All eyes on India’s HDFC Bank

The market’s favourite megabank is surrounded by a lending crisis

SINGAPORE: All around HDFC Bank Ltd, India’s biggest lender by market value, the news seems to be bad and getting worse: economic growth is slowing, loan losses are rising and shadow banks are mired in crisis.

And yet investors keep piling into HDFC Bank’s stock, convinced it will emerge a winner from India’s financial woes. The company’s market value has surged by Us$21bil over the past year, more than any other bank worldwide.

Among the 25 biggest lenders globally, no other stock commands a higher price relative to earnings or net assets.

Bulls say they have good reasons to be optimistic: HDFC Bank will grab market share from embattled shadow lenders and benefit from a flight to quality by investors who’ve grown wary of smaller competitors.

While skeptics argue that the bank is vulnerable to India’s economic challenges – pointing to its large consumer loan exposure and the looming retirement of its long-time leader – even they say betting against HDFC Bank is risky.

Among 54 analysts who cover the stock, only one has the equivalent of a “sell” rating.

“The business continues to perform very well,” said Nick Payne, the London-based head of global emerging markets at Merian Global Investors (UK) Ltd, which oversees about Us$33bil and has been adding to its holdings of HDFC Bank shares.

“Strong banks and franchises tend to get stronger when times get tough, as the weak fall by the wayside.”

India’s shadow banks, until recently a growing competitive threat to HDFC Bank and its peers, have been reeling since the latter half of 2018, when a group company of Infrastructure Leasing & Financial Services Ltd defaulted on its debt and triggered an industry-wide credit squeeze. Mortgage lender Dewan Housing Finance Corp Ltd has missed debt payments since June, while firms including Reliance Capital Ltd and Piramal Capital & Housing Finance Ltd have had their credit ratings cut on liquidity concerns.

The turmoil has come against a backdrop of five straight quarters of slowing economic growth, the highest unemployment rate in 45 years, and predictions that bad loans at Indian banks will jump to a record 12% by early next year.

All the while, HDFC Bank’s stock price has marched higher. Now valued at about Us$92bil, the company trades for 24 times projected earnings over the next 12 months.

That’s almost three times more expensive than the Bloomberg World Banks Index, within a hair’s breadth of the biggest valuation premium on record. The company’s price-tobook ratio of 4.3 compares with 1.5 at Jpmorgan Chase & Co, the biggest US lender by market capitalisation.

Not everyone is convinced the outsized gains will continue. Gautam Chhugani, an analyst at Sanford C. Bernstein & Co, downgraded HDFC Bank to market perform from outperform on Sept 9. He cited succession risks around next year’s planned departure of Aditya Puri, who has led the company since 1994, as well as the potential for deteriorating asset quality in the bank’s 4.43 trillion-rupee (Us$62.5bil) retail lending portfolio.

While HDFC Bank has said loan losses in its retail business have been stable and within expectations, that could change if India’s economic growth and employment trends continue to worsen.

Retail credit costs “are unlikely to remain benign over the medium term,” Chhugani said. HDFC Bank didn’t respond to a request for comment.

Optimists draw comfort from the firm’s nearly unmatched track record of keeping loan losses in check throughout multiple economic cycles.

HDFC Bank’s per-share book value has grown at a compound annual rate of more than 20% over the past decade, while its gross non-performing loan ratio of 1.4% at the end of June was the lowest among Indian peers.

HDFC Bank is likely to report “strong’” profit growth and stable asset quality for the quarter ended September, Diksha Gera, an analyst at Bloomberg Intelligence, wrote in a report. As shadow lenders retrench, the bank would pick up market share, said Ross Cameron, the head of Northcape Capital Ltd’s Japan office. It should also get a boost from a recently announced cut to India’s corporate tax rate.

The business continues to perform very well. Strong banks and franchises tend to get stronger when times get tough, as the weak fall by the wayside.

Nick Payne