Hdfc 010311 Jb Final

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March 01, 2011 HDFC Bank Limited

“Melioration in Asset Quality; Marginal Compression in NIM; Initiating Coverage with HOLD”

CMP Rs. 2139.0

1Yr Target Price Rs. 2446.8

Primium/Discount 14.4%

Stock Information

BSE HDFCBANK

NSE HDFCBANK

Bloomberg HDFCBIN

Factset 500180-IN

Face Value Rs. 10

Equity Capital (Rs. Million) 215,225

Market Cap (Rs. Million) 1,033,444

Average Volume (NSE) 923,113

Shareholding Pattern (%)

Promoter & Promoter Group 23.4%

Institutions 40.1%

Public 19.1%

Total Shares held by custodians 17.4%

Key Financial

Year 2010 A 2011E 2012E

Income (Rs. Million) 121942.1 143168.3 178188.4

Operating Profit ( Rs. Million) 64297.3 76834.7 104058.2

PAT ( Rs. Million) 29487.0 30729.8 43119.8

P/E (x) 31.7 30.4 21.7

P/ABV (x) 4.4 4.0 3.5

ROE (%) 16.12% 13.53% 16.85%

Analyst: Janaki Ballav Panigrahi

Phone: 215-568-5500

Fax: 215-568-5588

www.boegroup.com

Contact Information

We initiate coverage on HDFC Bank Limited with a HOLD rating and aintrinsic value estimate of Rs. 2,446.8/share. Valuations: According to our Shareholder Value Analysis, HDFC Bank currently trading at a 14.4% discount to our intrinsic value estimate. The stock currently trading at a P/ABV of 3.5x and 2.99x FY12 and FY13 estimateadjusted book value, respectively. We believe the stock will trade at a targeprice of Rs. 2446.8 in the next 12 to 15 months assuming a target multip(P/ABV) of 4.01x at FY12E adjusted book value (We have arrived at th

multiple using residual income Model).

Our Rating is Based on the Following Factors:1) Marginal compression in NIM followed by expansion in NIM due to lo

cost of fund.

2) Strong non-interest income to support net income growth in the time adverse interest rate movement.

3) Cost to income ratio to fall irrespective of increase in operatinexpenses, indicating further improvement in profitability.

4) Firm NII growth irrespective of marginal compression in NIM.

5) Melioration in asset quality to tame credit cost.

6) Robust growth in loan portfolio.

7) RoA to improve further in the long term.

8) Further space for leverage.

9) ROE to improve further in the long term. 10) Adequate capital to support growth.

Risks to our Rating:

1) Any lower economic growth than anticipated may have adverse impaon profitability.

2) Fair valuation.

Chart 1: Stock Price History

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35004000

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I n R s .

Volume (in ' 000 )L HS Share Price (RHS)

Source:NSE

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HDFC Bank Limited BOE RESEARCH REPORT PAGE

Copyright © 2011 BO

d)Firm NII Growth

e) Melioration in Asset Quality

f) Loan Portfolio to Grow at a CAGR of 24%g) ROA to Improve in Long run

h) Space for Leverage

i) ROE to Improve Further

j) Adequate Capital to Support Growth

6) Investment Concerns

7) Outlook And Valuation

8) Financial Statement Exhibits

9) Disclosures

13

13

14

15

17

4

4

5

6

7

13

b) Strong Non-interest Income to Support Net Income 10

c)Cost to Income Ratio to Fall 10

12

12

f) New Banking License to Increase Competition

4) Recent Quarter Performance 8

5) Investment Merits 9

7

a) NIM marginal Compression Followed by Expansion 9

10

11

11

a) Macro Economic Headwind to Stay in Near Term

b) Inflation a Primary Concern

c) NIM to get Compressed Marginally

d) Credit Cost to Soften on Melioration of Asset Quality

e) Interest Rate Deregualation

3

3

4

CONTENTS PAGE No.

1) Company Background

2) Operating Segment

3) Sector Overview

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HDFC Bank was incorporated in

August 1994 in the name of 'HDFC

Bank Limited', with its registered

office in Mumbai, India.

Chairman

Managing Director

Wholesale Banking is one of theprimary business segments as it

contributed around 26.6% to total

revenue in FY10.

Retail Banking is the major business

segment of the bank as it contributed

around 50.7% to total revenue inFY11.

Treasury Segment accounted for

15.1% of total revenue in FY10.

HDFC Bank along with its subsidiaries is engaged in providing banking and othefinancial services primarily in India. HDFC Bank was incorporated in August 1994 ithe name of 'HDFC Bank Limited', with its registered office in Mumbai, IndiaHousing Development Finance Corporation Limited (HDFC) received an 'in principlapproval from the Reserve Bank of India (RBI) to set up a bank in the private sectoHDFC Bank commenced operations as a Scheduled Commercial Bank in January

1995. Management Team:

Mr. C.M. Vasudev

Mr. C.M. Vasudev assumed charge as the Chairman of the HDFC Bank from 6th Jul2010 subject to the approval of the RBI and the shareholders. He has been a directoof the bank since October 2006. A retired IAS officer, he has had an illustrious careein the civil services and has held several key positions in India and overseaincluding Finance Secretary, Government of India, Executive Director, World Banand Government nominee on the Boards of many companies in the financial sector.

Mr. Aditya Puri

Mr. Aditya Puri, has been a professional banker for over 25 years, and prior to joininHDFC Bank in 1994 he was heading Citibank's operations in Malaysia.

Operating Segment: HDFC Bank primarily operates in three business segmentnamely Wholesale Banking, Retail Banking and Treasury.

Wholesale Banking: Wholesale Banking provides commercial and transactionbanking services including working capital finance, trade services, transactionaservices, cash management, etc. This is one of the primary business segments as contributed around 26.6% to total revenue in FY10 (See Chart 2, Below).

Retail Banking: This business segment is responsible for providing a full range ofinancial products and banking services to retail customers. This is the major businessegment of the bank as it contributed around 50.7% to total revenue in FY11 (Se

Chart 2, Below).

Treasury: The Treasury segment is primarily responsible for dealing with ForeigExchange and Derivatives, Local Currency Money Market & Debt Securities, anEquities. The Treasury Segment is responsible for managing the return and market SLR and other investments. Treasury Segment represented 15.1% of total revenue iFY10 (See Chart 2, Below).

Chart 2 : Revenue by Business Segment

15.1%

50.7%

26.6%

7.6%

Treasury Retail Banking Wholesale Banking Other Banking Operations

Source: Company & BOE

Company Background:

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Macro economic factors like

inflation and policy rates to tame

inflation will remain a concern.

Food inflation to remain moderate tohigh as the food inflation is a result

of changes in food habit and

reduction of food productive land

due to industrialization and

urbanization.

Macro Economic Headwinds to Stay in Near Term: The Indian banking sector haalready bounced back from the eventuality of corruption charges against some of thvery highly placed people in the industry and 2G scam. However, macro economfactors like inflation and policy rates to tame inflation will remain concerns in thfirst half of FY12. Higher inflation may put pressure on deposit growth rate anattract policy tightening measures by the central bank. However, we believinflationary pressure with reduce from mid of the fiscal year.

Inflation a Primary Concern: The Indian economy has experienced a stable and loinflationary environment during FY 00 and FY05. Inflationary environment becamvolatile and high during the recent years, primarily driven by high food ancommodity prices.

Average primary article inflation remained at 14.5% during January FY09 anFebruary FY11. It has reached a peak of 22.16% in March FY10. However, it haexperienced moderation since March FY10 to 14.79% in February FY11 (See Cha3, Below). Primary article inflation was mainly driven by higher price of all of icomponents (Food Articles, Non-Food Articles and Minerals); however, food articinflation contributed maximum as it has higher weightage ( 14.34% of WPI an

71.27% of Primary Article Inflation) in the primary inflation index. Average inflatiofor food article remained at 15.10% during January FY09 to February FY 11.

Food article inflation eased from 20.97% in June FY11 to 10.16% in February FY1However, we believe food inflation will remain moderate to high as the food inflatiois a result of changes in food habit and reduction of food productive land due toindustrialization and urbanization. Along with the structural changes, increase iincome level of people also played a significant role in the price increase.

Chart 3: Primary Inflation and Its Components

0%

5%

10%

15%

20%

25%

J a n - 0 8

F e b - 0 8

M a r - 0 8

A p r - 0 8

M a y - 0 8

J u n - 0 8

J u l - 0 8

A u g - 0 8

S e p - 0 8

O c t - 0 8

N o v - 0 8

D e c - 0 8

J a n - 0 9

F e b - 0 9

M a r - 0 9

A p r - 0 9

M a y - 0 9

J u n - 0 9

J u l - 0 9

A u g - 0 9

S e p - 0 9

O c t - 0 9

N o v - 0 9

D e c - 0 9

J a n - 1 0

F e b - 1 0

M a r - 1 0

A p r - 1 0

M a y - 1 0

J u n - 1 0

J u l - 1 0

A u g - 1 0

S e p - 1 0

O c t - 1 0

N o v - 1 0

D e c - 1 0

J a n - 1 1

Food Articles (Wtg: 14.34% in WPI , 71.26% in PA )

Non Food Articles (Wtg: 4.26% in WPI, 21.16% in PA)Minerals (Wtg: 1.52% in WPI, 7.57% in PA)

Primary Article (Wtg:20.12% in WPI, 100% in PA)

WPI: Wholesale Price Index

PA: Primary Article InflationWtg: Weightage

Source: MOSPI

Sector Overview

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Agitations in the Middle East and

North Africa (MENA) and its impact

on oil prices are a primary concern

for fuel and power inflation in the

near term.

WPI inflation to remain moderate tohigh in the first half of FY12 driven

by primary article inflation and fuel

and power inflation.

Following slower deposit growth

than the credit growth and with very

less excess SLR investment, banks

are likely to compete for attractingnew deposits by increasing the

deposit rate.

Fuel and Power inflation remained stable in a range of 11.02% to 11.49% fromSeptember FY11 to February FY11, after reaching a high of 14.42% in May FY11Agitations in the Middle East and North Africa (MENA) and its impact on oil priceare a primary concern for fuel and power inflation in the near term.

Irrespective of increasing labor cost, inflated price of commodities in internationmarkets and increasing raw material prices manufactured product inflation remainemoderate. Highest level of manufactured product inflation was 6.43% in April FY1during the financial year. It has softened to 3.75% in January FY11 and againbounced back to 4.94% in February 2011. However, we believe manufactured produinflation to stay in a reasonable range going forward in Q4 FY11 and FY12, due tbase effect.

Following the above discussion, we believe WPI inflation will remain moderate thigh in Q4 FY11 and first half of FY12, driven by primary article inflation and fuand power inflation. Hence, it may attract the central bank to tighten the policy rate b50 basis point during the first half of the FY12. However, further policy rattightening during the second half of FY12 cannot be ignored. We expect inflation tbe moderate in the second half of FY12 following Kharif ( Monsoon Crop) agrproduction and the effect of political turmoil will start subsiding in the MENregion.

Chart 4: WPI Inflation and Its Components.

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

Prim ary (Wtg: 20.12%) Fuel & Pow er ( Wtg:1 4. 91% ) Manufactured (64.97%) WPI A ll ( Wtg. 1 00 %)

Source: MOSPI

Net Interest Margin to Get Compressed Marginally: The banking sector NIM likely to fall marginally, primarily following the below stated reasons:

1. Upward Re-pricing of Deposit Rates: In a fast growing economenvironment, credit uptake is likely to pick up with the increase in creddemand from industries for capital expenditure to fulfill the increasinproduct demand in the economy. Same time in a high inflationarenvironment saving growth is likely to moderate as people will always searcalternative investment opportunities to get higher return for protecting thvalue of saving from inflationary pressure. Following slower deposit growtthan the credit growth and with very less excess SLR investment, banks arlikely to compete for attracting new deposits by increasing deposit rates.

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Interest Rate Deregulation: In March 2003, the RBI deregulated interest rate on akind of deposits except saving bank deposits. Savings bank deposits are the only kinof deposits where the interest rate remained constant at 3.5% and is regulated by thRBI. At a low cost of deposits of 3.5% saving banks deposits became an attractivsource of funds for banks.

In most of the developed economies like the U.S, the U.K and Japan have deregulatesaving bank deposit interest rates and commercial banks decide interest rate on savin

bank deposits. The RBI has indicated to deregulate saving bank interest rate bannouncing the proposal of posting a discussion on this topic with general public othe RBI website. We believe the RBI may deregulate the interest rate on saving bankdeposits partially to tame irregular competitions among banks.

Probable Impact of Interest Rate Deregulation: We believe the following would bthe most likely impact of deregulating interest rate on saving bank deposits.

(i) Cost of fund likely to increase significantly in the near term followinirregular competition among banks with low CASA ratio to attract savingdeposits. However, we believe saving banks deposits rate will come to aequilibrium rate in the long term.

(ii) We believe public sector banks will get effected more than private sectobanks as component of other income in total income is less in public sectobank.

(iii) Banks like HDFC Bank, AXIS Bank will be less impacted as current accoundeposits consist of a significant portion of CASA for these banks.

New Banking License to Increase Competition: New banking license is likely tincrease competition in the banking sector. Once the RBI is ready with threquirement norms to get a license for operating a bank, we believe many of thcorporate houses and NBFC are likely to qualify for the requirements of the RBI. W

believe banks with huge branch network like SBI,PNB,HDFCB and ICICI Bank wibe less impacted by new bank licensing. Impact of new bank licensing will be visibin case of banks with less number of branches and new private sector banks like YEBank, Indusind Bank, etc.

Savings bank deposits are the only

kind of deposits where the interest rate remained constant at 3.5%

and is regulated by the RBI.

Aggressive strategies of the new

players in the market most likely to

ncrease deposits rate, Increase

operating expense due to enhanced

customers service facilities, thus

resulting less profitability for thebanking sector.

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Increase in net interest income was

supported by asset growth and a

NIM of 4.2%.

HDFC BANK Limited reported a 29.6% y-o-y increase in total interest income tRs.52,299.6 million in Q3 FY11. The increase in interest income was mainly due to 30% y-o-y growth in interest on advances/bills and a 330.6% growth in interest obalances with the RBI and other interbank fund. Net interest income rose 24.9% y-o-to Rs.27,766.9 million in Q3 FY11. Increase in net interest income was supported basset growth and a NIM of 4.2%. Other income grew 32.2% y-o-y to Rs.11,278million in Q3 FY11, primarily due to a 22.5% y-o-y growth in fees and commissionOperating expenses were up 22.2% in Q3 FY11. The core cost to income ratio stooat 46.5% in Q3 FY11 compared to 47.6% for the same quarter of previous year. Nincome increased 32.9% y-o-y to Rs.10,878.3 million in Q3 FY11 from Rs.8,18million a year earlier (See Table 1, Below).

Table:1 Quarterly Performance

(Amount in Rs. Million except EPS ) Q3FY11 Q3FY09 % Change Q2FY11 % Chang

Interest/discount on advances/bills 39503.8 30389.2 30.0% 36731.8 7.5%

Income on Investments 12258.3 9801.6 25.1% 11002.6 11.4%

Interest on balances with RBI and Other Inter Bank Fund 517.1 120.1 330.6% 354.6 45.8%

Others 20.4 37.2 -45.2% 11.0 85.5%

Total Interest Income 52299.6 40348.1 29.6% 48100.0 8.7%

Interest Expended 24532.7 18109.0 35.5% 22837.2 7.4%

Net Interest Income 27766.9 22239.1 24.9% 25262.8 9.9%

Other Income 11278.2 8530.1 32.2% 9607.0 17.4%

Total Income 39045.1 30769.2 26.9% 34869.8 12.0%

Operating Expenses 18318.2 14532.2 26.1% 16798.8 9.0%

Operating Profit 20726.9 16237.0 27.7% 18071.0 14.7%

Provisions and Contingencies (Excluding Tax) 4658.7 4477.2 4.1% 4544.8 2.5%

Tax Expense 5189.9 3574.8 45.2% 4404.8 17.8%

Net income 10878.3 8185.0 32.9% 9121.4 19.3%

Basic earnings per common share: 23.5 18.7 25.7% 19.8 18.7%

Diluted earnings per common share 23.1 18.4 25.5% 19.5 18.5%

Source: Company & BOE

CASA ratio remained at 50.5%

driven by a 30.7% y-o-y growth in

saving deposits.

The bank reported a growth in total deposit of 24.2% y-o-y to Rs.1,922,015.6 millioin Q3 FY11. CASA ratio remained at 50.5% driven by a 30.7% y-o-y growth isaving deposits to Rs.160,380.0 million in Q3 FY11. Gross advances grew by 32.7%y-o-y to Rs.160,6190.0 million in Q3 FY11. Asset quality in Q3 FY11 remainehealthy with GNPA to gross advances ratio of 1.1% and NNPA to net advances ratiat 0.5%.

As on December 31, 2010, the Bank’s distribution network was 1,780 branches an5,121 ATMs in 833 cities as against 1,725 branches and 3,898 ATMs in 771 cities aof December 31, 2009.

The Bank’s total Capital Adequacy Ratio as at December 31, 2010 (computed as pe

Basel 2 guidelines) remained strong at 16.3%, against the regulatory minimum of 9%Tier-I CAR was 12.1% as of December 31, 2010.

Recent Quarter Performance:

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Demand deposits represent a

significant amount of CASA deposits

(43.65% of CASA).

NIM, Marginal Compression Followed by Expansion on Low-Cost of Deposits

HDFC Bank experienced compression in net interest margin of 59 basis points to4.4% in FY10 from 4.9% in FY09 (See Chart 7, Below). HDFC Bank’s depositcomposition is one of the lowest cost compositions having 48% of CASA deposits(See Chart 8, Below). A significant amount of CASA deposits constitutes of demanddeposits(43.65% of CASA). Low-cost CASA deposits have grown at a CAGR of

29.8% from Rs.264,935.5 million in FY06 to Rs. 7,52,317.7 million in FY10. As aresult of low-cost of fund and high yielding loan portfolio, the bank has highest NIMamong its peers. We believe NIM of the bank may experience a marginalcompression in FY11 following macroeconomic headwinds. NIM is likely to expandin the long term as the effect of deposit reprising would not be significant followinghigh demand deposits in deposit composition of the bank. HDFC Bank have adeposit market share of 3.7% (among schedule commercial private, public and SBI &

its Associates), which has expanded 100 basis point from 2.7% in FY 06.

Chart 6: Trend in CASA Ratio:

48.0%

48.0%

48.0% 48.0%

48.0% 48.0%

47.9%

48.0%

48.1%

0

100

200

300

400

500

600700

800

FYO9 FY 10 FY11 FY12E FY13E FY14E

R s . i n M i l l i o n

C ASA Per B ran ch ( LHS) C AS A R atio (R HS)

Source: Company Filings & BOE

Chart 7 : Net Interest Margin of Peers :

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

FY O6 FY 07 FY 08 FY 09 FY 10 FY

HDFCB ICICIB AXIS SBI PNB


Chart 8: Composition of Deposits:

20.97%

27.07%

51.96%

Demand Deposit Saving Deposits Term Deposits

CASA 48.04%


INVESTMENT MERITS:

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HDFC Bank Limited BOE RESEARCH REPORT PAGE 1


Non-interest income consists of

31.2% of total income.

Marginal cost of operating

expenses would be less than themarginal income received by

expanding branch network resulting in a fall in cost to income

ratio.

Regardless of marginal NIM

compression, NIM of HDFC Bank

is likely to distinctly stand out of its

peers.

Strong Non-Interest Income to Support Net Income: A major portion of net incomeconsists of non-interest income for HDFC Bank, which makes net income stable in anadverse interest rate scenario (See Chart 9, Below). Non-interest income consists of31.2% of total income and grown at a CAGR of 35.7% from Rs.11,239.8 million inFY06 to Rs.38,076.1 million in FY10. Core fee-based income constitutes 28.4% oftotal income. Considering the growth in advances, fee and commission is likely toincrease in the coming years.

Chart 9 : Composition of Total Income

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30%

40%

50%

60%

70%

80%

90%

100%


Net Interest Income Other Non-Interest Income

Core Fee Based Income


Cost to Income Ratio to Fall, Irrespective of Rise in Operating Expenses

Historically, operating expense have shown a trend of steady growth following branchexpansion. Operating expenses of HDFC Bank has grown at a CAGR of 35.9% fromRs.16,910.0 million in FY06 to Rs.57,644.8 million in FY10. However, cost to incomeratio has shown a falling trend in recent years (See Chart 10, Below). Cost to incomehas started declining from 48.6% in FY07 to 47.3% in FY10. We expect the trend tocontinue following the bank’s branch expansion, as the marginal cost of operatingexpenses would be less than the marginal income received by expanding branchnetwork resulting a fall in cost to income ratio. We have factored an 80 basis point fallin cost to income ratio and 15.1% y-o-y growth in operating expenses for FY11.

Chart 10: Trend in Operating Expenses

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40%

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60%

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Operating Expenses Cost to Income Ratio


Firm NII Growth Irrespective of Marginal NIM compression: NII has grown at aCAGR of 34.7% from Rs.25,458.4 million in FY06 to Rs.83,866.0 million in FY10We have factored NIM compression of 25 basis point in FY11, following the adverseimpact of macroeconomic headwinds. Regardless of marginal NIM compression, NIMof HDFC Bank is likely to distinctly stand out of its peers. Firm NIM along withrobust growth in advances results 17.9% y-o-y growth in NII for FY11 and 25.5%CAGR for FY11 to FY14 (See Chart 11, Below).

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Fast growing economic

environment is likely to impact

positively for reduction in slippage

in coming years.


Chart 11: Trend in NII and NIM

4.9%

4.4%

4.1%

4.2%4.4% 4.4%

3.6%

3.8%

4.0%4.2%

4.4%

4.6%

4.8%

5.0%

5.2%

0

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R

s . M i l l i o n

NII NIM


Melioration in Asset Quality: Historically , HDFC Bank maintains less non-performing assets among its peers due to conservative nature and effective credit

approval process. Further, fast growing economic environment is likely to impactpositively for reduction in slippage in coming years. HDFC Bank maintains 78.4% ofprovision coverage ratio, which is significantly high than 70% of provision coverageratio stipulated by the RBI (See Chart 13, Below). Due to significantly high provisioncoverage ratio and less new slippage would enable HDFC Bank to make less provisionfor loan losses in the coming years. At the end of FY11, % GNPAs stood at 1.43% and% NNPA stood at 0.3%.

Chart 13: Trend in Asset Quality and Provision Coverage


Loan Portfolio to Grow at a CAGR of 24%: Historically, HDFC Bank’s growth inadvances remained high compared to sectoral (Private, Public and SBI & Associatesgrowth in advances. Sectoral advances grew at a CAGR of 23.8% from FY06 to FY10and HDFC Bank’s loan portfolio grew at a CAGR of 37.7% for the same period. Webelieve growth in advances to moderate in the coming years. We estimate HDFCBank’s loan portfolio will grow at a CAGR of 24% between FY11-FY14 (See Char

15, Below).

66

71

76

81

86

91

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%


Gross NPA (%) Net NPA (%) Provision Coverage Ratio (%)

Chart 12: Trend in Slippage

2.22%2.56%

5.38%

2.64%

2.35% 2.40% 2.45%

2.45%

2%

3%

3%

4%

4%

5%

5%

6%

6%

FY07 FY08 FYO9 FY 10 FY11 FY12E FY13E FY14E

Slippage

SlippageIncreased

Significantly

in FY 09

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Chart 16: ROA, Peer Comparison

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

1.8%


1.53%

1%

1.67%

0.88%

1.44%

ROA (%)

Source: Company Filings & BO E

Return on Assets to Improve Further in the Long Term: HDFC Bank ROA stood at1.45% (Yearly Average) at the end of FY 10. It stands well above the industry averageComparing with its peers it stands next to AXIS Bank’s ROA (See Chart 16, Below)We believe marginal ROA compression in FY11 following marginal compression inNIM. We have factored a 20 basis point compression in ROA for FY11. HoweverROA of HDFC Bank will improve further following strong business growth andprofitability in the coming years. We anticipate an expansion in ROA of 45 basis pointo 1.7% in FY14 from 1.25% in FY11.

Chart 17: Dupont Analysis with Respect to Average Assets

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

N I I

N o

n - I n t e r e s t I n c o m e

T o t a l I n c o m e

O P E X

P & C

T a x

R O A

4.1%

1.9%

6.0%

-2.8%

-1.1% -0.7%

1.5%


Space for Leverage: HDFC Bank’s leverage ratio stood at 10.8x at the end of FY10HDFC Bank’s leverage ratio is lower than its peer average leverage ratio of 12.3x (See

Chart 18, Below). However, ICICI Bank’s leverage is significantly lower than its peeraverage leverage ratio, thus pulling down the average peers leverage ratio. SBI andPNB’s leverage ratio are significantly above the peer’s average. We believe HDFCBank has sufficient space to leverage its balance sheet in the coming years. Furtherleverage of balance sheet is likely to improve ROE of HDFC Bank.

Chart 14: Growth in Advances (Sectoral & HDFC Bank)

0%

10%

20%

30%

40%

50%

60%

FY-06 FY-07 FY-08 FY-09 FY-10

Sectorial(Private+ Public+ SBI & Associates) HDFCB

Due to

Merger With

CenturionBank of

Punjab

Source: Company Filings, RBI & BOE

Chart 15: Growth in Loan Portfolio

0

500000

1000000

1500000

2000000

2500000

3000000

3500000


Rs.Million


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HDFC Bank has sufficient space to

leverage its balance sheet in the

coming years.

Chart 18:Leverage, Peer Comparison

0

2

4

6

8

10

12

14

16

18


11.0

7.1

11.5

15.516.7


Return on Equity to Improve Further: ROE of HDFC Bank is 16.1% (Yearly

Average) for FY10, which is likely to go up following robust net income growth. Theprimary reasons for robust growth in net income would be (i) growth in other income(ii) growth in net interest income, irrespective of marginal compression in NIM (iii)

Provision for substandard assets are likely to come down following melioration inasset quality and (iv) further space for leverage.

Chart 19: Return on Equity: A Peer Comparison

5%

10%

15%

20%

25%

FY O6 FY 07 FY 08 FY 09 FY 10 FY 11 E



Sufficiency of Capital to Support Growth: The bank is sufficiently capitalized tosupport growth. As on Q3 FY11, the Bank’s total Capital Adequacy Ratio remainedstrong at 16.3% (computed as per Basel 2 guidelines), against the regulatory minimumof 9%. Tier-I CAR was 12.1% as on December 31, 2010. Capital adequacy is unlikelyto be a hindrance to growth.

In the Case of Slower-than-anticipated Economic Growth: Economic growth andgrowth of banking industry are highly related to each other. HDFC Bank has grown ata faster pace than that of the industry in recent years. Slower economic growth thananticipated may affect the growth of the bank adversely. Irrespective of HDFC Bank’ssound financial, rising interest rates, higher cost of fund and compression in NIM maypose a concern.

INVESTMENT CONCERNS:

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Assumptions FY11E FY12E FY13E FY14E

NII Growth (%) 18.4% 28.5% 28.0% 25.5%

NIM (%) 4.1% 4.2% 4.4% 4.4%

Other Income Growth (%) 15.2% 15.3% 18.3% 23.0%

Cost to Income Ratio (%) 46.3% 41.6% 37.4% 33.8%

Total Income Growth (%) 17.4% 24.5% 25.3% 24.8%

Net Income Growth (%) 4.2% 40.3% 38.6% 35.9%

EPS ( Rs.) 70.4 98.8 136.9 186.1

Deposit Growth (%) 22.5% 25.3% 21.5% 20.0%

Loan Growth (%) 29.8% 23.9% 22.4% 24.4%

GNPA (%) 1.5% 1.5% 1.5% 1.5%

NNPA (%) 0.3% 0.3% 0.3% 0.2%

Slippage Ratio (%) 2.4% 2.4% 2.5% 2.5%

ROE (x) 13.5% 16.9% 20.2% 23.2%

ROA (x) 1.1% 1.3% 1.4% 1.6%

P/E (x) 30.4 21.7 15.6 11.5

P/ABV (x) 4.0 3.5 3.0 2.5

Table No. 2:

To arrive at our target price, we have used two stage residuincome model to get the residual income per share and we havused (P/B) = (ROE-g) / (Ke-g) to get terminal value.

We have used CAPM model i.e Ke= Rf+ß(Rm-Rf ) to calculatecost of equity by taking Rm (market return) as return on Niftysince April 2000 till the date. We have calculated ß value of

HDFC Bank stock as 0.83 by taking covariance of the stockwith Nifty, upon variance of Nifty. Our assumption for riskfree rate is 8%.

The stock is currently trading at a P/ABV of 3.5x and 2.99xFY12 and FY13 estimated adjusted book value, respectivelyWe believe the stock will trade at a target price of Rs. 2446.8in the next 12 to 15 months assuming a target multiple(P/ABV) of 4.01x at FY12E adjusted book value (We have

arrived at this multiple using residual income Model).

P/ABV (x)

FY11E FY12E FY11E FY12E FY11E FY12E FY11E FY12E

HDFC Bank 13.5% 16.9% 1.1% 1.3% 30.4 21.7 4.0 3.

ICICI Bank 11.8% 12.7% 1.1% 1.2% 19.3 16.4 2.2 2.

Punjab National Bank 22.0% 22.5% 1.4% 1.4% 10.0 10.5 2.1 2.

AXIS Bank 19.3% 20.0% 1.6% 1.5% 13.9 11.5 2.5 2.

State Bank of India 16.3% 17.2% 1.0% 1.1% 11.2 9.2 1.7 1.

Source: Bloomberg & BOE

ROE (%) ROA (%) P/E (x)Table No. 3:

Valuation Estimates

(A Peer Analysis)

Chart 20: P/ABV Band.

100

600

1100

1600

2100

2600

3100

3600

I n R s .

Closing Price 2x 3x 4x 5x 6x

Source: Company Filing s, NSE & BOE

Chart 21: P/E Band

0

500

1000

1500

2000

2500

3000

3500

4000

I n

R s .

Closing Price 11x 11x 16x 21x 26x 31x 36x

Source: Company Filings, NSE & BOE

Outlook and Valuation:

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Chart 22: Sources of Fund

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

R s . M i l l i o n

Total Equity Deposits Borrowings

Exhibit I: Income Statement (in millions of Rs. Except Per Share Data)

2009 2010 2011E 2012E 2013E 2014

Interest income 163,323 161,729 207,133 269,932 345,983 433,38

Interest Expenses 89,111 77,863 107,835 142,306 182,563 228,27

Net interest income 74,212 83,866 99,298 127,626 163,420 205,1

% Change 42% 13.0% 18.4% 28.5% 28.0% 25.5

Non-Interest Income 32,906 38,076 43,870 50,562 59,816 73,5

% Change 44.1% 15.7% 15.2% 15.3% 18.3% 23.0

Total Income 107,118 121,942 143,168 178,188 223,236 278,6

Operating Expenses 55,328 57,645 66,334 74,130 83,466 94,1

Profit Before Provision & Contigency 51,790 64,297 76,835 104,058 139,770 184,5

Prov. & contingency 18,797 21,406 30,274 38,725 49,229 61,43

PBT 32,992 42,891 46,560 65,333 90,541 123,0

Provision Fot Tax 10,543 13,404 15,830 22,213 30,784 41,84

PAT 22,449 29,487 30,730 43,120 59,757 81,2

Earning Per Share 52.85 67.56 70.41 98.80 136.92 186.1

Shares Outstanding 424.78 436.44 436.44 436.44 436.44 436.4

Exhibit II: Balance Sheet (in millions of Rs.)

2009 2010 2011E 2012E 2013E 2014

Assets

Cash 15,862 24,353 32,820 62,641 97,562 121,72

balance with Reserve Bank of India 119,410 130,480 169,630 208,979 256,895 312,03

Balances with banks and money at call and short notice 39,794 144,591 169,630 229,203 291,147 365,83

Investments 588,175 586,076 697,604 887,152 1,099,509 1,342,82

Advances 988,830 1,258,306 1,633,418 2,024,398 2,478,723 3,083,35

Fixed Assets 17,067 21,228 20,344 18,067 15,054 12,74

Other Assets 63,568 59,551 71,462 82,181 94,508 103,95

Total Assets 1,832,708 2,224,586 2,794,908 3,512,622 4,333,398 5,342,49

Capital and Liabilities

Equity Capital 4,254 4,577 4,577 4,577 4,577 4,57

Equity Shares Warrants 4,009 0 0 0 0

Reserve & Surplus 142,209 210,618 234,517 268,051 314,524 377,69

Employee Stock Options 55 29 28 26 25 2

Deposits 1,428,116 1,674,044 2,050,081 2,567,996 3,120,115 3,744,13

(i)Demand Deposits 284,449 372,271 432,977 554,687 681,433 826,70

(ii)Saving Bank Deposits 349,147 498,768 551,062 677,951 816,222 970,48

(iii)Term Deposits 794,519 803,006 1,066,042 1,335,358 1,622,460 1,946,95

Borrowings 91,636 129,157 258,314 387,471 581,206 871,80

Other Liabilities and Provision 162,428 206,159 247,391 284,500 312,950 344,24

Total Liabilities & Equity 1,832,708 2,224,586 2,794,908 3,512,622 4,333,398 5,342,49

FINANCIAL STATEMENT EXHIBITS:

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Exhibit III: Ratio Analysis

2009 2010 2011E 2012E 2013E 2014E 5 Yr Av

Income Statement Ratios

Net Interest Income Growth (%) 42.0% 13.0% 18.4% 28.5% 28.0% 25.5% 22.7

Net Interest Margin (%) 4.9% 4.4% 4.1% 4.2% 4.4% 4.4% 4.3

Non-Interest Income Growth (%) 44.1% 15.7% 15.2% 15.3% 18.3% 23.0% 17.5

Net Profit Growth (%) 41.2% 31.3% 4.2% 40.3% 38.6% 35.9% 30.1

Interest Expenses/ Interest Income Ratio (%) 54.6% 48.1% 52.1% 52.7% 52.8% 52.7% 51.7

Non Interest Income/Total Income Ratio (%) 30.7% 31.2% 30.6% 28.4% 26.8% 26.4% 28.7

Cost-Income Ratio (%) 51.7% 47.3% 46.3% 41.6% 37.4% 33.8% 41.3

Balance Sheet Ratios

C/D Ratio (%) 69.2% 75.2% 79.7% 78.8% 79.4% 82.4% 79.1

Incremental C/D Ratio (%) 84.1% 109.6% 99.8% 75.5% 82.3% 96.9% 92.8

CASA (%) 48.0% 48.0% 48.0% 48.0% 48.0% 48.0% 48.0

Growth in Advances (%) 55.9% 27.3% 29.8% 23.9% 22.4% 24.4% 25.6

Growth in Deposits (%) 41.9% 17.2% 22.5% 25.3% 21.5% 20.0% 21.3

Credit Quality Ratios

%GNPA 2.0% 1.4% 1.5% 1.5% 1.5% 1.5% 1.5

%NNPA 0.6% 0.3% 0.3% 0.3% 0.3% 0.2% 0.3

Provisioing Coverage(%) 68.4% 78.4% 81.8% 80.9% 81.4% 85.4% 81.6

Slippage Ratio (%) 5.4% 2.6% 2.4% 2.4% 2.5% 2.5% 2.5

Employee Related Ratios

Employees Per Branch 37.3 30.1 30.0 29.0 29.0 28.0 29.

Costs per employee (Rs.Million) 0.4 0.4 0.5 0.5 0.5 0.6 0.

Profit per employee (Rs. Million) 0.4 0.6 0.5 0.7 0.9 1.2 0.

Business per employee (Rs. Million) 45.9 56.5 64.6 77.2 87.8 101.6 77.

Staff Cost / Operating Expenses (%) 40.5% 39.7% 40.2% 39.8% 40.2% 39.7% 39.9

Staff Cost /Total Income (%) 20.9% 18.8% 18.6% 16.5% 15.0% 13.4% 16.5

Business Per Branch (Rs. Million) 1,711.7 1,699.9 1,938.7 2,240.2 2,544.9 2,844.8 2,253.

Valuation Ratios

P/E ratio (x) 40.5 31.7 30.4 21.7 15.6 11.5 22

P/BV (x) 6.0 4.3 3.9 3.4 2.9 2.4 3

P/ABV (x) 6.3 4.4 4.0 3.5 3.0 2.5 3

ROA (%) 1.4% 1.5% 1.2% 1.4% 1.5% 1.7% 1.4

Leverage (x) 11.9 11.1 11.0 12.3 13.3 13.8 12.

ROE (%) 16.9% 16.1% 13.5% 16.9% 20.2% 23.2% 18.0

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Analyst: Email: Phone: Fax: Website:Janaki Ballav Panigrahi [email protected] 215-568-5500 215-568-5588 www.boegroup.com

Certifications:

The BOE Group (BOE) is comprised of BOE Securities, Inc., BOE Research Services, Inc. and BOE Research Private Limited. BOE hereby certifies that the viewsexpressed in this research report accurately reflect the company’s independent personal views about the subject stocks and issuers. This report was prepared by Janak

Ballav Panigrahi. BOE also certifies that no part of BOE’s or the analyst’s respective compensation was, is, or will be, directly or indirectly, related to the specificrecommendations or view expressed in this research report.

BOE’s financial analysts are not subjected to NASD rule 2711 and NYSE rule 472 which provide guidance on communications with subject company, public appearance

and trading securities, held by BOE Research Private Limited or its affiliates. However, BOE makes its best efforts to ensure the highest professional and ethical standardsare adhered to its analysts.

BOE’s distribution of stock ratings is:

Rating BUY HOLD SELL Not Rated

Distribution 32% 45% 23% 0%

Stock Ratings:

Buy: Stocks whose total return is expected to exceed the S&P 500 Index average over the next 12 months.Hold: Stocks whose total return is expected to be in line with the S&P 500 Index average over the next 12 months.Sell: Stocks whose total return is expected to be below the S&P 500 Index average over the next 12 months.

Not Rated: BOE has decided not to publish a rating on this stock due to unusual or extraordinary business circumstances.

Other Disclosures:

The information, tools and material presented in this report are provided to you for information purposes only and are not to be used or considered as an offer or thesolicitation of an offer to sell or to buy or subscribe for securities or other financial instruments. BOE will not treat recipients as its customers by virtue of their receivingthe report. The investments or services contained or referred to in this report may not be suitable for you and it is recommended that you consult an independent investmentadvisor if you are in doubt about such investments or investment services. Nothing in this report constitutes a personal recommendation to you.

Information and opinions presented in this report have been obtained or derived from sources believed by BOE to be reliable, but BOE makes no representation as to theiraccuracy or completeness, except with respect to the Disclosure Section of the report. Additional information is available upon request. BOE accepts no liability for loss

arising from the use of the material presented in this report, except that this exclusion of liability does not apply to the extent that liability arises under specific statutes oregulations applicable to BOE. This report is not to be relied upon in substitution for the exercise of independent judgment. BOE may have issued, and may in the futureissue, other reports that are inconsistent with, and reach different conclusions from the information presented in this report. Those reports reflect the different assumptionsviews and analytical methods of the analysts who prepared them and BOE is under no obligation to ensure that such other reports are brought to the attention of any

recipient of this report. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding futureperformance. Information, opinions and estimates contained in this report reflect a judgment at its original date of publicat ion by BOE and are subject to change withou

notice. The price, value of and income from any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of securities andfinancial instruments is subject to exchange rate fluctuation that may have a positive or adverse effect on the price or income of such securities or financial instrumentsInvestors in securities such as ADR’S, the values of which are influenced by currency volatility, effectively assume this risk.

BOE does not make markets in any of the securities mentioned in this report. BOE and its employees may have long/short positions or holdings in the securities or otherrelated investments of companies mentioned herein. Neither the analysts responsible for this report nor any related household members are officers, directors, or advisoryboard members of any covered company. No one at a covered company is on the Board of Directors of BOE Research Private Limited or any of its affiliates. BOE or any

of its employees do not own shares equal to one percent or more of the company in this report .

CONTACT INFORMATION:

IMPORTANT DISCLOSURES:

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