HDFC Bank: Unbridled Expectations Or Communication Gap?

Investor darling HDFC Bank Ltd., on Wednesday, saw its worst day on the markets in over three years. The stock dropped nearly 9% on Wednesday and opened 3% lower on Thursday, before marginally recovering but still is trading in the red.

The villain in the story? A weaker-than-expected set of earnings. While HDFC Bank's profitability and asset quality looked strong in the December quarter, the core operational performance did not inspire a lot of confidence for investors.

But the bank did go through a mammoth merger with Housing Development Finance Corp. just in July 2023. So would it not be expected that performance will wobble mildly, before the benefits kick in? Apparently not.

The blame for this adverse market reaction falls not just on jittery investors, but also on some commentary from the bank.

The Deposit Question

Owing to the merger, the bank's credit-deposit ratio is hovering around 110%, indicating that its deposit growth is trailing its loan growth. In the December quarter, it added Rs 41,100 crore worth additional deposits. Compare this with over Rs 1 lakh crore worth deposits it added in July-September and Rs 1.5 lakh crore in January-March.

Was that sharp reduction in pace of deposits expected? Maybe. Could this have been avoided with better communication early on? Definitely.

While announcing the July-September quarter result, the bank noted that it had started to let go of high-ticket wholesale deposits. Sashidhar Jagdishan, managing director and chief executive officer, told analysts that this outflow was masking the momentum it was seeing on retail deposits. This means that the growth would have been even better, if bulk deposits were not a factor.

"So we are very sanguine and very confident that funding is never going to be an issue, and you will see the kind of execution that we are capable of going forward as well," Jagdishan had told analysts on Oct. 16, 2023.

The execution did suffer. The bank added a shade under Rs 85,000 crore retail deposits in the September quarter, compared with Rs 53,000 crore in the December quarter.

The Branch Question

This financial year the bank has added roughly 270 branches, and has 550 branches in the pipeline. It has guided for the branch network to be expanded by 800-1,000 branches this fiscal. The pace is clearly slower than approximately 1,500 branches the bank added last year.

"FY24 branch addition. At this moment, we expect to continue the speed at which, not necessarily every quarter evenly, but the speed at which we have done over the last 15 months to 18 months, we will continue," Srinivasan Vaidyanathan, chief financial officer, had told analysts during the April 15, 2023 conference call announcing the FY23 results.

Even as late as October, the bank had not clarified that the outlook of branch opening for the year would undergo a revision.

During the conference call, Vaidyanathan had agreed that branch openings are bunched up in the second half of a year, owing to multiple factors which need to be addressed. These include the marketing team's review of the locations, credit analytics team's review of the credit potential and the infrastructure team's review of available properties.

The Margin Question

Reported net interest margin for the third quarter came in at 3.4%, remaining flat sequentially. In the July-September quarter, NIMs took a knock (narrowing 70 basis points quarter-on-quarter), owing to the merger management in July, the impact of incremental cash reserve ratio and sudden increase in the low-yielding home loan book.

The third quarter did not feature the liquidity constraints or the merger costs and yet the margins did not see any positive momentum.

Now, to be fair, it is unrealistic to expect a large merger of two entities with entirely different business models to immediately start making higher margins. But then, maybe, this need to have been communicated to investors in as many words.

While addressing analysts during the July-September results call, HDFC Bank CFO Srinivasan Vaidyanathan noted that margin accretion would happen "over a period of time". This is because it would take the bank some time to rebuild its high-yielding retail loans to match the large mortgage book it inherited from HDFC.

On Tuesday, when discussing December quarter results, Vaidyanathan told analysts that there is a need to bring up retail growth, with a focus on unsecured loans.

"That is an enhancer for the margin and to some extent picks up on the ROA too... So that's an important mix that go by. That's not what we have seen in recent times. The recent times, the wholesale growth has been overwhelming, the retail loan growth," he said.

On the current account-savings account deposits front, the bank is expecting things to turn when customer spending starts to abate "at some point in time".

Vaidyanthan further noted that the bank is willing to let go on some of its business, if it is not giving it necessary returns.

"What does it give from an overall ROA point of view, that's the first pass. Then it comes because when you do a product pricing or a product choice to do to a customer, you're looking at returns more than the margins as such," he said.

So, is the final stance that margin depletion is not a worry? How long will return ratios be prioritised over margins? That part remains unclear.

Just to be clear, fundamentally there is nothing wrong with the bank's financials. The merger made a lot of sense on paper, because the only way HDFC Bank could quickly climb up the ladder of large banks in India was through consuming HDFC's book.

What it all boils down to, however, is the timing of the merger benefits. Investors will cautiously watch out for this clarity, as the financial year comes to a close.