Being HDFC Bank
One cannot ignore the big banking giant - HDFC bank.
Being a market favourite comes with high stakes, and falling short of market expectations can lead to severe consequences. This became evident earlier this week when the markets responded sharply to concerns over a decline in core margins to 3.4 per cent. The bank, which once boasted 4 per cent plus margins pre-merger with HDFC Ltd, now faces the repercussions of failing to meet these historically lofty standards.
The initial two quarters post the merger (Q2 & Q3 FY24) proved challenging for the bank, as expected after merging with HDFC Ltd, the largest HFC in the country, in June 2023. The significant reset in HDFC Bank's liability book is an unavoidable and protracted process, altering the bank's financial landscape compared to the familiar HDFC Bank before merger announcement. Anticipated increases in costs and a potential hit to profitability contribute to a lowered growth outlook. The credit-deposit ratio, hovering around 110 per cent due to the merger, underscores the bank's task ahead, with deposit growth trailing loan growth.
HDFC Bank stands on the brink of adapting to a new normal, both in terms of its business operations and the consequential impact on its financials. This readjustment process carries significant weight for its investors, as evidenced by its laggard performance since the announcement of the merger with HDFC Limited. Q3 results indicate the likelihood of more challenging quarters ahead.
But then the investors should accept this, and should acknowledge the inevitable merger-related challenges, signalling the possible end to the 20% plus growth rate witnessed in the past. The liabilities inherited from HDFC Ltd come at an average funding cost of around 7.5 per cent, notably higher than the bank's own cost of funds, which is at least 3% lower. Despite these financial adjustments, the reassuring aspect is the lack of concerns regarding asset quality, underwriting capabilities, or standards—a remarkable outlier in the Indian banking sector.
Let’s keep all the corridor whispers or market speculation aside. The merger was a logical move, especially considering the limited depth of India's debt markets. For a large, rather then the largest, housing finance company (HFC) to thrive and expand, merging with a bank is practically the only viable route. The advantages of this merger, although not immediate, were promptly realised by the HFC, whereas the bank is grappling with the substantial costs associated with this union. Ultimately, the crux of the matter lies in the timing of reaping the benefits from the merger. Something that the bank could well indicate to the markets.
In theory, banking business is straightforward—it revolves around managing three crucial variables: loan mix, deposit accretion, and handling bad loans. The operational approach involves soliciting public deposits, allocating funds for regulatory-provisioning, and lending the remainder to generate profits exceeding the costs associated with deposits and covering the bank’s operational expenses. But then, the banking reality is brutal.
HDFC Bank has experienced slowdown in its deposit growth. However, considering its expansive scale and size, mobilising substantial deposits is a formidable challenge. The anticipation is that with opening of new branches, as the bank has planned, would expedite deposit accumulation. Meanwhile, the bank has been borrowing from high-cost wholesale markets, to fuel the expansion of its loan book. Persistent weak deposit growth poses the risk of constraining loan expansion and eroding margins, potentially leading to a decline in earnings growth in FY25 and FY26.
Another alternative is to scale down its loan churning machinery. Recent bank mergers consistently involved balance sheet restructuring, accompanied by a deceleration in loan growth. This approach could potentially address the asset-liability matching challenge. The question remains: will the bank opt for this strategy?
In straightforward terms, the bank is restrained from raising loan charges due to competitive pressures. Simultaneously, it cannot restrain its well-oiled aggressive loan origination machinery. To simplify, the bank management must prioritise the establishment of new branches. The positive aspect is that India has a significant unbanked population. However, HDFC Bank must adapt to interacting with Indian consumers it has not engaged with, in its previous years of existence, especially in the newer markets it would open branches in. Fortunately, the bank possesses an advantage—the knowledge and goodwill accumulated by its parent HFC long before the bank's inception. The bank is known for what analysts would call as - ruthless execution - capabilities. That would stand them in good stead.
However, a lesson drawn from various listed-entities, especially in technology space, is to cease providing ‘guidance’ and instead convey a directional journey. Although this may move the stock from many a radar, it affords the management, necessary time to concentrate on business priorities rather than managing the delicate balance between expectations and reality.
This approach aligns with embracing the notion that being a ‘boring bank’ is advantageous. In contrast to many other banks, aspiring to be event sponsors and so-called ‘thought-leaders’, the challenge for banks, especially the large ones like HDFC Bank, lies in maintaining a low-profile yet highly pertinent and profitable status. A small price to pay - for being the market-darling!
( Dr. Srinath Sridharan - Policy Researcher & Corporate advisor. / X : @ssmumbai )
