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Low risk, high reward: The secret of HDFC Bank

HDFC Bank has posted profit growth of over 30% every year for the last decade, richly rewarding its investors


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

Even as Deccan, which also owned a glitzy cricket team, sought to reassure that it held enough assets to stave off a crisis, 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 has since lost its cricket franchise and its lenders, including heavyweight Ltd , Ltd 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 Bank, told Reuters in an interview, pointing to the bank's low bad loans of 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, Bank's conservative business model and its knack of delivering returns are proving unique, and offer a lesson for its hard-pressed competitors.

Bank has posted profit growth of over 30% every year for the last decade, richly rewarding its investors. India's number two private sector bank earlier this year climbed to be the country's biggest by market value, ahead even of State Bank of , which controls a quarter of the country's loans and deposits market.

Since 2008, Bank's shares have risen nearly 87%, while rival ICICI is down about 16%.

Thomson Reuters StarMine's models also paint a flattering picture of its shares, a third of which are held by foreign funds. Trading at five times its book value, 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 of a bank that has sky-rocketed from being a penny stock when it was launched in 1994 to a bellwether and which now features in Forbes Asia's 'fab 50' list of companies for its ability to weather the slowdown?

Bank has built its consistent growth through 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."

Bank is choosy about issuing credit cards, offering them mostly to existing customers to avoid delinquency, and it has steered clear of lending for two-wheeler purchases in some regions - risk-averse strategies that ICICI now emulates.

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

Competition Looms

For all its success, Bank faces stiff competition in its stronghold retail segment, where the default rate is low, as several lenders including ICICI, and Ltd have rushed to expand into home and auto loans.

With the central bank planning to issue new licences, the landscape could become even more competitive for 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 A S V Krishnan, an analyst at Ambit Capital, which rates Bank a 'sell' due to its high valuation.

The gloomy economic climate also poses a threat.

Loan growth in is expected to ease to around 15% in fiscal 2011/12 from over 20% in 2010 as a flagging 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 K.R. Choksey.

Bank hopes to grow 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.

"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 Bank. "If you want peace of mind, this is the bank for you."

First Published: Mon, November 19 2012. 08:29 IST