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Thematic Report[February 17, 2012] Sharekhanwww.sharekhan.com

Summary of Contents

THEMATIC REPORT

Switch from HDFC Bank to HDFC

Key points

Tactical switch from HDFC Bank to HDFC: In the past one year, HDFC Bank has appreciated by close to 30% as compared to the 14% appreciation in HDFC in the sameperiod. This has usually been the case in a rising interest rate scenario due toHDFC?s dependence on bulk/wholesale deposits and corporate loans. On the otherhand, HDFC Bank benefits from its strong retail deposit (current account/savingsaccount) and asset base. However, it is the other way round when the interest rate cycle reverses. HDFC tends to outperform relative to HDFC Bank in a declining interest rate scenario. The empirical evidence from the past interest rate cycle supports our argument. Thus, we expect the discount in the valuation of HDFCBank (vs HDFC) to revert to a mean of 20% plus (from around 6-7% now) over the next one year.

HDFC?relatively better placed to gain from the reversal in the interest rate cycle: As the interest rates ease out, HDFC?s cost of funds is expected to declinerelatively faster due to its dependence on wholesale funds that constitute 75% of its funding. Even on the assets side (advances), the bulk of its mortgage loans are on a floating rate. Plus, the advances under the dual rate home loan scheme (Rs22,000 crore of teaser loans with a lower interest rate for the initial twoyears) are scheduled to get re-priced over the next one year). Going ahead, asthe operating environment improves the performance of the subsidiaries (insurance, asset management etc) should also improve, boosting the overall valuations and leading to a re-rating of the stock. In this note, we have revised our sum-of-the-parts (SOTP) based price target for HDFC to Rs785 per share (valuing the subsidiaries and investments at Rs235 per share) and upgraded our recommendation onthe stock to Buyfrom Hold earlier.

HDFC Bank?the best operational metrics among private sector banks but offers limited upside: While HDFC Bank is among the best private sector banks but tactically it can underperform HDFC in the next 6-12 months as seen in the past. This isdue to the relatively slower rate of repricing of its assets and liabilities. The bank is essentially current account and savings account (CASA) funded for which the cost is fixed (4% for savings deposits) and is facing increased competition from the other private sector banks that are offering higher rates on savingdeposits. The bank has also raised its deposit rates recently by 50-100 basis points to catch up with its peers; this will also affect its margins. In addition,70% of its non-CASA deposits are from the retail segment where the cost is stickier. Further, the valuations have run up over the three-year mean and further upside seems limited from these levels.

HDFC Bank?the best operational metrics among private sector banks but offers limited upside: While HDFC Bank is among the best private sector banks but tactically it can underperform HDFC in the next 6-12 months as seen in the past. This is due to the relatively slower rate of repricing of its assets and liabilities.The bank is essentially current account and savings account (CASA) funded for which the cost is fixed (4% for savings deposits) and is facing increased competition from the other private sector banks that are offering higher rates on saving

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deposits. The bank has also raised its deposit rates recently by 50-100 basis points to catch up with its peers; this will also affect its margins. In addition, 70% of its non-CASA deposits are from the retail segment where the cost is stickier. Further, the valuations have run up over the three-year mean and furtherupside seems limited from these levels.