50 43.4 31% 17.2 16.7
39.8 16.3
1.7
(in ` bn)

40 30% 1.64
32.9 15.0 1.73
(%)

1.57
(%)

30 29%
29.1% 29.4% 10.0
20 28% 1.45 1.5
28.3% 1.42
10 27% 5.0

0 26%
0.0 1.3
FY09 FY10 FY11 FY12E FY13E
FY09 FY10 FY11 FY12E FY13E
Non Interest Income As a % of Net Revenue ROAE (LHS) ROAA (RHS)

Source: Company, ABML Research

Page No. 8
Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

    Operating expense ratio to remain stable despite aggressive branch expansion plans mainly led by
modest Net Interest Income growth and technological up gradation leading to cost efficiency – HDFC
Bank has witnessed improvement in its operating efficiency over past two years with cost to income ratio
falling to 48.1% in FY11 from 51.7% in FY09. We expect C/I ratio to remain fairly stable going forward despite
aggressive branch expansion plans mainly driven by modest Net Interest Income (NII) growth in a challenging
environment, aggressive investment made in technological up-gradation and continuous improvement in
employee and branch productivity. We expect NII to grow at a CAGR of 21.2% over FY11-FY13E driven by
robust loan growth (CAGR growth of 23.0%), stable CASA base (leading to cost minimization) and healthy
yield on investments. Besides this, the bank’s huge capex plan in technological up-gradation (aggregate
capital expenditure of approx `15.1 bn including `9.7 bn to upgrade and expand hardware, data center,
network and other systems) during the current fiscal will boost efficiency, thereby helping it in keeping
operational cost ratios fairly stable going forward.
Chart 24 – Trend in cost ratios Chart 25 – Improving branch and employee productivity

54% 5.6% 6.0%

2500 1.2
1.03
0.91 1.0
51.7% 2000
52% 5.0%
0.70 0.8
1500

(in ` mn)
(in ` bn)
0.57
50% 4.0% 0.6
0.43
48.0% 1000
49.9% 48.1% 48.1% 0.4
47.8%
3.5%
48% 3.0%
500
0.2
2.9% 2.9%
2.7% 2.7%
46% 2.0% 0 0.0
FY08 FY09 FY10 FY11 FY12E FY13E FY09 FY10 FY11 FY12E FY13E
Cost / Income Ratio (LHS) Opex / Avg Assets (RHS)
Business Per Branch (in bn) Profit Per Empl (in mn)

Source: Company, ABML Research

    Low duration investment book to benefit in reporting MTM gains going forward as liquidity situation
eases and yields at the shorter end of the yield curve comes off – The average duration of the bank’s
total investment book is quite low at 1.5 with 60.0% in HTM category and 40.0 %in AFS category (which is
subject to mark to market). During 9MFY12, the bank reported MTM losses as the yields at the shorter end of
the yield curve increased more aggressively than the longer term bonds on account of liquidity squeeze in the
system. This can be gauged from the fact that the average increase in the yield for the short maturity bonds (3
month to 1 year) was ~100 bps during 9MFY12 as against 56 bps for 10 year bonds. Similarly post 9MFY12
the average increase for the short duration bonds was ~10 bps as against a decline of ~26 bps for 10 year
bonds. So far the central bank has not succeeded in easing liquidity pressure in the banking system despite
50 bps cut in CRR and conducting multiple OMOs to infuse liquidity into the system (~`820 bn till date). We
expect RBI to go for another cut in CRR the near term as the liquidity pressure further aggravated due to state
elections and intervention by the RBI to stabilise rupee. We believe as the liquidity situation improves going
forward, the shorter end of the yield curve will fall more aggressively than the longer term, thus benefiting the
bank in generating MTM gains.
Chart 26 – Investment Book Break-up Chart 27 – Movement in Yield curve

8.8 8.71
8.55 8.50 8.55
8.6 8.46
AFS & HFT 8.39
8.4
40% 8.45
8.2 8.42 8.41
8.27 8.30
8.0 8.12 8.19
(%)

7.8 7.96 7.99

7.6
7.4
7.51
7.45
HTM 7.2
60% 7.25
7.0
3m 6m 1Yr 5Yr 10Yr 15Yr
16-Feb-12 31-Dec-11 1-Apr-11

Source: Company, ABML Research

Page No. 9
 Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

  Peer Group Analysis

HDFC Bank is competitively placed among its peers and is one of the most consistent performer in the
banking space. The bank’s net profit grew at a CAGR of 32.3% over the last three years as against the peer
group average of 21.0%. We expect the bank to continue to deliver robust growth in NII (CAGR 21.9% FY11-
14E) and earnings (CAGR 28.6% FY11-14E) going forward. The stock currently quotes at a premium to its
peers (TTM P/ABV of 4.2x for HDFC Bank vs. 2.1x for peer group). Considering the bank’s strong growth
prospects, favourable asset quality, adequate capitalization and higher branch and employee productivity, we
believe the stock deserves a premium valuation as compared to its peer group.

Particulars (In ` mn) HDFC Bank ICICI Bank Axis Bank BoB PNB SBI

Net Interest Income* (in ` bn) 117.5 101.4 75.7 101.3 131.3 396.5
CAGR Growth (3 yrs) (%) 17.7 6.9 29.6 29.4 25.5 23.9
PAT* (in ` bn) 48.3 60.2 39.9 47.8 46.6 76.8
CAGR Growth (3 yrs) (%) 32.3 13.0 35.7 39.8 19.0 -2.4
EPS* 58.5 52.2 96.9 124.6 147.9 120.9
ABVS** 124.2 511.2 520.0 583.4 540.9 837.9
Deposits (in ` bn)** 2325 2606 2087 3492 3565 10010
Advances (in ` bn)** 1958 2462 1487 2607 2626 8694
No of Branches** 2201 2552 1484 3691 5393 13946
Mkt Cap (in ` bn) 1232.6 1116.7 505.1 338.1 334.8 1492.5

Key Ratios
NIM (%)* 4.2 2.0 3.6 3.1 3.9 3.6
GNPA (%)** 1.0 3.8 1.1 1.5 2.4 4.6
NNPA (%)** 0.2 0.8 0.4 0.5 1.1 2.2
CAR (%)** 16.3 18.9 0.0 13.5 11.5 11.6
Tier 1 (%)** 11.2 13.1 0.0 9.3 7.9 7.6
Mkt Cap / Branch (in mn) 560.0 437.6 340.4 91.6 62.1 107.0
Business / Branch (in bn) 1.9 2.0 2.4 1.7 1.1 1.3
Profit / Branch (in bn) 21.9 23.6 26.9 13.0 8.6 5.5
ROAA (FY11) (%) 1.6 1.4 1.7 1.3 1.3 0.7
ROAE (FY11) (%) 16.7 9.7 19.3 23.5 24.5 12.6

Valuations
Price 526.5 968.8 1224.3 863.5 1056.7 2350.4
P/E 9.0 18.6 12.6 6.9 7.1 19.4
P/ABV 4.2 1.9 2.4 1.5 2.0 2.8
 
Source: Company, Capitaline, ABML Research
Note – * TTM figures
** As on December 2011

Page No. 10
Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

  Valuations
We estimate HDFC Bank to report an EPS CAGR of 28.3% over FY11-FY14E. ABV is estimated to grow at
19.0% CAGR during the same period. The bank’s strong asset quality, superior return ratios, strong asset
growth and adequate capitalization bodes well for its future growth. HDFC Bank has historically commanded a
premium valuations vis-à-vis its peers due to its track record of consistent growth in earnings and assets.
Despite macro headwinds, the bank has continued to deliver +30% earnings growth and maintained its asset
quality.

The stock currently trades at 3.6x FY13E ABV and 2.9x FY14E ABV. Over the last five years, the bank has
traded at a mean multiple of 3.5x its one year forward ABV, which suggests that the discount to the current
fair value has come off post the current market rally. However the stock price is likely to track earnings growth
largely from here onwards giving us a one year forward fair value of 635.9/share. We believe the bank to
continue to command premium valuations going forward. We initiate coverage on HDFC Bank with a BUY
rating and March’13 price target of `635.9 /share (based on 3.5x March-14E ABV which is five year
average one year forward multiple), implying an upside of 20.8% from current levels.

  Chart 28 – Forward P/ABV

 
5.5

5.0 +2 SD

4.5
+1 SD
4.0

3.5
Mean: 3.5
3.0

2.5 -1 SD

2.0
-2 SD
1.5
Mar-07 Sep-07 Feb-08 Jul-08 Jan-09 Jun-09 Nov-09 Apr-10 Oct-10 Mar-11 Aug-11 Feb-12

  Source: Bloomberg, ABML Research

  Based on Price to Earnings, the stock currently discounts its FY13E and FY14E EPS of `146.4 and `181.7 at
18.8x and 14.8x respectively. Over the last five years, the bank has traded at a mean multiple of 21.8x its one
year forward EPS, which suggests that the current price is at ~14.0% discount to its fair value.

  Chart 29 – Forward P/E

 
36.0

31.0 +2 SD

+1 SD
26.0

Mean : 21.8

21.0

-1 SD
16.0

-2 SD
11.0
Mar-07 Sep-07 Feb-08 Jul-08 Jan-09 Jun-09 Nov-09 Apr-10 Oct-10 Mar-11 Aug-11 Feb-12

  Source: Bloomberg, ABML Research

 
 

Page No. 11
Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

Standalone Financials – HDFC Bank

Income Statement Key Ratios

Financial Year (` mn) FY10 FY11 FY12E FY13E FY14E Financial Year (` mn) FY10 FY11 FY12E FY13E FY14E

Net Interest Income 83864 105431 122728 154768 191080 Return Ratios

Growth (%) 13 26 16 26 23 Average Yield on Advances 10.8% 10.0% 11.2% 11.2% 10.6%
Other Income 39831 43352 51090 61175 72374 Average Cost of Deposits 4.5% 4.6% 6.1% 6.0% 5.4%
Growth (%) 21 9 18 20 18 NIM 4.5% 4.6% 4.2% 4.2% 4.4%
Net Income 123695 148783 173818 215944 263453 Non Int Income / Net Income 32.2% 29.1% 29.4% 28.3% 27.5%
Operating Expenses 59398 71529 83598 103148 126638 Return on Avg Equity 16.3% 16.7% 18.6% 20.3% 21.4%
Operating Profit (pre-prov) 64297 77254 90220 112796 136815 Return on Avg Assets 1.5% 1.6% 1.6% 1.7% 1.9%
Other Prov. & Contingencies 21400 19061 15792 17723 15842

Profit Before Taxes 42897 58193 74428 95073 120973 Asset Quality

Prov for tax 13410 18929 23181 29473 37502 Gross NPA to Advances 1.43% 1.05% 1.13% 1.21% 1.15%
Net profit for the year 29487 39264 51248 65600 83472 Net NPA to Advances 0.31% 0.19% 0.21% 0.21% 0.20%

Growth (%) 31 33 31 28 27 Provision Coverage 78.4% 82.5% 81.3% 83.0% 83.0%

Slippage Ratio 2.7% 1.1% 1.3% 1.2% 0.8%
Balance Sheet

Financial Year (` mn) FY10 FY11 FY12E FY13E FY14E Efficiency Ratios

Sources of Funds Business Per Emp. (in mn) 56.5 66.1 77.8 84.5 94.7

Capital 4577 4652 4683 4683 4683 Net Profit Per Emp. (in lakh) 5.7 7.0 9.1 10.3 12.0

Reserve and Surplus 210618 249111 292513 343025 426497 Business Per Branch (in bn) 1.7 1.9 1.9 2.1 2.2

Net Worth 215225 253793 297199 347711 431183 Cost / Income Ratio 48.0% 48.1% 48.1% 47.8% 48.1%

Deposits 1674044 2085864 2439736 2951485 3586588

Growth (%) 25 27 17 21 18 Business Ratios

Borrowings 129157 143941 241915 296252 361248 Credit Deposit Ratio 75.2% 76.7% 80.0% 82.0% 83.0%

Other Liabilities and Prov. 206159 289929 495046 512769 528611 Investment Deposit Ratio 35.0% 34.0% 34.0% 33.4% 32.8%

Total Liabilities 2224586 2773526 3473896 4108218 4907629 CASA Ratio 52.0% 52.7% 47.4% 47.0% 47.0%

Application of Funds Valuations Ratio

Cash and balances with RBI 154833 251008 260524 214052 202814 EPS 12.9 16.9 21.9 28.0 35.65

Bal. with banks & call money 144591 45680 36454 44101 53591 P/E (x) 40.9 31.2 24.1 18.8 14.8

Investments 586076 709294 829510 985796 1176401 BVPS 94.0 109.1 126.9 148.5 184.2

Advances 1258306 1599827 1951789 2420218 2976868 P/BV (x) 5.6 4.8 4.1 3.5 2.9

Growth (%) 27 27 22 24 21 Adj. BVPS 92.3 107.8 125.2 146.4 181.7

Fixed assets 21228 21706 21465 22937 23989 P/ABV (x) 5.7 4.9 4.2 3.6 2.9

Other assets 59551 146011 374154 421114 473967

Total Assets 2224586 2773526 3473896 4108218 4907629

Source: ABML Research, company data

Page No. 12
 Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

Research Team
Vivek Mahajan Hemant Thukral
Head of Research Head – Derivatives Desk
022-42333522 022-42333483
vivek.mahajan@adityabirla.com hemant.thukral@adityabirla.com

Fundamental Team
Avinash Nahata Head of Fundamental Desk 022-42333459 avinash.nahata@adityabirla.com
Akhil Jain Metals & Mining 022-42333540 akhil.jain@adityabirla.com
Sunny Agrawal FMCG/Cement 022-42333458 sunny.agrawal@adityabirla.com
Sumit Jatia Banking & Finance 022-42333460 sumit.jatia@adityabirla.com
Shreyans Mehta Construction/Real Estate 022-42333544 shreyans.m@adityabirla.com
Dinesh Kumar Information Technology/Auto 022-42333531 dinesh.kumar.k@adityabirla.com
Pradeep Parkar Database/Production 022-42333597 pradeep.parkar@adityabirla.com

Quantitative Team
Rizwan Khan Technical and Derivative Strategist 022-42333454 rizwan.khan@adityabirla.com
Jyoti Nangrani Sr. Technical Analyst 022-42333454 jyoti.nangrani@adityabirla.com
Raghuram Technical Analyst 022-42333537 raghuram.p@adityabirla.com
Rahul Tendolkar Derivatives Analyst 022-42333532 rahul.tendolkar@adityabirla.com
Amit Somani Derivative Analyst 022-42333532 amit.somani@adityabirla.com

Advisory Support
Indranil Dutta Advisory Desk – HNI 022-42333494 indranil.dutta@adityabirla.com
Suresh Gardas Advisory Desk 022-42333535 suresh.gardas@adityabirla.com
Sandeep Pandey Advisory Desk 022-30442104 sandeep.pandey@adityabirla.com

ABML research is also accessible in Bloomberg at ABMR

Page No. 13
Initiating Coverage | Banks – Private | 17 February 2012 Aditya Birla Money

Our Rating Methodology

Stock Ratings Absolute Returns (R)
Buy R > 15%
Accumulate 5% < R ≤ 15%
Neutral -5% < R ≤ 5%
Reduce -10% < R ≤ 5%
Sell R ≤ -10%

Disclaimer:

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The information , opinion, views contained in this document are as per prevailing conditions and are of the date of
appearing on this material only and are subject to change. No reliance may be placed for any purpose whatsoever on
the information contained in this document or on its completeness. Neither Aditya Birla Money Limited (ABML) nor any
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or any of its associate or group companies. The information set out herein may be subject to updating, completion,
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Aditya Birla Money Limited

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Page No. 14