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What is HDFC Bank’s secret of success?

Tuesday, 20 November 2012 - 4:30am IST | Place: Mumbai | Agency: Reuters
The bank has posted profit growth of over 30% every year for the last decade, richly rewarding its investors. Since 2008, its shares have risen nearly 87% while rival ICICI Bank is down about 16%.

When reports surfaced in July that Indian newspaper publisher Deccan Chronicle Holdings Ltd was struggling for survival, several of its creditors were caught off-guard. Not HDFC Bank.

Even as Deccan Chronicle, which also owned a glitzy cricket team, sought to reassure the markets that it held enough assets to stave off a crisis, HDFC Bank was busy getting rid of the loans extended to the group, three sources with direct knowledge of the matter said.

That agility paid off: Deccan Chronicle has since lost its cricket franchise and its lenders, including heavyweight ICICI Bank, Axis Bank and a dozen others, have been left with bad loans totalling $750 million.

“Alertness and the ability to pick early signs of problems have helped,” Paresh Sukthankar, executive director at HDFC Bank, said in an interview, pointing to the bank’s low bad loans at 0.9% of its book compared with 4.2% expected for the industry by March.

At a time when lenders across the world are battling slowing growth and rising loan defaults, HDFC Bank’s conservative business model and its knack of delivering returns are proving unique, and offer a lesson for its hard-pressed competitors.

HDFC Bank has posted profit growth of over 30% every year for the last decade, richly rewarding its investors. Since 2008, HDFC Bank’s shares have risen nearly 87%, while rival ICICI Bank is down about 16%.

Trading at five times its book value, HDFC Bank is the world’s most expensive lender and is among 15 banks globally to trade at a premium to its intrinsic value — a measure of how much shares should be worth when considering expected growth rates over the next decade.

So what is the secret sauce?

Selective lending, diversified exposure and focus on low-cost savings deposits, Sukthankar said. It has also shunned risky, exotic products and is picky about its borrowers.

“We live in a volatile world,” said Sukthankar, who has worked at the bank since its inception after moving from Citigroup Inc. “We don’t chase higher yields and run into higher risks.”

The lender expects non-performing loans to remain within its five-year average of 1.3-1.5%.

For all its success, HDFC Bank faces stiff competition. With the central bank planning to issue new banking licences, the landscape could become even more competitive for HDFC Bank, putting pressure on its margins, analysts say. Its net interest margins — a key gauge of bank profitability — now stand at more than 4%, one of the sector’s
highest.

“That would mean tougher competition for customer acquisition as well as pricing,” said ASV Krishnan, an analyst at Ambit Capital, which rates HDFC Bank a ‘sell’ due to its high valuation. The gloomy economic climate also poses a threat.

Loan growth in India is expected to ease to around 15% in fiscal 2012-13 from over 20% in 2009-10 as a slowing economy and high interest rates dent demand. Indeed, loan growth at the bank has slowed and retail deposits, its biggest strength, have shifted slightly to smaller competitors offering much higher interest rates.

“If balance-sheet growth remains slow, then maintaining 30% profit growth will not be easy,” said Manish Ostwal, a sector analyst with Mumbai-based brokerage KR Choksey.

HDFC Bank hopes to increase its market share and is charging into India’s hinterland, where millions still have no bank accounts.

Still, the lender’s old-school approach will stand it in good stead when good times return, say analysts and investors. It has largely stayed away from project finance, in contrast with several other banks that lent heavily to India’s power and infrastructure projects during
the pre-2008 boom period.

The bank’s infrastructure funding is largely limited to working capital loans to contractors of project developers, keeping exposures smaller, shorter and relatively safer.

There is talk in trade circles that the country’s No 3 lender may be losing money in its aggressive investment banking push. The bank insists the reality is “far from it”. “We don’t do businesses to lose money,” said Sukthankar.

Over the past year, HDFC Bank has hired five senior executives and has ambitions of
soon getting into equity offerings. It already has several million-dollar deals to show from the country’s top corporate houses and is intent on pushing old-time players off the league tables.

“HDFC Bank has been solid, other banks may have more risks coming,” said Taina Erajuuri, a Helsinki-based portfolio manager at FIM India, which owns shares in HDFC Bank. “If you want peace of mind, this is the bank for you."


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