HDFC Bank's ADR premium shrinks to nearly zero as FPIs turn bearish

After the latest rout, the American depositary receipt (ADR) premium of HDFC Bank to its local shares has shrunk to nearly zero.

Shares of HDFC Bank on Thursday fell 3.1 per cent to Rs 1,490, extending its two-day decline to 11 per cent.

Meanwhile, the ADR has slumped over 15 per cent in the past two trading sessions.

This is after the private sector lender’s slower-than-expected margin recovery during the December 2023 quarter triggered a sell-off in the stock.

A huge part of the selling pressure has come from foreign portfolio investors (FPIs).

They have pulled out Rs 20,000 crore from the overall cash market in the past two days.

On the NSE, HDFC Bank has clocked a trading turnover of Rs 12,040 crore on Thursday and Rs 13,319 crore a day before.

A month ago, the ADR premium stood near the 52-week average of 11 per cent.

The shrinking premium is indicative of growing pessimism of overseas investors towards the country’s largest private sector lender.

The bank is battling net interest margin (NIM) woes following the $40-billion merger with parent HDFC.

Most analysts on the Street have cut HDFC Bank’s NIM and earnings per share (EPS) forecasts.

“We have cut our NIM estimates by 15 basis points (bps) across FY25-26F, as the benefit of funding mix improvement appears to be a significant challenge and a much longer-term story.

"As a result, we cut FY25-26F profit after tax (PAT) by 6 per cent, with return on assets cut 10 bps to 1.7 per cent,” said Nomura in a note, downgrading the stock to 'neutral’.

It expects the lender to clock EPS of Rs 89 in FY25, down from the earlier estimate of Rs 94.5.

Analysts believe HDFC Bank will have to make some painful adjustments, going ahead.

“They (HDFC Bank) have a stock problem, not a flow problem.

"The liabilities acquired from HDFC have come at a 7.5-7.7 per cent funding cost whereas the bank’s own cost of funds is a good 300-350 bps lower,” said Suresh Ganapathy, managing director (MD) & head of financial services research, Macquarie Capital. He added that the bank will have to “consolidate.”

“It is a painful process but you have to get the loan growth down.

Be it ICICI-ICICI Bank merger, be it ICICI having non-performing loan issues in the past, be it Axis Bank or IndusInd Bank — every bank had to get the loan growth down to restructure the balance sheet.

"That is what the need of the hour is,” he added.

During its heyday in early 2021, HDFC Bank’s ADR premium was as high as 31 per cent.

One of the reasons for the premium was lack of investment room for foreign portfolio investors (FPIs) in the domestic market.

However, following a record pullout of $30 billion between October 2021 and June 2022 from the Indian markets, the investment legroom for FPIs expanded.

Following this, FPIs no longer felt the need to pay a hefty premium to buy US-listed shares of the lender.

The FPI legroom increased further after the HDFC-HDFC Bank merger became effective.

At the end of the December 2023 quarter, the FPI investment legroom stood at nearly 20 per cent, which could fall further if the FPI selling continues.

Analysts don’t rule out HDFC Bank ADR slipping into discount to local shares, as domestic investors remain relatively more bullish on the stock.

Two other private sector lenders — ICICI Bank and Axis Bank — that have active ADR programmes, also trade at a discount to their local shares.