Why investors aren’t buying HDFC Bank CEO Jagdishan’s optimism


The final example of self-aggrandizement comes, surprisingly, from an institution that has built its reputation on the back of careful risk management and effective investments in systems and processes. In an interaction with analysts, Sashidhar Jagdishan, MD and CEO of HDFC Bank, spoke eloquently about future business prospects, adding almost breathlessly that the bank’s merger with parent company HDFC Ltd will double profits over the next few years. next five years. And then, a little after the fact, he also added that liability growth could be a problem.

This could serve to disentangle the two thoughts.

HDFC Bank’s merger with its parent company HDFC Ltd – which will take another 12-15 months, subject to all regulatory approvals being in hand – is likely to produce a juggernaut in the financial services sector. If the two had merged at the end of March 2022, the combined entity would have impressive figures – a capital base of 360,344 crore, a balance sheet size of 27,10,000 crores and net profits above $6 billion, or more 50,000 crores. If we look at net profit alone, that’s a lot of money with the ability to add extra juice to the balance sheet.

Jagdishan told analysts that this level of net profit could easily double to $14 billion to $15 billion over the next five years, indicating a compound annual growth rate (CAGR) of just over 20% each year. To be fair, using this projection is justified: HDFC Bank’s net profits have grown at a CAGR of 20.5% over the past five years. It might be instructive to remind him of the disclaimer written by the market regulator Securities and Exchange Board of India: past performance is not necessarily indicative of future performance.

This is where pride trumps restraint. Three points stand out.

First, Jagdishan’s prospect of anti-gang growth rests on the impending merger with parent company HDFC Ltd and economic growth of 7-8% each year. The GDP outlook looks uncertain given the Russian-Ukrainian conflict which is worsening the economic downturn inflicted by the pandemic. The latest edition of the World Bank’s Global Economic Prospects report also issues dire warnings of stagflation threatening the global economy. In such a situation, the claim that any financial institution will be able to grow its balance sheet by more than 14-15% every year, or achieve a CAGR of more than 20% in net profit, over the next 5 to next 7 years seems a bit reckless. .

Second, there must be a realistic assessment of what the merger brings to the table. Is it good in general and should they accept it? Of course, the merger is undoubtedly desirable in terms of synergies and efficiency. But will this completely change the game for HDFC Bank, creating a sea change in its fortunes? The jury is out on that one.

Here’s why. At its core, HDFC Ltd is an oversized, oversized housing finance company. She has no other financial products in her portfolio. It is reaching the limits of its growth potential. This is despite the fact that the Indian mortgage market has ample room for future growth. The core issue is funding and HDFC’s growing reliance on market borrowing – 65% from debentures, securities and term loans; 32% of public deposits – limits the company’s ability to extract higher returns. Therefore, merging with a bank allows the mortgage business to access cheaper funds.

But, at the same time, a critical factor for HDFC Bank will be deciding what percentage of the asset portfolio should include mortgage business to allow the bank to earn a healthy blended return on its asset mix. The efficiency of capital allocation will be the determining factor here. Using the ceteris paribus principle, or assuming all other things remain constant, the post-merger mortgage portfolio should be around 30% of the total asset portfolio, more or less. Even assuming the mortgage portfolio is maintained at a constant level of 30% of the overall asset portfolio, which is expected to grow by more than 15% per year, HDFC Bank will still need to systematically divert additional money from its other activities to maintain the mortgage portfolio. to this stable state. The question then is: will it be worth it for the bank and its shareholders?

Finally, the point on liabilities, which is banker talk for deposits. It’s supposed to be the secret sauce behind the merger, a key raison d’etre, and Jagdishan is already expressing doubts about it. Before the game even begins.

Commercial banks with extensive branch networks have access to current and savings accounts (CASA), which are low-cost liabilities; moreover, due to marginal fluctuations in volumes, they are assimilated to perpetual liabilities, which facilitates the task of asset-liability management. In contrast, most term deposits – better known as fixed deposits – have a maximum maturity of only 5 years, while housing loans are typically between 15 and 20 years, resulting in currency mismatches. potentially unfavorable maturities. That is why, at first glance, HDFC Bank’s CASA deposits, representing more than 48% of its total deposits, look attractive. The problem is that much of this is already spoken. To fuel the voracious mortgage industry, Jagdishan will have to aggressively find additional liabilities.

Two problems arise here. HDFC Bank has hit a wall when it comes to digitalization; it has not been able to compete with its peers in using the digital platform to extract additional efficiencies. The sprawling institution has become extremely bureaucratic and needs a major organizational overhaul if it is to compete with its peers or the newly consolidated public sector banks. Digitization will be essential to reduce origin costs and administrative costs.

The other problem is that Jagdishan tells analysts that he plans to add 1,500 to 2,000 new branches every year. From the conference reports in the newspapers, it is surprising that none of the analysts challenged Jagdishan on this. HDFC Bank already has 6,300 branches and the opening of another 2,000 branches adds more than 30% capacity in one year. This is a huge capital investment, which will leave the bank with reduced funds to pursue additional activities or seek additional income. This then puts the whole assumption of a 20% CAGR for net profit under a cloud.

The market has consistently driven down the prices of HDFC Ltd and HDFC Bank since the announcement of the merger. Both stocks have lost almost 19% of their value since April 4, 2022, the day the respective boards approved the merger. Continuing conflict in Europe, rising commodity prices, an impending economic downturn and a general environment of uncertainty have a definite role to play in the erosion of value. But when compared to the BSE 30-stock Sensitive Index (which lost only 10.5% over this period) or the S&P BSE Bankex Index (which fell 9.7%) , it is clear that a class of investors are concerned about the merger.

Jagdishan should talk to these guys, try to find out what’s haunting them, and maybe come up with a clearer communication strategy to address specific concerns. Exaggerated claims, in the style of pompous politicians, are unlikely to sway die-hard investors.

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