A Solid Subcontinent Play

Indian banking giant and Long-Term Holdings Portfolio member HDFC Bank (NYSE: HDB) benefits from a demographically young nation with rising incomes and strong domestic demand. Furthermore, banking services are underpenetrated in the Indian market, so HDFC has substantial room to grow. Additionally, Indian banks like HDFC boast a relatively solid financial footing when compared to their developed-world peers. Indeed, Indian banks have debt-to-income ratios of about 6 percent, far lower than the ratios of about 50 percent that are common in the developed world.

HDFC Bank has over 2,200 branches and more than 15 million retail clients, and the lender’s business continues to expand. Management expects the bank to grow at a faster pace than the overall industry and believes that its expanding branch network and rising penetration into rural markets will spur growth in deposits.

HDFC reported fourth-quarter profits of USD285 million, a 31 percent year-over-year jump that beat analysts’ forecasts. Its loan book grew 22 percent year over year, driven by 30 percent growth in retail loan products. Although loan growth was lower on a year-over-year basis than the previous quarter, it remains healthy despite the slowdown in the economy.

Unsecured loans (i.e., credit card debt and personal loans) represent around 9.5 percent of the bank’s total loans, an increase of 36 percent year over year, versus a 33 percent year-over-year rise in the previous quarter. HDFC plans to add 4 million credit card customers in the next two years. At present, the bank has about 6 million credit card users.

Last quarter, management decided to cut back on the corporate side of its wholesale lending operations due to the difficulty it expected to face when trying to expand margins in that segment during a period of higher interest rates. As a result, growth in this segment declined 2 percent quarter over quarter, as compared to the 12 percent sequential growth produced during the previous quarter.

Source: HDFC Bank

HDFC’s so-called CASA (current and savings account) ratio improved slightly last quarter to 47.7 percent. CASA is a good metric for Indian banks because it compares current and savings account deposits to total deposits. The interest paid on CASA deposits is lower than other deposits, so a higher CASA ratio indicates a lower cost of financing for the bank. HDFC’s deposits grew by 1 percent on a sequential basis and 21 percent year over year.

HDFC’s CASA ratio is traditionally one of the highest in the industry, which means the bank enjoys substantial margins from this relatively cheap source of funding. Additionally, HDFC does not pay interest on current deposits. As a result, HDFC boasts a substantial net interest margin (NIM) of around 4 percent.

Although HDFC opened 421 new branches and expanded operations in 342 new cities, management was still able to keep the resulting increase in noninterest expenses from exceeding its overall growth. The bank’s employee expenses grew 20 percent year over year, while non-employee expenses grew 17 percent year over year.

The majority of HDFC’s new branches are located in non-metropolitan regions that are underpenetrated by the banking industry. This is the result of a regulatory mandate that management has used to attract more current and savings accounts from smaller towns. About 62 percent of HDFC’s branches are outside India’s nine biggest cities.

The Indian government has placed an emphasis on lending in the agricultural sector, as the government continues to emphasize peripheral growth. India’s economic plan closely mirrors China’s roadmap in which non-urban areas are provided assistance and incentives to grow faster and participate in the country’s economic boom.

The bank has also kept it gross nonperforming loans (NPL) to around 1 percent, an indication of solid asset quality, while maintaining a high NPL coverage ratio of 114 percent. Beyond that, its tier one capital ratio stands at 11.6 percent. HDFC has minimal exposure to problematic segments of the market, such as loans for corporate capital expenditure investments and infrastructure investments.

Although HDFC’s shares trade at a premium, the bank has a strong position in the Indian market and has consistently delivered strong earnings.

As we’ve previously noted, HDFC is one of Asia’s best-run financial institutions and management has a good track record of producing steady growth without incurring excessive risk. A direct play on rising domestic demand in India, HDFC Bank is a buy up to USD37.

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