HDFC Bank: Limited NIM downside from current levels

May cut base rates in on-going quarter. Confident of keeping net interest margin 4.1 to 4.4%

As expected, HDFC Bank's net interest margin (NIM) compressed sequentially as well as over a year ago to 4.2 per cent in the September quarter. (NIM is the difference between the interest income generated by a financial institution and the interest paid to its lenders (for example, deposits), divided by the interest-earning assets.) This is largely on account of a sharp 35-basis-point base rate cut it took from September 1 onwards. (Banks are not allowed to lend below the base rate, which is linked to the cost of funds.) Higher growth in fixed deposits is another factor that hit NIM in the quarter. The management says that it may again cut its base rate in this quarter as the central bank has cut its repo rate sharply. (Repo rate is the rate at which the central bank lends money to commercial banks in the event of any shortfall of funds.) The cut will also depend on re-pricing of deposit rates in this period.

The bank remains confident of keeping NIM in 4.1 to 4.4 per cent gap. This is due to a lower proportion of base-rate-linked loans (30 per cent). A gradual re-pricing of deposits will provide some support to NIM, as will a higher current account savings account (CASA) ratio of 40 per cent. The CASA ratio shows how much deposit a bank has in the form of current and savings account deposits in the total deposit. A higher ratio means higher portion of the deposits from current and savings deposits, which are a cheaper source of fund.

Lower margin was compensated by higher loan growth and was partly responsible for the bank's robust loan growth of 27.9 per cent in the quarter. This is bank's highest loan growth in the past 18 quarters. Healthy traction in its home and personal loans, among others, fuelled retail loans in the quarter (up 29 per cent). Loans to corporates grew 23.4 per cent. Bank confident of achieving higher loan growth than the sector’s. Asset quality remained stable, with a fall in gross non-performing assets (NPA), as well as net NPA ratios, sequentially as well as over a year ago. The gross NPA and net NPA ratios stood at 0.91 per cent and 0.25 per cent, respectively.

Net profit grew in line with recent trends at 20.5 per cent year-on-year to Rs 2,869 crore. Healthy loan growth as well as fee income growth, coupled with stable asset quality, were the key factors driving earnings in the quarter. The net profit fell a bit short of Bloomberg consensus estimate of Rs 2,896 crore. Net profit was also aided partly by higher foreign exchange and derivative income and gains on re-valuation of investments, both of which are non-core and unsustainable revenue streams.

The bank stock closed at Rs 1,095 on Wednesday, with a marginal decline. It trades at 3.3 times FY17 estimated book value near its historical average one-year forward price/book value ratio of 3.4. Most polled by Bloomberg this month are positive on the bank. The average stock target price of Rs 1,242 indicates 13 per cent upside.