Q2 Comment . Why HDFC Bank Q2 performance suggests re-rating of the stock in the coming months

Even as high-yielding retail loans continued to deliver muted growth, core net interest margins (NIMs) fell notably and provisions increased significantly, HDFC Bank delivered a resilient performance and reported 18 per cent YoY growth in net profit in the September quarter. While treasury gains helped boost overall earnings, higher liquidity in the balance sheet dragged NIMs. Strong traction in deposits, alongside healthy growth in corporate loans, has nonetheless aided earnings.

Importantly, the bank, as a prudent move, has made provisions on unrecognised NPAs and increased Covid-related provisions. Also, the management commentary on collection and disbursement trends across corporate and retail segments evince healthy earnings outlook for the second half.

The weak link however, is the bank’s NBFC subsidiary, HDB Financial Services, which has witnessed uptick in bad loans —GNPA ratio at 4.3 per cent, up from 3.4 per cent last year.

Faster-than-expected recovery

HDFC Bank has steadily gained market share over the past few years, thanks to its healthy loan mix. Even as retail loan growth slowed in FY19 and FY20, strong growth in corporate loans, held the bank in good stead. In the first half of the current fiscal too, even as the pandemic impacted retail credit offtake, HDFC Bank’s corporate segment continued to deliver strong growth, aiding earnings.

In the September quarter, the bank’s loan book grew 15 per cent, led by 26 per cent growth in corporate loans. The management commentary (post earnings call) indicates that the traction should continue going ahead, with festival season spending triggering the near-term uptick. Corporate collections in the September quarter has been strong. In September alone, collections were 14.5 per cent higher than in September last year. Signs of normalisation was also visible in disbursements. The bank has added customers which was three times that in Q1 and disbursements were 2.65 times that in Q1, with September showing all-time high disbursements.

The quality of the book and broad growth strategy for the segment remain intact. Almost all of the growth came from top half of the 10-point internal rating scale and about 70 per cent of the growth in disbursements came from assets from less than 1 tenure year, according to the management.

Retail segment

While the retail segment continued to lag, trends in disbursements point to good recovery ahead in the second half of the fiscal. In the September quarter, retail loan growth stood at 5 per cent YoY, with auto, CV/CE, and two-wheelers registering a negative growth. However, the management indicated that traction in retail loans is also picking up, thanks to the recovery in economic activity and the run-up to the festival season. The bank has been witnessing sequential double-digit monthly growth from July to September, with disbursals at almost 90 per cent pre-Covid levels.

For HDFC Bank, auto (16 per cent of total retail loans), personal loans (23 per cent), home loans (12 per cent), business banking (12 per cent) and credit cards (11 per cent), are key drivers of retail loans.

According to the management, recent bureau trends indicate credit enquiry at near pre-Covid levels, particularly in auto, two-wheeler and home loan segment. Unsecured loans are also seeing good traction, and should reach pre-Covid level soon. Strong increase in two-wheeler sales led by rural demand, healthy demand for tractor loans and positive uptick in self-employed/business segments across India, indicate stronger growth in the second half for the bank (unless Covid situation worsens hereon). HDFC Bank is also launching ‘auto first’ a digital platform in the auto lending space.

Hence, going ahead even as corporate loans continue to deliver healthy traction, substantial uptick in retail loans can boost core earnings. The bank’s NIM declined 20 bps to 4.1 per cent in the September quarter from 4.3 per cent in the June quarter, on the back of excess liquidity on the balance sheet and muted growth in high yielding retail loans.

Prudent provisioning

While the bank’s reported GNPA ratio fell 28 bps QoQ to 1.08 per cent in the September quarter, it has mainly been due to the stay on asset classification. The Supreme Court (in the pending interest waiver case) has directed banks to not declare accounts (that were not NPA till August 31) as NPAs until further orders.

However, HDFC Bank has, as a prudent move, made contingent provisions on such accounts alongside Covid-related provisions. This should provide cushion to earnings if asset quality deteriorates hereon, as real impact of the pandemic on businesses and individuals unfolds.

The bank has stated that if it had classified borrower accounts as NPA after August 31, and also adopted an early recognition of NPA using its analytical models, then the GNPA ratio would have been 1.37 per cent in the September quarter, as against 1.36 per cent in the June quarter. The bank holds floating provisions of ₹ 1,451 crore and contingent provisions of ₹ 6,304 crore as on September 30, 2020.

Valuations/outlook

HDFC Bank has put up a resilient performance in the September quarter. The bank providing adequately for the likely slippages and beefing up its Covid-related provisions should hold it in good stead, with significant recovery in the retail segment bolstering earnings further. Going by the sanguine management commentary on collections and disbursements, the stock could re-rate in the coming months, unless Covid situation worsens.

At the current price, the stock trades at about 3 times one-year forward book value, lower than long term average of 3.5-4 times.