HDFCB underperformed and remained rangebound over last couple of months, weighed by pressure on NII growth/ margins.

HDFC Bank (HDFCB) is India’s largest private sector bank by assets and by market capitalization. It has a banking network of 5,653 branches and 16,291 ATMs in 2,917 cities/towns as of date. Lifting of RBI restrictions on new credit card sourcing before festive season augurs well: The RBI has partially lifted the restrictions placed on HDFCB in Dec’20 and allowed the bank to source new credit cards.

However, the restrictions on new digital application launches would continue. This addresses a key overhang as HDFCB is the largest credit card issuer in the country, and this segment is key to the bank’s overall profitability. HDFCB has lost ~0.6m cards since the date of the embargo, while other players such as ICICIBC/SBICARD have sharply ramped up their incremental market share by ~49%/~28% during this period. In recent quarters, HDFCB reported moderation in fee income / NII, impacted by the restriction, as this segment contributes 25–33% to its total fee income.

Thus, the lifting of restrictions before the start of the festive season is a positive development as HDFCB is usually aggressive during this time, offering various discounts on consumer products.

Healthy performance in 1Q amid challenges: HDFCB delivered healthy growth in advances in 1QFY22 despite a challenging environment. Growth was led by commercial and rural banking, while retail witnessed moderation. While growth could remain soft over 1HFY22E, we expect a strong uptick in the second half; thus, we estimate loans to grow by 15%/17.5% in FY22E/FY23E. Deposit growth remains strong, led by CASA, which would support the margin trajectory. Its fee income profile was impacted by muted business activity in 1QFY22.

As lending picks up, with a revival in economic activity, fees would reflect improving trends. Strong cost control, led by further digitalization, is likely to drive overall improvement in the bank’s return ratios. Although margins have moderated, we expect a gradual increase on account of lower cost of funds and a strong and granular liability franchise. Strong capitalization and liquidity levels should help HDFCB sustain its growth momentum over the next few years. This renders the bank better placed to tide over the crisis and gain incremental market share.

Asset quality controlled: Asset quality deteriorated marginally in 1QFY22, led by higher slippage (on account of the second COVID wave). GNPA/NNPA stood at 1.47%/0.5%. The restructuring book remains limited at ~0.8% of total loans. Moreover, PCR stands at ~68%. Along with a floating provision of Rs 14.5 billion and contingent provision of Rs 65.9 billion, this would keep credit costs in check and limit the impact on profitability. While asset quality may be moderately pressured over the near term, we expect NNPA to remain at 0.5% in FY22E/FY23E.

Valuation and view: HDFCB underperformed and remained rangebound over last couple of months, weighed by pressure on NII growth/ margins. The lifting of restrictions by the RBI has addressed this key overhang. We expect growth trends to revive in Retail, especially in the Unsecured Lending segment in coming quarters. HDFCB continues to make additional contingent provisions to further strengthen its balance sheet against any potential COVID-19 impact and expects stress to remain controlled. Maintain ‘Buy’ with a target price of `1,800 (3.5x FY23E ABV).