Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

HDFC Bank Demonstrating prowess in difficult times

Promoted by HDFC, HDFC Bank is Indias leading private sector bank with an enviable asset quality and a consistent growth record. The bank has created a strong brand name for itself in the banking space by gaining market share and through consistent performance on the operating front. Post merger of CBoP, it has a strong distribution network with 2201 branches and 7110 ATMs in 1174 cities. We initiate coverage on HDFC Bank with a BUY rating and a price target of `635.9 /share, implying an upside potential of 20.8% from current levels.

Rating
Buy

CMP
526.5

Target
635.9

Upside %
20.8

Source: NSE, ABML Research

Risk Return Matrix

Low Medium High

Investment Arguments
Low cost liability profile remained largely unscathed post de-regulation of savings rate CASA to decline moderately in the coming quarters led by migration to high rate term deposits HDFC Bank has one of the best liability profiles in the banking space with one of the highest CASA as a % of total deposits. The bank has been maintaining a CASA of ~50.0% over the past few years, helping it in keeping its cost of funds at lower levels. The banks aggressive expansion to semi-urban and rural areas has helped it to keep the momentum in new savings accounts accretion despite higher term deposit rates and hike in savings rate by some competitors post deregulation of savings rate. Going forward we expect CASA to decline moderately from 47.6% at the end of Q3FY12 to 47.0% by FY13E. Impeccable asset quality with lowest restructured assets amongst the peer group Asset quality to witness slight deterioration going forward - HDFC Bank has one of the best asset quality amongst the peer group with gross NPA at 1.0% (NNPA at 0.2%). Total restructured assets were 0.4% of the Banks gross advances (0.3% included in NPAs) as of Q3FY12. However we believe the asset quality to witness slight deterioration going forward on the back of higher slippages in the coming quarters (with stress visible in some sectors) and normalization of recoveries and write-offs. We expect the GNPA to inch towards 1.13% in FY12E and likely to peak at ~1.21% by FY13E. Strong fee income provides diversification to the revenue stream and aides in higher return ratios - Growth to remain moderate going forward - HDFC Bank has a strong and diversified source of fee based income that helps the bank to maintain higher return ratios (ROAA at ~1.6-1.7%). We believe, the Banks strategy to cross sell wide range of financial products and services by leveraging the existing client relationships is likely to boost profits through fee and fund based income going forward. We expect the fee income to grow by 17.9% and 19.7% for FY12E and FY13E respectively. Advance book growth to moderate slightly in the current fiscal - Retail loan book to drive the loan book growth - HDFC Bank has always maintained above industry growth in credit (~24% to 27%) in the past. During the current fiscal the management has guided for 34% above industry growth in credit. We expect credit to grow by ~ 22.0% in FY12E and 24.0% in FY13E.Going forward, we believe the growth in credit will be broad based with growth in retail book likely to be higher than the corporate loan book. Operating expense ratio to remain stable despite aggressive branch expansion plans mainly led by modest NII growth and technological up gradation leading to cost efficiency HDFC Bank has witnessed improvement in its operating efficiency over past two years with cost to income ratio falling to 48.1% in FY11 from 51.7% in FY09. We expect C/I ratio to remain fairly stable going forward despite aggressive branch expansion plans mainly driven by modest Net Interest Income (NII) growth in a challenging environment, aggressive investment made in technological up-gradation and continuous improvement in employee and branch productivity. Valuations We estimate HDFC Bank to report an EPS CAGR of 28.3% over FY11-FY14E. ABV is estimated to grow at 19.0% CAGR during the same period. The banks strong asset quality, superior return ratios, strong asset growth and adequate capitalization bodes well for its future growth. HDFC Bank has always commanded a premium valuations vis--vis its peers due to its track record of consistent growth in earnings and assets. We initiate coverage on HDFC Bank with a BUY rating and March13 price target of `635.9 /share (based on 3.5x March-14E ABV which is five year average one year forward multiple), implying an upside of 20.8% from current levels.
Return

Low

Medium

High

Risk
Source: ABML Research

Company Data
BSE Code NSE Code Equity Capital (` mn) Face Value (`) Market Cap (` bn) Avg Daily Volume (Qtly) 52 week H/L (`)
Source: NSE, BSE

500180 HDFCBANK 4682.6 2.0 1232.7 3602234 537.9/400.3

Shareholding (%)
Holders Promoters FIIs MFs/Banks & FIs Public & Others Source: BSE Dec 11 23.20 29.67 10.87 36.26 Sep 11 23.23 29.30 10.97 36.50 Jun 11 23.28 29.23 11.14 36.35

Chart: HDFC Bank vs. Sensex

130 125 120 115 110 105 100 95 90 85 80 Dec-11 Feb-11 Jun-11 Oct-11 Apr-11 Aug-11 Feb-12 Relative Performance

HDFC Bank Return

Sensex Return

Source: Capitaline

Analyst Details
Sumit Jatia 022-42333460 sumit.jatia@adityabirla.com

Financial Snapshot (` mn)

In ` mn FY11 FY12E NII 105431 122728 YoY (%) 26 16 Operating Profit 77254 90220 YoY (%) 20 17 25 Net Profit 39264 51248 65600 YoY (%) 33 31 28 NIM (%) 4.6 4.2 4.2 EPS (`) 16.9 21.9 28.0 YoY (%) 31 30 28 ABV (`) 107.8 125.2 146.4 RoAE (%) 16.7 18.6 20.3 RoAA (%) 1.6 1.6 1.7 P/E (x) 31.2 24.1 18.8 P/ABV (x) 4.9 4.2 3.6

FY13E 154768 26 112796 Source: Company, ABML Research

Page No. 1

Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Industry Section
Macroeconomic scenario deteriorated sharply, however, signs of improvement witnessed off-late The risk emanating from macroeconomic environment have increased sharply in the current fiscal on the back of Weakening domestic growth - Indias GDP growth slowed to 6.9% in the July-September quarter from 7.7% in Q1 FY12 and 8.8% YoY, on account of a sharp deceleration in industrial growth due to rising interest rates. The first half of 2011-12 saw a slower growth of 7.3% in overall GDP compared to 8.6% in the first half of 2010-11. The set back to economic growth in the first half of the current fiscal year was on account of a decline in mining output and weak growth in manufacturing and construction sector. RBI in its credit policy on 24 January 2012 has revised GDP growth downwards from 7.6% to 7.0% considering increase in global uncertainty, weak industrial growth, slowdown in investment activity and deceleration in the resource flow to the commercial sector. Index of Industrial Production - In Oct, 2011, Indias industrial production growth fell to -5.1% sharply below expectations, as output levels contracted across all categories. For the AprilSeptember 2011 period, IIP grew by only 5.0% as against 8.2% YoY. The cumulative impact of rising interest rates coupled with global growth slowdown has taken a toll on IIP numbers

Chart 1 Quarterly GDP Growth

12 10 (%)

Chart 2- Slowdown in IIP growth

15 10 (%) 5 0 -5

8 6 4 Mar-07 Mar-10 Sep-05 Dec-04 Sep-08 Dec-07 Sep-11 Dec-10 Jun-06 Jun-09

-10 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar FY11 FY12

GDP Growth
Source: Bloomberg, ABML Research

Signs of improvement, however its sustainability is a serious concern Post sharp deceleration in IIP in October, the index rose at a better-than-expected 5.9% YoY in Nov, 2011, supported by a revival in consumer goods & basic goods. In December the growth again moderated to 1.8% on account of contraction in capital goods and mining sectors along with weakness in manufacturing sector which dragged the overall industrial growth down. We believe the sustainability of IIP numbers is a concern as the growth in major sectors like capital goods and chemicals continues to be in the negative territory (account for 25% of the manufacturing sector). Inflation stabilizing, however non-food manufactured inflation still at elevated levels RBI to adopt calibrated approach in cutting rates - Headline WPI inflation, which averaged 9.7% YoY during AprilOctober 2011, moderated to 9.1% in November and further to 7.5% and 6.55% in December and January respectively. The decline in inflation was driven largely by a decline in primary food and non-food articles inflation. Primary articles inflation, which was in double digits for over two years from September 2009 to October 2011, moderated to 8.5% in November and further to 3.1% in December. This benefit has, however, been offsetted to a large extent by the lower than expected moderation in non-food manufactured products inflation and fuel inflation (led by higher global crude oil prices and rupee depreciation). The monetary easing, we believe, going forward would be a consequence of manufacturing inflation coming down coupled with the favourable currency. The RBI said in its credit policy statement that - In the absence of credible fiscal consolidation, the Reserve Bank will be constrained from lowering the policy rate in response to decelerating private consumption and investment spending. We believe RBI would go for a rate cut post the forthcoming Union Budget which is expected to signal fiscal consolidation in a more sustainable way.

Chart 3 Inflation cooling off

12 10 8 (%) 6 4 2 0 Jan-10 Jul-10 Inflation 2 1 -1 -2 -3 -4 Jan-11 Jul-11 Jan-12 Real Rate of Return (%) 0

Chart 4 Key policy rates

10 9 8 7 6 5 4 3 May-08 May-09 May-10 May-11 Jan-09 Jan-10 Jan-11 Sep-08 Sep-09 Sep-10 Sep-11 Jan-12 Jan-08

(%)

CRR

Repo Rate

Reverse Repo

Source: Bloomberg, ABML Research

Page No. 2

Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Rising fiscal deficit Lower than expected tax revenue collection due to growth slowdown coupled with dim prospects for disinvestment has put significant strain on the countrys fiscal deficit target for the current fiscal. Added to this sticky oil price and increase in subsidy expenditures (primarily food, fertiliser & fuel) has further aggravated the deficit. Indias fiscal deficit in the first eight months of FY12 touched `3.53 tn, accounting for 85.6% of the budgeted `4.13 tn for the current year (49% in the same period last year). The government has raised its borrowing target twice in the last five months by `928.72 bn. This takes the gross market borrowing target for 2011-12 to `5090 bn as against the earlier target of `4170 bn set out in the budget. Bonds yields stable, heavy government borrowing and continued fight against rupee depreciation kept liquidity under pressure Based on the expectations of rate cuts, benchmark 10 year government bonds yield that hit a high of 9.0% in November have cooled to ~8.2% now. In its mid quarter policy review RBI stated on 16 December 2011 that further rate hikes might not be warranted. It stated that monetary policy actions are likely to reverse the rate hike cycle. Added to this, OMOs, which are conducted by the RBI to infuse liquidity in the system has further aided in bringing the bond yields lower. The apex bank has purchased government securities worth over `820 bn from the money markets in nine instalments in the past two months as part of efforts to infuse liquidity into the system. Increased government borrowing coupled with continued fight against rupee depreciation has kept the liquidity under pressure. Due to the present tightness, banks have been borrowing more than `1100 bn daily, on average, since November from the repo window of RBI. Despite several steps by the central bank in recent times, such as reducing CRR and infusing money via open market purchases of government bonds, the liquidity deficit continued to be much above the comfort zone of RBI(~ `500 bn). Going forward we believe liquidity to remain under pressure for some more time owing to factors like advance tax payment and higher government borrowings.

Chart 5 Government bond yields Stable after sharp fall

Chart 6 Reverse Repo Outstanding

1,500 1,000

9.0

8.5 (%)

500 (` bn)

8.0

(500) (1,000)

7.5 Jan-11

(1,500)

Apr-11

Jul-11

Oct-11

Feb-12

GIND5YR Index
Source: Bloomberg, ABML Research

GIND10YR Index

(2,000) Jan-10

Jun-10

Nov-10

Apr-11

Sep-11

Feb-12

Declining corporate profitability Corporate profits had fallen by 13.2% in the first half of 2011-12 on the back of steep rise in raw material, fuel prices and high interest rates. Besides this sharp depreciation in rupee since September 2011 brought MTM losses to companies which further pulled down profits. A study by CRISIL Research reveals that the interest coverage ratio of Indian companies in the S&P CNX 500 Index has dipped to a five-year low. The median interest coverage ratio has fallen to 4.8 times in July-Sept, FY12 quarter against average interest coverage for the past five years at 8.4 times. However, we believe corporate profits to revive in March quarter on the back of possible reversal of the currency losses generally; robust growth in banking profits due to lower provisioning and low base. Added to this reversal of interest rate cycle going forward coupled with stabilizing global uncertainty is likely to revive the capex cycle which remained sluggish in the current fiscal.

Banking industry outlook Credit growth to pick up with the reversal of interest rate cycle We expect credit growth in the current fiscal to remain subdued on account of project delays, low capex related demand for loans and subdued retail loan growth in the current elevated interest rate scenario. The key sectors that will be a drag on the credit growth would be metals, gem & jewellery, infrastructure sector (led by power and telecom sector). Power sector growth would be affected by delays in execution of projects and issues related to increasing coal prices. However, we believe the credit growth to gain momentum in the next fiscal with the reversal of interest rate and gradual revival of economic growth. We expect the credit to grow by ~16-17% in the current fiscal in line with the RBIs growth target.

Page No. 3

Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Chart 7 Credit and Deposit growth

26 24 22 20 18 16 14 12 10 8 6 Nov-10 Nov-11
4.0 Phase I Phase II Phase III 3.5 3.0 (%) 2.5 2.0 1.5 1.0 200609 200612 200703 200706 200709 200712 200803 200806 200809 200812 200903 200906 200909 200912 201003 201006 201009 201012 201103 201106

(%)

Feb-10

Apr-10

Apr-11

Jan-11

Jun-11

Sep-09

Deposit Growth
Source: Bloomberg, ABML Research

Sep-10

Dec-09

Credit Growth

Slippages near its peak - Asset quality to deteriorate further in Q4 on account of stress visible in various sectors together with lag effect of rising interest rates and slowing growth The primary sources of stress on asset quality include telecom, commercial real estate, state-owned utilities, electricity boards, metals and airlines. These sectors are experiencing financial strain owing to highlyleveraged balance sheets, inadequate cash flow from operations and changes in the regulatory landscape. Historically it has been seen that strong credit growth was synonymous with lowering of the risk perceptions leading to noticeable improvement in asset quality, whereas slow down in credit growth was followed by increase in impaired assets. During March 2007 - September 2008, while the outstanding credit growth remained relatively high at about 24%, NPAs had either decelerated or grew very modestly, as against which during the slow down phase i.e. between December 2008 December 2009 when the credit off-take started declining and fell to 12-13% in December 2009, the NPAs rose sharply from about ~2.1% to ~2.6%. In the third phase i.e. 2010-11 as the credit growth picked up to the pre crisis level, there was substantial deceleration gross NPAs. Apart from reflecting cyclicality, the pattern was also indicative of impairment in assets being actually initiated during phases of rapid credit growth. We believe in the current adverse macroeconomic scenario when the credit growth is expected to slow down, we might see incremental slippages going forward as the historical trend suggest. However, we believe the reversal of rate cycle might trigger a fresh demand for loan post FY12 and consequently asset quality might also peak out. Chart 8 Historical Trend in Credit Growth and GNPA

35 30 25 (%) 20 15 10 5 0

Credit Grow th
Source: RBI, ABML Research

GNPA

Sector Outlook
Banks have delivered strong Q3 numbers driven by lower than expected slippages, higher other income and modest growth in NII. Private sector banks have outpaced PSU banks during the quarter mainly led by strong core business growth and lower slippages relatively. The gross NPA for PSBs, rose from 2.3% of advances in Q3FY11 to 3% at the end of the Q3FY12. In contrast, private banks reduced their gross NPA ratio from 2.5% to 2.1% over the same period. With a sharp rise in bad loans, PSBs have had to increase provisions too. During the nine months ended December 2011, the provisions of PSBs went up by 53%, while that for private banks fell by 25%. However improvement in margins during the quarter, offsetted the increase in provisions to some extent.

Page No. 4

Aug-11

Jan-12

Jul-09

Jul-10

Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Overall we have a positive view on the banking sector as we believe the recent policy actions by the government to resolve various contentious issues in power sector related to fuel security and linkages coupled with change in RBIs monetary policy stance is likely to alleviate asset quality concerns to some extent. We prefer private sector banks over PSUs as we believe they are well placed in terms of capital adequacy, thus removing the overhang from capital dilution which will drive return ratios going forwards. We believe forthcoming Union budget will be a key event which might signal fiscal consolidation in a more sustainable way and help RBI ease monetary policy. As interest rates start moving downward and monetary conditions become easier, we will see the capex cycle gaining momentum and consequently the credit off take.

Investment Rationale
Low cost liability profile remained largely unscathed post de-regulation of savings rate CASA to decline moderately led by migration to high rate term deposits HDFC Bank has one of the best liability profiles in the banking space with one of the highest CASA as a % of total deposits. The bank has been maintaining a CASA of ~50.0% over the past few years, helping it in keeping its cost of funds at lower levels. The deregulation of savings bank rate by RBI in October 2011 aimed at providing greater flexibility to the banks in fixing rates for the savings account, was perceived to have negative impact on the banks with high CASA as it might trigger flight of deposits to banks offering higher savings rates. However, the impact was minimal as till date only three banks have increased the rate including Yes Bank, Indusind Bank and Kotak Mahindra Bank (which are relatively smaller in size controlling 7% of the total business with major presence in metropolitan cities) with no large banks going for a rate hike. HDFC Bank has managed to maintain its CASA balance despite higher term deposit rates and hike in savings rate post deregulation of savings rate, on the back of aggressive branch expansion over the last one year. Chart 9 Quarterly CASA movement
100% 80% 60% 40% 20% 0% 30 21 Q3FY10 30 22 Q4FY10 29 20 Q1FY11 30 20 Q2FY11 32 19 Q3FY11 30 22 Q4FY11 31 18 Q1FY12 30 17 Q2FY12 30 18 Q3FY12 48 48 51 49 50 47 51 53 51

Chart 10 CASA ratio Peer group comparison

50% 45% 40% 35% 30% 25% 20% HDFC Bank SBI Axis ICICI PNB BoB 27.4% 47.6% 47.5% 42.2% 42.1% 36.3%

Current Deposits
Source: Company, ABML Research

Savings Deposits

Term Deposits

However, we believe in the current elevated interest rate scenario, the bank may see some flight of deposits from savings to higher yield term deposits. On the flip side aggressive branch expansion plans of the bank is likely to partly offset the decline in CASA going forward. The bank opened 421 branches in last 12 months the highest ever branch addition till date. As of December 31, 2011, the Banks distribution network is spread across 2201 branches and 7110 ATMs in 1174 cities. We expect the bank to take the total number of branches to ~2600 by FY13E. In Q3FY12 the bank registered a slight improvement in CASA sequentially from 47.3% to 47.6% despite high fixed deposit rates and some flight of deposits from savings account post deregulation of savings rate. The banks aggressive expansion to semi-urban and rural areas has helped it to keep the momentum in new accounts accretion. Going forward we expect CASA to decline moderately from 47.6% at the end of Q3FY12 to 47.0% by FY13E.

Chart 11 Trend in CASA

1600 1200 (in ` bn) 44% 800 400 0 FY08 FY09 CASA
Source: Company, ABML Research

Chart 12 Trend in branches

60% 52% 53% 55% 50% 47% 47% 45% 40% 35% 30% FY10 FY11 FY12E FY13E CASA as a % of deposits

55%

3000 2500 2000 1500 1000 500 0 FY08 FY09 FY10 FY11 FY12E 761 1725 1412 1986 2276

2606

Number of Branches

Page No. 5

FY13E

Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Impeccable asset quality with lowest restructured assets among the peer group - Asset quality to witness slight deterioration going forward - HDFC Bank has one of the best asset quality amongst the peer group with gross NPA at 1.0% of gross advances and net NPA at 0.2% of net advances. Total restructured assets were 0.4% of the Banks gross advances (0.3% included in NPAs) as of December 31, 2011. The bank has been able to maintain its asset quality despite its strong presence in high yielding risky segments like credit card, personal loans, etc mainly on the back of disciplined credit risk management and focused retail strategy. The banks slippages during FY11 were lowest in the preceding 5 years at 1.13%. The absolute addition to gross NPA has been fairly stable over the past few quarters (as can be seen from the graph below). Besides this, higher recoveries and write-offs further eased pressure on asset quality. However we believe the asset quality to witness slight deterioration going forward on the back of higher slippages in the coming quarters (with stress visible in some sectors) and normalization of recoveries and write-offs. The pace of recoveries and write-offs which has been a key reason for the banks improving asset quality is coming off, with the rundown of slippages added few years back. We expect the GNPA to inch towards 1.13% in FY12E and 1.21% by FY13E with slippages at around 1.29% and 1.17% respectively going forward.

Chart 13 Quarterly Gross NPA movement Peer group comparison

120 100 in ` bn 80 60 40 20 0 Axis Bank HDFC Bank

Q3FY11

Bank of Baroda
Q1FY12

Punjab Natl.Bank
Q2FY12 Q3FY12

ICICI Bank

Q4FY11

Source: Company, ABML Research

The banks NPA is well diversified across various segments with no major single exposure to any one segment. Besides this it has a conservative provisioning policy which provides it a cushion against any adverse macroeconomic events. The bank has been providing for floating provision (counter cyclical buffers) and contingency provisions (on account of MFIs) besides specific loan loss provisions over the last few quarters. The banks provision coverage is comfortable at 80.3% as at December 31, 2011.

Chart 14 Asset Quality to deteriorate slightly

2.5 2.0 2.0 1.5 1.0 0.5 0.5 0.0 FY08 FY09 FY10 FY11 FY12E FY13E Gross NPA (LHS) Net NPA (LHS) 0.6 0.3 0.2 0.2 0.2 50 40 Prov. Coverage (RHS) 1.4 1.4 1.0 1.1 1.2 80 70 60 90

Chart 15 Peer group comparison Lowest impaired asset

5.0 4.0 3.0 (%) 2.2 2.0 1.0 0.0 SBI ICICI Bank PNB
GNPA

4.6 3.8

(%)

2.4 1.5 0.8 1.1 0.5

(%)

1.1 0.4 Axis Bank

1.0 0.2 HDFC Bank

BoB
NNPA

Source: Company, ABML Research

Margin profile largely stable Matched funding book to keep the margins at around current levels HDFC bank has been maintaining margin at ~ 4.0%+ over the last few years mainly driven by high CASA base and its unique loan book positioning. The banks margin profile is relatively stable vis--vis its peer group as ~ 80.0% of the loan book is fixed rate loan with matched funding book on the deposit side. In the retail side ~ 95.0% of the book is fixed in nature. On the other hand, in the wholesale side the bank provides working capital loans to corporates which constitutes ~ 70.0% of the total wholesale book. Working capital loans are short term in nature leading to faster repricing. Besides this the bank is currently focusing towards high yielding retail loans which are likely to provide some support to the margin. The bank has run off some low yielding short term corporate loans and consciously remained slow on the corporate book while expanding the retail book during Q3FY12. During the current fiscal the management has indicated that the margins are likely to move in a range of 3.9%-4.2%.

Page No. 6

Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Chart 16 NII and NIM movement

Chart 17 Peer group comparison NIMs (TTM)

210 190 170 (in ` bn) 150 130 110 90 70 50 FY10 84 4.5%

4.6% 155 123 105 4.2% 4.2%

191

4.7% 4.6% 4.5% 4.4% 4.3% 4.2% 4.1% 4.0% 3.9%

4.5 3.5 (%) 2.5 1.5 0.5

4.2

3.9

3.6

3.6 3.1

4.4%

2.0

FY11 NII

FY12E

FY13E

FY14E

NIM (%)

HDFC Bank

PNB

SBI

Axis Bank

BoB

ICICI Bank

Source: Company, ABML Research

Advance book growth to moderate slightly in the current elevated interest rate scenario Retail loan book to remain strong - HDFC Bank has always maintained above industry growth in credit (~24% to 27%) in the past. During the current fiscal the management has guided for 3-4% above industry growth in credit. We expect credit to grow by ~ 22.0% in FY12E and 24.0% in FY13E. The banks advance book is equally shared between corporate and retail segment. Going forward, we believe the growth in credit will be broad based with growth in retail book likely to be higher than the corporate loan book. In Q3FY12 the banks retail loan book grew at a healthy ~30.0% as against the market expectation of some slowdown in the current elevated interest rate scenario partly attributed to the rising income levels of the middle class and banks geographical expansion into Tier2 and Tier3. The retail loan book is well diversified among 6-7 major segments including auto loans, personal loans, business banking, CV/CE and housing loans. The diversified nature of the loan book helps the bank to maintain consistent growth as slowdown in any segment is partly offsetted by strength in others. The growth in the wholesale book stood at 15.0% YoY (-2% QoQ) at the end of Q3FY12. The bank has run off some low yielding short term corporate loans and consciously remained slow on the corporate book while expanding the retail book. However, the management has indicated that it has the flexibility to grow its wholesale book to some extent in the pace at which it wants it to grow depending on the interest rate environment and the margins that the bank earns on the marginal corporate assets.

Chart 18 Advance book mix

100% 80% 60% 40% 20% 0% Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12 50.2 44.6 44.1 48.7 50.1 47.8 49.3 50.3 49.8 51.3 49.9 52.2 50.7 49.7

Chart 19 Credit growth comparison HDFC Bank vs Industry

45 40 40.9 38.2 33.1 27.1 21.9 19.15 21.38 15.4 18.1 15.94 24.42 19.9 21.42 21.0

55.4

55.9

35 (%) 30 25 20 15 10

Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12 HDFC Bank Industry

Retail Advances
Source: Company, ABML Research

Wholesale Advances

Page No. 7

Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Adequately capitalized to support its growth plans No capital dilution over the next two years to keep return ratios high HDFC Bank is well capitalized with CAR of 16.3% (Tier 1 of 11.2%). The bank has no plan to raise capital over the next two years, thus removing the overhang of capital dilution in the current market conditions. This would support the return ratios of the bank. The bank proposes to maintain its CAR in the band of 13.0%-13.5% in the coming years with Tier-I between 8.0% and 8.5%. With such a strong capital base, HDFC bank is all set to support its growth plans going forward.

Chart 20 Quarterly movement in CAR

20 16 (%) 12 8 4 0 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12 13.8 13.3 18.3 4.5 17.4 4.1

Chart 21 CAR Peer group comparison

16.3 3.9

17.0 4.3

16.3 16.2 4.2 4.0

16.9 5.5

16.5 16.3 5.1 5.1

20 16 (%) 12 8 4 0

18.9 16.3 13.1 11.2 9.3 13.5 11.8 8.3 11.6 7.6 11.5 7.9

12.4

12.7

12.1

12.2

11.4

11.4

11.2

Tier 1 (%)

Tier 2 (%)

ICICI Bank

HDFC Bank

Axis SBI Bank CAR (%) Tier 1 (%)

BoB

PNB

Source: Company, ABML Research

Strong fee income provides diversification to the revenue stream and aides in higher return ratios Growth to remain moderate going forward - HDFC Bank has a strong and diversified source of fee based income that helps the bank to maintain higher return ratios. The substantial contribution of non interest income to total net income reflects the diversified revenue base of HDFC Bank. Since its inception, non interest income contributed on an average ~30.0% to its total net income. The robust growth in other income (CAGR growth of 31.0% over FY06-11) has helped the bank to maintain higher return ratios in the range of ~1.6% over the past few years. The banks principal sources of fee and commission revenue are retail banking services, retail asset fees and charges, credit card fees, home loan sourcing commissions, cash management services, documentary credits and bank guarantees, distribution of third party mutual funds and insurance products and capital market services. Due to some regulatory changes that resulted in the capping of earnings from the distribution of insurance products, the bank has seen slight moderation in income from distribution of third party mutual funds and insurance products. However, the increase in Banks sales volumes made up partly for the reduction in units commission. Going forward, the management feels the growth to remain in the range of 15.0-19.0%. We believe, the Banks strategy to cross sell wide range of financial products and services by leveraging the existing client relationships is likely to boost profits through fee and fund based income going forward. We expect the fee income to grow by 17.9% and 19.7% for FY12E and FY13E respectively.

Chart 22 Non-interest income as a % of Net Revenue

70 60 50 (in ` bn) 40 30 20 10 0 FY09 FY10 FY11 FY12E FY13E Non Interest Income
Source: Company, ABML Research

Chart 23 Trend in Return Ratios

33% 32% 31% 30%
(%) 20.0 15.0 10.0 1.42 5.0 0.0 FY09 FY10 FY11 FY12E ROAA (RHS) FY13E ROAE (LHS) 1.3 17.2 18.6 16.3 16.7 1.64 1.57 1.45 1.73 1.7 (%) 25.0 20.3 1.9

32.2% 30.7% 39.8 32.9 29.1% 29.4% 43.4 51.1

61.2

29% 28.3% 28% 27% 26%

1.5

As a % of Net Revenue

Page No. 8

Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Operating expense ratio to remain stable despite aggressive branch expansion plans mainly led by modest Net Interest Income growth and technological up gradation leading to cost efficiency HDFC Bank has witnessed improvement in its operating efficiency over past two years with cost to income ratio falling to 48.1% in FY11 from 51.7% in FY09. We expect C/I ratio to remain fairly stable going forward despite aggressive branch expansion plans mainly driven by modest Net Interest Income (NII) growth in a challenging environment, aggressive investment made in technological up-gradation and continuous improvement in employee and branch productivity. We expect NII to grow at a CAGR of 21.2% over FY11-FY13E driven by robust loan growth (CAGR growth of 23.0%), stable CASA base (leading to cost minimization) and healthy yield on investments. Besides this, the banks huge capex plan in technological up-gradation (aggregate capital expenditure of approx `15.1 bn including `9.7 bn to upgrade and expand hardware, data center, network and other systems) during the current fiscal will boost efficiency, thereby helping it in keeping operational cost ratios fairly stable going forward.

Chart 24 Trend in cost ratios

54% 5.6% 51.7% 6.0%

Chart 25 Improving branch and employee productivity

2500 2000 0.91 0.70 0.57 0.43

1.03

1.2 1.0 0.8 (in ` mn) 0.6 0.4 0.2 0.0

52%

5.0%

50% 49.9% 48% 3.5% 2.9% 46% FY08 FY09 FY10 FY11 FY12E FY13E Cost / Income Ratio (LHS) 48.0% 48.1% 48.1% 47.8%

4.0%

(in ` bn)

1500 1000 500 0 FY09

3.0% 2.9% 2.7% 2.7% 2.0% Opex / Avg Assets (RHS)

FY10

FY11

FY12E

FY13E

Business Per Branch (in bn)

Profit Per Empl (in mn)

Source: Company, ABML Research

Low duration investment book to benefit in reporting MTM gains going forward as liquidity situation eases and yields at the shorter end of the yield curve comes off The average duration of the banks total investment book is quite low at 1.5 with 60.0% in HTM category and 40.0 %in AFS category (which is subject to mark to market). During 9MFY12, the bank reported MTM losses as the yields at the shorter end of the yield curve increased more aggressively than the longer term bonds on account of liquidity squeeze in the system. This can be gauged from the fact that the average increase in the yield for the short maturity bonds (3 month to 1 year) was ~100 bps during 9MFY12 as against 56 bps for 10 year bonds. Similarly post 9MFY12 the average increase for the short duration bonds was ~10 bps as against a decline of ~26 bps for 10 year bonds. So far the central bank has not succeeded in easing liquidity pressure in the banking system despite 50 bps cut in CRR and conducting multiple OMOs to infuse liquidity into the system (~`820 bn till date). We expect RBI to go for another cut in CRR the near term as the liquidity pressure further aggravated due to state elections and intervention by the RBI to stabilise rupee. We believe as the liquidity situation improves going forward, the shorter end of the yield curve will fall more aggressively than the longer term, thus benefiting the bank in generating MTM gains.

Chart 26 Investment Book Break-up

Chart 27 Movement in Yield curve

8.8 8.6 8.71

8.55

8.50 8.39

AFS & HFT 40%

8.46

8.55

8.4 8.2 (%) 8.0 7.8 7.6 7.4

HTM 60%

8.42

8.41 8.12

8.45 8.27 7.96 8.30 8.19 7.99

7.2 7.0

7.45 7.25 3m 6m 16-Feb-12

7.51

1Yr

5Yr 31-Dec-11

10Yr

15Yr 1-Apr-11

Source: Company, ABML Research

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Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Peer Group Analysis

HDFC Bank is competitively placed among its peers and is one of the most consistent performer in the banking space. The banks net profit grew at a CAGR of 32.3% over the last three years as against the peer group average of 21.0%. We expect the bank to continue to deliver robust growth in NII (CAGR 21.9% FY1114E) and earnings (CAGR 28.6% FY11-14E) going forward. The stock currently quotes at a premium to its peers (TTM P/ABV of 4.2x for HDFC Bank vs. 2.1x for peer group). Considering the banks strong growth prospects, favourable asset quality, adequate capitalization and higher branch and employee productivity, we believe the stock deserves a premium valuation as compared to its peer group.

Particulars (In ` mn) Net Interest Income* (in ` bn) CAGR Growth (3 yrs) (%) PAT* (in ` bn) CAGR Growth (3 yrs) (%) EPS* ABVS** Deposits (in ` bn)** Advances (in ` bn)** No of Branches** Mkt Cap (in ` bn) Key Ratios NIM (%)* GNPA (%)** NNPA (%)** CAR (%)** Tier 1 (%)** Mkt Cap / Branch (in mn) Business / Branch (in bn) Profit / Branch (in bn) ROAA (FY11) (%) ROAE (FY11) (%) Valuations Price P/E P/ABV

HDFC Bank 117.5 17.7 48.3 32.3 58.5 124.2 2325 1958 2201 1232.6

ICICI Bank 101.4 6.9 60.2 13.0 52.2 511.2 2606 2462 2552 1116.7

Axis Bank 75.7 29.6 39.9 35.7 96.9 520.0 2087 1487 1484 505.1

BoB 101.3 29.4 47.8 39.8 124.6 583.4 3492 2607 3691 338.1

PNB 131.3 25.5 46.6 19.0 147.9 540.9 3565 2626 5393 334.8

SBI 396.5 23.9 76.8 -2.4 120.9 837.9 10010 8694 13946 1492.5

4.2 1.0 0.2 16.3 11.2 560.0 1.9 21.9 1.6 16.7

2.0 3.8 0.8 18.9 13.1 437.6 2.0 23.6 1.4 9.7

3.6 1.1 0.4 0.0 0.0 340.4 2.4 26.9 1.7 19.3

3.1 1.5 0.5 13.5 9.3 91.6 1.7 13.0 1.3 23.5

3.9 2.4 1.1 11.5 7.9 62.1 1.1 8.6 1.3 24.5

3.6 4.6 2.2 11.6 7.6 107.0 1.3 5.5 0.7 12.6

526.5 9.0 4.2

968.8 18.6 1.9

1224.3 12.6 2.4

863.5 6.9 1.5

1056.7 7.1 2.0

2350.4 19.4 2.8

Source: Company, Capitaline, ABML Research Note * TTM figures ** As on December 2011

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Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Valuations
We estimate HDFC Bank to report an EPS CAGR of 28.3% over FY11-FY14E. ABV is estimated to grow at 19.0% CAGR during the same period. The banks strong asset quality, superior return ratios, strong asset growth and adequate capitalization bodes well for its future growth. HDFC Bank has historically commanded a premium valuations vis--vis its peers due to its track record of consistent growth in earnings and assets. Despite macro headwinds, the bank has continued to deliver +30% earnings growth and maintained its asset quality. The stock currently trades at 3.6x FY13E ABV and 2.9x FY14E ABV. Over the last five years, the bank has traded at a mean multiple of 3.5x its one year forward ABV, which suggests that the discount to the current fair value has come off post the current market rally. However the stock price is likely to track earnings growth largely from here onwards giving us a one year forward fair value of 635.9/share. We believe the bank to continue to command premium valuations going forward. We initiate coverage on HDFC Bank with a BUY rating and March13 price target of `635.9 /share (based on 3.5x March-14E ABV which is five year average one year forward multiple), implying an upside of 20.8% from current levels.

Chart 28 Forward P/ABV

5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 Mar-07 Mean: 3.5 -1 SD -2 SD Sep-07 Feb-08 Jul-08 Jan-09 Jun-09 Nov-09 Apr-10 Oct-10 Mar-11 Aug-11 Feb-12 +2 SD +1 SD

Source: Bloomberg, ABML Research

Based on Price to Earnings, the stock currently discounts its FY13E and FY14E EPS of `146.4 and `181.7 at 18.8x and 14.8x respectively. Over the last five years, the bank has traded at a mean multiple of 21.8x its one year forward EPS, which suggests that the current price is at ~14.0% discount to its fair value.

Chart 29 Forward P/E

36.0

31.0

+2 SD

+1 SD 26.0 Mean : 21.8 21.0

16.0

-1 SD

11.0 Mar-07

-2 SD Sep-07 Feb-08 Jul-08 Jan-09 Jun-09 Nov-09 Apr-10 Oct-10 Mar-11 Aug-11 Feb-12

Source: Bloomberg, ABML Research

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Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Standalone Financials HDFC Bank Income Statement

Financial Year (` mn) Net Interest Income Growth (%) Other Income Growth (%) Net Income Operating Expenses Operating Profit (pre-prov) Other Prov. & Contingencies Profit Before Taxes Prov for tax Net profit for the year Growth (%) FY10 83864 13 39831 21 123695 59398 64297 21400 42897 13410 29487 31 FY11 105431 26 43352 9 148783 71529 77254 19061 58193 18929 39264 33 FY12E 122728 16 51090 18 173818 83598 90220 15792 74428 23181 51248 31 FY13E 154768 26 61175 20 215944 103148 112796 17723 95073 29473 65600 28 FY14E 191080 23 72374 18 263453 126638 136815 15842 120973 37502 83472 27 Asset Quality Gross NPA to Advances Net NPA to Advances Provision Coverage Slippage Ratio 1.43% 0.31% 78.4% 2.7% 1.05% 0.19% 82.5% 1.1% 1.13% 0.21% 81.3% 1.3% 1.21% 0.21% 83.0% 1.2% 1.15% 0.20% 83.0% 0.8%

Key Ratios
Financial Year (` mn) Return Ratios Average Yield on Advances Average Cost of Deposits NIM Non Int Income / Net Income Return on Avg Equity Return on Avg Assets 10.8% 4.5% 4.5% 32.2% 16.3% 1.5% 10.0% 4.6% 4.6% 29.1% 16.7% 1.6% 11.2% 6.1% 4.2% 29.4% 18.6% 1.6% 11.2% 6.0% 4.2% 28.3% 20.3% 1.7% 10.6% 5.4% 4.4% 27.5% 21.4% 1.9% FY10 FY11 FY12E FY13E FY14E

Balance Sheet
Financial Year (` mn) Sources of Funds Capital Reserve and Surplus Net Worth Deposits Growth (%) Borrowings Other Liabilities and Prov. Total Liabilities 4577 210618 215225 1674044 25 129157 206159 2224586 4652 249111 253793 4683 292513 297199 4683 343025 347711 4683 426497 431183 FY10 FY11 FY12E FY13E FY14E

Efficiency Ratios Business Per Emp. (in mn) Net Profit Per Emp. (in lakh) Business Per Branch (in bn) Cost / Income Ratio 56.5 5.7 1.7 48.0% 66.1 7.0 1.9 48.1% 77.8 9.1 1.9 48.1% 84.5 10.3 2.1 47.8% 94.7 12.0 2.2 48.1%

2085864 2439736 2951485 3586588 27 143941 289929 17 241915 495046 21 296252 512769 18 361248 528611 Business Ratios Credit Deposit Ratio Investment Deposit Ratio CASA Ratio 75.2% 35.0% 52.0% 76.7% 34.0% 52.7% 80.0% 34.0% 47.4% 82.0% 33.4% 47.0% 83.0% 32.8% 47.0%

2773526 3473896 4108218 4907629

Application of Funds Cash and balances with RBI Bal. with banks & call money Investments Advances Growth (%) Fixed assets Other assets Total Assets 154833 144591 586076 1258306 27 21228 59551 2224586 251008 45680 709294 260524 36454 829510 214052 44101 202814 53591

Valuations Ratio EPS P/E (x) BVPS P/BV (x) Adj. BVPS P/ABV (x) 12.9 40.9 94.0 5.6 92.3 5.7 16.9 31.2 109.1 4.8 107.8 4.9 21.9 24.1 126.9 4.1 125.2 4.2 28.0 18.8 148.5 3.5 146.4 3.6 35.65 14.8 184.2 2.9 181.7 2.9

985796 1176401

1599827 1951789 2420218 2976868 27 21706 146011 22 21465 374154 24 22937 421114 21 23989 473967

2773526 3473896 4108218 4907629

Source: ABML Research, company data

Page No. 12

Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Research Team
Vivek Mahajan Head of Research 022-42333522 vivek.mahajan@adityabirla.com Hemant Thukral Head Derivatives Desk 022-42333483 hemant.thukral@adityabirla.com

Fundamental Team
Avinash Nahata Akhil Jain Sunny Agrawal Sumit Jatia Shreyans Mehta Dinesh Kumar Pradeep Parkar Head of Fundamental Desk Metals & Mining FMCG/Cement Banking & Finance Construction/Real Estate Information Technology/Auto Database/Production 022-42333459 022-42333540 022-42333458 022-42333460 022-42333544 022-42333531 022-42333597 avinash.nahata@adityabirla.com akhil.jain@adityabirla.com sunny.agrawal@adityabirla.com sumit.jatia@adityabirla.com shreyans.m@adityabirla.com dinesh.kumar.k@adityabirla.com pradeep.parkar@adityabirla.com

Quantitative Team
Rizwan Khan Jyoti Nangrani Raghuram Rahul Tendolkar Amit Somani Technical and Derivative Strategist Sr. Technical Analyst Technical Analyst Derivatives Analyst Derivative Analyst 022-42333454 022-42333454 022-42333537 022-42333532 022-42333532 rizwan.khan@adityabirla.com jyoti.nangrani@adityabirla.com raghuram.p@adityabirla.com rahul.tendolkar@adityabirla.com amit.somani@adityabirla.com

Advisory Support
Indranil Dutta Suresh Gardas Sandeep Pandey Advisory Desk HNI Advisory Desk Advisory Desk 022-42333494 022-42333535 022-30442104 indranil.dutta@adityabirla.com suresh.gardas@adityabirla.com sandeep.pandey@adityabirla.com

ABML research is also accessible in Bloomberg at ABMR

Page No. 13

Initiating Coverage | Banks Private | 17 February 2012

Aditya Birla Money

Our Rating Methodology

Stock Ratings Buy Accumulate Neutral Reduce Sell Absolute Returns (R) R > 15% 5% < R 15% -5% < R 5% -10% < R 5% R -10%

Disclaimer:
This document is not for public distribution and is meant solely for the personal information of the authorised recipient. No part of the information must be altered, transmitted, copied, distributed or reproduced in any form to any other person. Persons into whose possession this document may come are required to observe these restrictions. This document is for general information purposes only and does not constitute an investment advice or an offer to sell or solicitation of an offer to buy / sell any security and is not intended for distribution in countries where distribution of such material is subject to any licensing, registration or other legal requirements. The information , opinion, views contained in this document are as per prevailing conditions and are of the date of appearing on this material only and are subject to change. No reliance may be placed for any purpose whatsoever on the information contained in this document or on its completeness. Neither Aditya Birla Money Limited (ABML) nor any person connected with it accepts any liability or loss arising from the use of this document. The views and opinions expressed herein by the author in the document are his own and do not reflect the views of Aditya Birla Money Limited or any of its associate or group companies. The information set out herein may be subject to updating, completion, revision, verification and amendment and such information may change materially. Past performance is no guarantee and does not indicate or guide to future performance. Nothing in this document is intended to constitute legal, tax or investment advice, or an opinion regarding the appropriateness of any investment, or a solicitation of any type. The contents in this document are intended for general information purposes only. This document or information mentioned therefore should not form the basis of and should not be relied upon in connection with making any investment. The investment may not be suited to all the categories of investors. The recipients should therefore obtain your own professional, legal, tax and financial advice and assessment of their risk profile and financial condition before considering any decision. Aditya Birla Money Limited, its associate and group companies, its directors, associates, employees from time to time may have various interests/ positions in any of the securities of the Company(ies) mentioned therein or be engaged in any other transactions involving such securities or otherwise in other securities of the companies / organisation mentioned in the document or may have other potential conflict of interest with respect of any recommendation and / related information and opinions. Analyst holding in the stock: NIL

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