HDFC Bank - Moderate NII growth, elevated slippages; recovery in the offing - ICICI Securities

HDFC Bank's decadal low NII growth at 9% YoY in Q1FY22 dragged earnings growth below expectations at 16% (against past 6-year average of 18-20%). NIMs (at 4.1%) settled at the lower end of the guided range. Slippages, amidst second covid wave disruption, too were elevated at 2.54%, though partially offset by sale of NPAs (Rs18bn) and write-offs (Rs31bn). GNPAs rose only marginally to 1.47% (from 1.32% in FY21) and credit cost was contained at 1.7%. Stage-3 assets for its subsidiary, HDB Financial, almost doubled. What gives confidence: 1) Demand resolution is just 100bps sigh of pre-covid levels; recoveries benefit to flow in coming quarters; 2) better-rated bureau score enquiries in every product is higher; and 3) MSME delinquency trend has shown QoQ improvement and utilisation rate has been rangebound. Maintain BUY with an unchanged target price of Rs1,818. Key risks: 1) Much-awaited lifting of credit card rollout embargo; and 2) higher-than-anticipated stress in HDB Financial.

- How we read Q1FY22 earnings: 1) NII growth moderated to sub-10% for the first time in past 10 years due to decline in yields. Rationale being a) low yielding corporate and home loan portfolio leading incremental growth; b) high yielding credit card portfolio declined 7% QoQ, particularly revolver balances; c) interest reversal impact on elevated slippages; d) high mandatory cash reserves. 2) Slippages at 2.54% were elevated relative to recent averages. As MSME delinquency trend has improved and corporate book is resilient, stress seems to be flowing from retail/agri segment. 3) With Rs 6 bn of contingency buffer, it carries cumulative credit-related contingency + floating buffer of 70bps; 4) sequentially, advances were up (contrary to declining trend anticipated for peers) that sustained YoY growth of >14%; 5) elevated stress pool for HDB Financial reflected in IGAAP NPA doubling QoQ to 7.75%. This is over and above OTR 1.0 restructuring pool of 8.7% of AUM by FY21.

- Read-through for other banks on a few aspects: 1) Trend of elevated slippages (than recent averages) due to second covid wave disruption will be reflected for other banks, too. 2) HDFC Bank has built further buffer (albeit marginal, of 5bps). Other banks, too, will create disruption buffers. 3) NII moderation and NIMs settling lower can be phenomena for other banks, too, particularly due to focus on building low risk portfolio, CD ratio moderation and incremental stress formation. 4) Deposit re-pricing benefit is almost nearing an end with decline in cost of deposits/funds arrested.

- Embarking on project 'Future Ready': The bank has unveiled project 'Future Ready' to add strength to its strategic and execution muscle. It includes: 1) Identifying growth engines (created new business segments of MSME and rural banking), 2) adding digital marketing as another key delivery channel, 3) expanding semi-urban and rural markets, 4) creating a new digital factory to foster innovation, and 5) putting in place the right talent and further strengthen its core functions to drive project 'Future Ready'.

- Slippages elevated at 2.54%; GNPA rose marginally to 1.47%: Amidst second covid wave disruption and management's 'employee safety first' approach restricting movement for collections/recoveries, slippages were elevated at 2.54% (compared to 1.6% in FY21 and 2.1% in FY20). Management highlighted MSME delinquency trend has improved and incremental MSME NPAs are lower than the previous quarter. Also, corporate book is resilient. This suggests stress is primarily flowing from retail/agri segment. Excluding agri, slippages would have been 2.2%.

Despite elevated slippages, with write-offs at Rs31bn (compared to Rs93bn for full year FY21), GNPAs settled at 1.47%, up 15bp QoQ and 11bp YoY. Also, the bank sold NPAs worth Rs18bn during the quarter and will consistently pursue sell-downs though quantum would tend to be volatile and more case specific. Net NPA at 0.48%, was up 8bp QoQ and 15bp YoY. Coverage ratio came off to 67.9% (vs past 5-year's average of ~70%). Slippages, though, seem to be a tad higher, better recoveries and improved collections will likely support asset quality trends in coming quarters.

- Besides higher specific provisioning, built contingency buffer further: On elevated slippages of 2.54%, the bank made specific provisions of Rs42bn and also created further contingency buffer of Rs6bn. This resulted in credit cost of 1.7% (relatively higher than FY21 run-rate of 1.5% but lower than our expectations). The bank now carries cumulative credit-related contingency + floating buffer of 70bps (comprising floating provisions of Rs14.5bn and contingency provisions of Rs66.0bn). Total provisions comprising specific, floating, contingency and general of Rs250bn is equivalent to 2.2% of advances or 146% of GNPAs. With improved recovery momentum and confidence in its inherent portfolio quality, we estimate credit cost to settle at ~1.3%/1.2% for FY22E/FY23E, respectively.

- Demand resolution and recovery trend encouraging in June & July: Demand resolution in April and May was impacted adversely, but recovery momentum June onwards has been encouraging. In June/July (MTD), it is back to Mar'21 levels that is just ~1% pps sigh of pre-covid levels. Furthermore, 0+dpd bounce rates have reverted to pre-covid levels. Overall bounce rates are almost 50% better than the industry average but for HDFC bank it is yet to fully revert to pre-covid levels. However, recovery is quite promising in June as well as July.

- Restructuring under OTR-1 at 70bps; approval of OTR 2.0 requests to flow in Q2FY22: Restructuring under OTR 1.0 has gone up marginally by 10bps post Mar'21 to 70bps (from Rs65bn to Rs78bn). Besides this, it has restructured MSME portfolio of Rs34bn by Mar'21 (30bps) and management indicated there is no further rise in MSME restructuring. Restructuring implemented under OTR 2.0 was mere Rs106mn (less than 0.01% of advances). This is because it has hardly been a month since the rollout of the scheme and a large part of restructuring is likely to complete by Q2FY22-end. It will be conservative in its approach providing it to borrowers with temporary business setback due to covid and will be on a selective case-on-case basis.

- Growth better than industry; investing and building capabilities for further growth: Sequentially, advances were up (contrary to declining trend anticipated for peers) that sustained YoY growth of >14%. This is commendable especially given disruption for major part of the quarter due to second covid wave and embargo on new credit card issuances. Credit growth was primarily driven by commercial and rural banking (up 4% QoQ/25% YoY). Also, corporate segment was up 1.5% QoQ (11% YoY), largely flowing from better-rated PSUs and quality NBFCs. Retail advances were down marginally QoQ primarily due to declining revolver credit card balances, adversely affected auto sales volume. Home loans and personal loans improved momentum thereby, supporting 9% YoY growth. With this Retail:Corporate portfolio mix for the bank stood at 47:53.

Within retail, credit card portfolio (5.3% of total loan book) was most impacted with 6.6% QoQ decline due to lower revolving balances and ban on credit card issuance to new customers. Home loans supported retail loan growth which was up 2.9% QoQ. On YoY basis, gold loans saw the highest uptick of 29.8% YoY.

For the first time, the bank has disclosed data on disbursements wherein retail disbursements (including home loans sourced under the arrangement with HDFC Limited) were ~Rs436bn vs Rs144bn YoY and Rs625bn QoQ indicating growth of 202% YoY but lower 30% QoQ impacted due to covid second wave.

Bank is beefing up resources to support the growth momentum - added 45 branches in Q1FY22 (with 150 branches in pipeline to be opened as situation normalises). It is also investing significantly in technology and focusing on semi-urban/rural areas.

With the overall economy on revival path and normalising, we believe, retail lending is also likely to resume its growth trajectory after the slight pause in FY21. Lifting of ban on credit card issuance to new customers would provide the required fillip to growth. Corporate and MSME growth may sustain which should result in overall loan growth of 18%/20% for FY22E/FY23E, respectively.

- NII growth moderation surprised negatively; NIMs at lower end of the guided range: NII growth moderated to decadal low of sub-10% due to decline in yields. Rationale being: a) Skew in favour of low yielding better-rated corporate and home loan portfolio; b) high yielding credit card portfolio declined 7% QoQ particularly revolver balances; c) interest reversal impact on elevated slippages; d) high mandatory cash reserves. Consequently, loan yield fell ~30bps QoQ thereby, settling NIMs at 4.1% - lower end of the management's guiding range.

Deposit re-pricing benefit is almost nearing an end with decline in cost of deposits/funds arrested. There was mere 6bp QoQ decline in cost of deposits, though on YoY basis, it is still down 102bps. Any incremental decline in loan yield will likely flow into margins in the absence of deposit cost benefit. HDFC Bank has been consistently guiding for 4.0-4.5% margins for the past several years and, as a policy, asset pricing is based on similar mark-up over deposit cost. Given the current normalcy in business operations and stable liability franchise, we expect margins to remain at similar levels (4.1%) in FY22E as well.

- Lower activity levels weigh on fee income; opex too down QoQ: Core fee income was up 74% YoY (though on a lower base), but down 23% QoQ. This was largely because business operations were curtailed for two-thirds of the quarter. As a result, retail loan originations, sale of third party products, card spends and efficiency in collection efforts were adversely impacted, more so for HDFC Bank as retail comprises 91% of its core fee income.

Treasury profits also came in lower at Rs6.0bn (compared to Rs6.6bn QoQ and Rs10.9bn YoY). Forex and derivative income on the contrary saw a better outcome, which stood at Rs12.0bn vs Rs8.8bn QoQ and Rs4.4bn YoY due to pick up in activity and spreads. Other income (including recoveries from written-off accounts) was also lower QoQ. Recovery from written-off accounts stood at 14bps as against 26bps QoQ.

Opex (ex-employee costs) saw a steep decline of 17% QoQ as business activities were curtailed. Staff cost movement was in-line with expectations at 3% QoQ rise and was up 10% YoY. With increased investments in strengthening technology infrastructure, building franchise, promotions etc., we expect cost/income to inch-up in the interim to 38-39% and later move towards its medium-term target of 35-36%.

- To consistently pursue down-selling opportunities: Management highlighted that in recent quarters, it has been witnessing growing interest from market participants to buy distressed assets. Hence, for Q1FY22, the bank sold assets worth Rs18bn, since it believes there is economic value in disposing off now rather than recovering on its own at a later stage. It will consistently engage in sell-downs though quantum would tend to be volatile and more case specific.

- MSME portfolio not showing signs of incremental stress build-up: MSME delinquency trend has shown improvement QoQ across all buckets - DPD 7+/15+/30+/60. Also, incremental MSME NPA formation has been lower QoQ while GNPAs have remained rangebound. There were incremental disbursements towards ECLGS scheme though not substantial - its disbursements under ECLGS 1.0 was slightly over Rs300bn (compared to Rs265bn in FY21), under ECLGS 2.0-3.0 was ~Rs25-30bn while very limited lending was towards ECLGS 4.0.

- HDB Financial Services (HDB) GNPAs almost double from 3.89% to 7.75%: GNPA based on approach followed by NBFC doubled to 7.75%. Given lending under this NBFC to customers is a notch below on quality curve, it is more susceptible to delinquencies in such disruptions. The bank is taking corrective action to address the same.

Credit cost came in at Rs4.7bn translating into run-rate of 3.3% (lower than >4% for Q4FY21). It has restructured 8.7% of gross advances under OTR 1.0 by Mar'21. It will be however crucial to understand the flow through from stage-2 to stage-3 and further forward flows into stage-2 as of Jun'21. Also, restructuring requests under OTR 2.0 will be a critical parameter to arrive at overall stress pool for HDB Financial.

On growth, disbursals were up 66% YoY (on a lower base) but fell 54% QoQ. As a result, AUM stood at Rs594bn vs Rs613bn QoQ. On profitability front, it reported profit of Rs1.3bn (similar to FY21 full year profit run-rate of Rs5bn, equivalent to <1% RoA).

Shares of HDFC Bank Ltd was last trading in BSE at Rs. 1443 as compared to the previous close of Rs. 1470.95. The total number of shares traded during the day was 196323 in over 12541 trades.

The stock hit an intraday high of Rs. 1454 and intraday low of 1436.25. The net turnover during the day was Rs. 283365956.

Source : Equity Bulls

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