Can the 'new' HDFC Bank reclaim its old glory?

For over a decade, HDFC Bank consistently outperformed industry growth rates in both deposits and advances, maintaining impeccable asset quality.

Amid a landscape where other banks struggled with soaring non-performing assets (NPAs), HDFC Bank thrived, eventually surpassing ICICI Bank to become the largest private sector lender in India.

Its net interest margin (NIM) remained stable in the range of 4.1-4.4 per cent.

However, in the year since mortgage financier Housing Development and Finance Corporation (HDFC) merged with the bank on July 1, 2023, the dynamics have shifted.

After the merger, HDFC Bank’s loan book increased by over Rs 6 trillion to Rs 22.5 trillion, while deposits rose by Rs 1.5 trillion to Rs 20.64 trillion.

HDFC was a deposit-taking non-banking financial company.

The integration led to an unusual scenario where the bank’s deposits were lower than its loan book, pushing the credit deposit ratio above 100 per cent, in contrast to the banking sector's average of 75.5 per cent at the time of the merger.

The timing of the merger didn’t help either. HDFC Bank had thought it would be able to replace HDFC’s high cost borrowings by low-cost deposits.

However, after the merger was announced in early April 2022, the interest rate environment shifted adversely.

The Reserve Bank of India (RBI) started raising interest rates following the Russian invasion of Ukraine to control inflation.

Between May 2022 and February 2023, the policy repo rate was increased by 250 basis points to 6.5 per cent, significantly altering HDFC Bank’s cost dynamics.

“The day the merger was announced, the CD (certificate of deposit) rate was 5 per cent. Now it is over 7 per cent; the peak is 7.25 per cent, which has turned the entire equation upside down,” said Nitin Aggarwal, senior group vice president, head of BFSI, Institutional Equities, Motilal Oswal Financial Services Ltd.

Another challenge came in the form of the RBI imposing an incremental cash reserve ratio (CRR) in September last year. Following the merger, the bank had to maintain a higher CRR and Statutory Liquidity Ratio, with no regulatory leniency.

The incremental CRR – 10 per cent on the increase in net demand and time liabilities between May 19, 2023 and July 28, 2023 – was a double whammy during that period. Communication with investors was another issue.

Sashidhar Jagdishan, MD and CEO of HDFC Bank, candidly acknowledged the gaps.

“Yes, it's quite a while since I joined an earnings call. So I may be a bit rusty, but do pardon me for that.

"Ever since the famous, or some of you may call it infamous, Q3 earnings call results, we have received a lot of feedback from several of you,” he said during the January-March earnings investor call.

It is all water under the bridge now.

The road ahead

As HDFC Bank 2.0 enters its second year post-merger, one of its primary goals is to reduce the credit deposit ratio.

There is a regulatory push, too, for the banking system on this front with deposit growth continuing to trail credit offtake by a good 300-400 bps.

Achieving this requires a balanced approach of increasing deposits while moderating loan growth.

In the January-March quarter, the bank successfully reduced the CD ratio to 104 per cent from 110 per cent by boosting deposits by 1.66 trillion compared to the loan growth of Rs 38,500 crore.

“One of the priorities for HDFC Bank should be deposits,” said Rikin Shah, vice-president of Research at IIFL Securities.

The bank should not be in a hurry to bring down the credit deposit ratio by accepting high-cost bulk deposits but should focus on growing at a steady 17-18 per cent, he said.

A deposit war is underway among banks, with some lenders offering higher rates to lure savers.

Earlier this month, HDFC Bank also increased deposit rates by 20 bps on certain buckets.

Besides rates, the strategy of briskly expanding its branch network will help it garner deposits.

In the last two years, the bank has entered 2,000 new pin codes, Shah pointed out. "Of those, 40-50 per cent do not have other big private banks.

"This means HDFC Bank will compete primarily against major public sector banks,” he explained.

Due to its wider product suite, better brand value, and limited competition from large private peers, HDFC Bank, Shah added, can quickly capture a significant share of the deposit market.

'The strategy to deepen its presence is the perfect approach.”  The bank's current and savings account (Casa) deposits, which are low-cost deposits, fell to 38 per cent from 42 per cent pre-merger. Branch expansion is seen as a key strategy to regain Casa share.

Analysts predict HDFC Bank’s loan growth will moderate to around 14 per cent. This moderation is necessary to address post-merger constraints, including the credit deposit ratio.

“HDFC Bank's loan growth is going to be a little softer compared to what the bank used to deliver,” said Aggarwal of Motilal Oswal.

“Historically, we have always seen the bank growing 400-600 basis points higher than the system.

"Now, certain post-merger compulsions, such as the CD ratio, are limiting loan growth.”

The bank, Shah added, has also corrected its communication.

“In the last quarter (after January-March earnings), it has refrained from giving near-term guidance, articulated medium-term franchise potential, and prioritised profitability over growth,” he said.

The bank will bring down the loan deposit rate (LDR), slow down loan growth, but ensure margins and return on assets (RoAs) remain intact – “now that it is well communicated and built into expectations,” Shah said.

The NIM is probably the biggest casualty post-merger, plummeting to 3.4 per cent from 4.1 per cent in April-June 2023 – the quarter before the merger came into effect.

ICICI Bank’s Q4 NIM was 4.4 per cent. HDFC Bank needs to change its loan mix to improve margins by moving away from corporate loans and focusing on better-yielding products such as business banking, unsecured loans, SME loans, credit cards, and commercial and rural banking.

Analysts believe HDFC Bank’s deposit repricing phase is over, and margins may remain steady even during a rate-cut cycle, mainly because the lender has inherited the interest rate swap book of HDFC.

When interest rates start to decline, wholesale liabilities could be re-priced faster than other banks.

On the loan front, too, there is scope to improve margins. In recent years, while some banks were growing their unsecured book, HDFC Bank slowed down growth of such loans.

Growing unsecured loans at a slightly faster pace could help improve margins.

HDFC Bank’s American Depositary Receipt (ADR) premium vanished after the ‘infamous’ Q3 earnings call, but efforts are underway to restore investor confidence.

The investor community often describes ICICI Bank as the new HDFC Bank – which, under former managing director Aditya Puri, was reputed for stability and consistency.

Can the new HDFC Bank reclaim that old glory? Execution – which the largest private sector bank prides in – could be the key.

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