Here's why HDFC is in a sweet spot compared to banks

Moneycontrol Bureau

The absence of rate war among banks actually put India's largest mortgage lender - HDFC - in an advantageous position or "sweet spot". This helps the lender to grow 10 percentage points higher than the system. Net interest income (NII)or the difference between interest earned and paid out, is expected to increase 20 percent in next three years, according to a research report by Morgan Stanley – a global investment bank.

"HDFC is in an enviable position - funding cost is falling while loan yields are holding up (base rate driven). This is causing spreads to expand while gaining market share. Top line is expected to grow at 20 percent plus over three years, which should help multiples (at long-term average now) expand," the research report said setting a price target from Rs1,010 to Rs1,125 over a period of next one year.

After the Reserve Bank of India cut the policy (repo) rate by 25 basis points in its annual policy, no bank reduced its lending rates due to higher cost of borrowings. Bankers were of opinion that a reduction in cash reserve ratio (CRR) would have helped them to cut lending rates. CRR is the portion of deposits that banks are mandated to keep with RBI. It does not earn any interest from RBI.

The lender offers home loans up to Rs 30 lakh at an interest rate of 10.15  percent while it is 10.40 percent for loans above Rs 30 lakh. Both rates marginally higher than rates offered by the State Bank of India that gives 9.95 percent interest rate in the first category and 10.10 percent in the second category. For home loans, SBI is considered to be the closest rival of HDFC.

Below is the select excerpt of the Morgan Stanley report:

"Funding costs have fallen sharply over the last few weeks: There is an element of seasonality, and rates usually decline in April and May. However, quantum of decline this year is sharp – across various maturities, HDFC’s borrowing costs have declined by almost 80-90bp. With inflation falling, this decline can be sticky."

"At the same time, lending rates are holding up. Given elevated LD (lending - deposit) ratios, banks are struggling to cut deposit and hence base rates. This is helping HDFC earn high incremental spreads. While banks will cut base rates at some time, spreads for HDFC are likely to remain resilient. On an incremental basis, HDFC is earning an individual loan spread of 2.1 - 2.2%, which is much higher than spreads on the individual loan portfolio, in our view."

"The lack of price competition is helping HDFC gain share: Unlike previous cycles, when banks competed on rates, this time they are unable to. As a result, HDFC is growing at almost 10ppt more than the system. We expect NII growth to top 20% for the next three years."

"Strong growth, strong balance sheet, and average multiples imply big upside potential: The stock is trading at 3.7x book and 18x earnings (on core basis) on F2014E. While this is not cheap on an absolute basis, it is not expensive given HDFC’s earnings and balance sheet profile. We expect multiples to expand well above average levels."