Why are analysts still bullish on HDFC Bank despite a mixed Q2 show?

NIMs bottoming out

While the net profit came in above estimates, HDFC Bank disappointed on net interest margins (NIMs), the amount that a bank earns from interest on loans compared to what it is paying in interest on deposits.

Core NIM for the quarter was 3.65 percent on total assets and 3.85 percent on interest earnings assets. HDFC Bank’s NIM stood at 4.1 percent in the previous quarter.

The margins contracted mainly due to surplus liquidity and the impact of the Incremental Cash Reserve Ratio (I-CRR).

Also read: HDFC Bank Q2 earnings growth: 50? 10? 6%? Here is the correct version

On August 10, the Reserve Bank of India asked banks to maintain an I-CRR of 10 percent on the increase in their net demand and time liabilities (NDTL) between May 19 and July 28. The move was aimed measure at sucking out the surplus liquidity generated by various factors, including the return of Rs 2,000 notes to the banking system.

Analysts, however, see NIMs bottoming out.

“Impact of ICRR (6-8 bps on NIMs) will go-away from 3Q onwards but overall margins will start showing reasonable impact only from 4Q as the bank may like to carry some buffer liquidity and share of term deposits is still rising,” foreign brokerage firm Jefferies said in a note.

ICICI Securities has a word of caution for investors.

“While the drag from I-CRR has almost ended and thus NIM seems to have bottomed out, we model in only gradual recovery due to heightened competitive intensity and calibrated absorption of excess liquidity,” it said.

Domestic brokerage firm JM Financial echoed the views.

“While we expect NIMs to see sequential improvement going ahead, as the impact of excess liquidity wanes out, it will be difficult to see pre-merger levels as lower-margin home loans of HDFC Ltd gets added to the loan portfolio,” it said.

Strong loan growth

Loan growth was strong at 18 percent YoY and 5.3 percent QoQ, led by robust growth in retail and continued traction in commercial and rural banking. A pick-up was seen in the corporate segment as well.

“HDFC Bank has made a good beginning, and given a huge pace of capacity building, we believe that there are levers in place to sustain this momentum in business growth. Margins are likely to recover gradually, which, along with improved operating leverage, should improve return ratios,” analysts at Motilal Oswal wrote in a note.

They expect HDFC Bank to deliver a CAGR of 18 percent in loans and 21 percent in earnings over FY24-26.

Also Read: HDFC Bank sees 5-10 bps I-CRR impact on net interest margins, says CFO Vaidyanathan

Deposit mobilisation

A major highlight of the Q2 report card was a strong deposit growth of 29.8 percent, as the private lender garnered Rs 1.1 lakh crore of deposits, with 85 percent being retail deposits. The change in the mix toward retail will lead to better margins.

“It was good to see improvement in deposit mobilisation to Rs 1.1 trillion…While the bank is carrying excess liquidity, it is still raising large fresh deposits and securitising loans, we expect these normalize over the next 2-3 quarters with an uptick in loan growth and normalisation of liquidity,” Jefferies added.

Acquisition of deposits remains a key focus area for the bank, JM Financial said, adding it plans to leverage the power of branch banking to source deposits.

Strong retail franchise

The bank added 85 branches during the quarter, taking the count to 7,945. Analysts are enthused by its pace of expansion, especially in rural and semi-urban markets.

HDFC Bank has added 2,213 branches across India in the past two years against 634 branches added by the nearest rival ICICI Bank.

“This will provide the first-mover advantage to HDFC Bank in rural areas. Our analysis suggests that HDFC Bank has significantly improved their presence in eastern and central states of India including UP, Bihar, MP and Northeastern states which are witnessing a sharp surge in organised penetration,” InCred Equities said.

Merger momentum 

InCred Equities said its channel checks indicate that while ICICI Bank has been more engaged in mining deeper into the existing customer base, HDFC Bank was more focused on acquiring customers.

“Post recent merger with HDFC Limited, we can visualise large and untapped cross-sell opportunity to existing mortgage customers which can further aid HDFC Bank’s retail growth momentum (especially unsecured) in the near term,” it said.

Stable asset quality

The bank’s accelerated stress recognition from HDFC’s corporate loan portfolio, including construction finance, led to a merged GNPA ratio of 1.3 percent in 2QFY24 (lower than the 1.4 percent as on July 1, post the merger).

However, the bank carries a healthy specific provision coverage ratio (PCR) at 73 percent and has already created a contingent buffer on HDFC loans, pulling up this buffer for the merged entity to 0.7 percent of loans.

PCR refers to the percentage of funds created against NPAs.

“Amid the rising noise around stress build-up in unsecured loans, where the bank has sizable exposure, the higher specific-/contingent-provision buffer provides comfort,” analysts at Emkay Research said.

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