HDFC Bank: Class action suits may prove to be an interim dampener

The stock may underperform until the Street gets clarity on asset quality and outcome of the litigation

Just when the HDFC Bank stock was beginning to regain momentum, three US-based law firms filing class-action suits against the lender dragged its share price down by over 5 per cent in a week. On a year-to-date (YTD) basis, the stock has shed 18 per cent. These lawsuits pertain to vehicle loans, accounting for 11.8 per cent of the bank’s total loans. While the bank has denied the allegations and expects its response to the lawsuit to be due in early 2021, analysts feel the litigation could cap the stock’s upside until a verdict is reached. 

“Class action suits are common in the US and until proven guilty, they don’t materially impact the balance sheet,” says an analyst from a foreign brokerage. However, the analyst believes foreign investors may be reluctant to pile on to shares of firms facing such litigation.

The lawsuits are at a time when uncertainties around the sector are peaking. With the gross non-performing assets (NPA) ratio at 1.4 per cent in Q1, HDFC Bank’s loan assets are the best in class and may continue to remain so. Yet, investors have to be mindful of the fluctuating slippages and slowing growth in retail.

Though the moratorium extended to only 9 per cent of its loan book in Q1, the slippages ratio of 1.2 per cent indicated an accumulation of stress in its book. Analysts at JM Financial note that 4.7 per cent (or half) of borrowers who had availed of the moratorium did so only to conserve liquidity. Hence, customers opting for restructuring may be limited. However, banks have time until December for loan recast and even customers who hadn’t availed of the moratorium earlier can opt for the benefit if affected by the slowdown. Therefore, it may be too early to judge the direction of restructuring. Also, whether HDFC Bank takes an upfront hit on its financials if loans aren’t recast will be known only by January.

As for growth, for the first time in over six years, HDFC Bank’s retail book shrunk 4 per cent sequentially in Q1, while its corporate book expanded 6 per cent. Accounting for 47 per cent of the total book, a prolonged slowdown in the retail segment may skew the NPA numbers unfavourably and dampen the bank’s fee income. Among private banks, at 24 per cent weighting to total income, HDFC Bank’s dependence on fee income is relatively high. 

In other words, there are multiple moving parts that can impact the bank’s financials going forward. With lawsuits compounding existing concerns, investors’ attention on the stock may be elevated in the near term.