The affirmation of Long-Term Issuer Rating factors in the bank’s diverse earnings profile and strong profitability, together with a high core capital buffer that is likely to be maintained. HDFC Bank’s comfortable capital buffers should be adequate to support its medium-term growth plans. The bank’s retail focus both on the assets and the liability side has helped it in building a stable funding profile, along with a high yielding granular asset book. HDFC Bank consistently maintains a superior performance across various credit metrics.
Ind-Ra has notched down the rating for HDFC Bank’s AT1 bonds from its Long-Term Issuer Rating. For AT1 instruments, the agency considers the 'discretionary component', 'coupon omission risk', and the 'write-down/conversion risk' as the key parameters to arrive at the final rating. The agency recognises the unique going-concern loss absorption features that these bonds carry and differentiates them from the bank's senior debt (one notch in this case) factoring in a higher probability of an ultimate loss for investors in these bonds. Ind-Ra envisages coupon deferrals and principal write down risk as a remote possibility in view of HDFC Bank’s financial strength and its track record of consistent and superior operating performance through cycles, over similar rated peers.
The Stable Outlook reflects Ind-Ra’s expectation that any deterioration in HDFC Bank’s asset quality will be adequately absorbed by its operating profits without any impairment in its above-average Tier 1 capitalisation (September 2016: CET1 ratio of 13.3%) .
KEY RATING DRIVERS
Steady Low Cost Funding: HDFC Bank’s current account and savings account (CASA) growth has been fairly robust, at around 40% as of September 2016 (September 2015: 40%). Its dependence on volatile and high-cost wholesale deposits at 20% continues to be the lowest among its peers, helped by its constant efforts to attract deposits through a focussed retail strategy. Ind-Ra expects a further improvement in the bank’s CASA ratio by FYE17, even after assuming partial retention of the cash deposits attracted under the currency demonetisation. HDFC Bank has been consistently outperforming its peers - in terms of CASA growth (CAGR of 18.6% over FY13-FY16); however, its CASA ratio has remained stable on account of the proportionate growth in its term deposit book. The bank’s strong funding profile is its key competitive strength, yielding low funding costs and high pricing power.
Stable Asset Quality: HDFC Bank maintains stable asset quality through the cycles (gross NPL September 2016: 1.02%; September 2015: 1.04%). This is in contrast to the banking system’s gross NPL ratio, which surged to 7.6% as of March 2016, while private sector banks were at 2.7% on a blended basis. This, in the agency’s view, is underpinned by the bank’s strong credit underwriting and monitoring culture. The agency also derives comfort from the bank’s granular asset book and proportionately smaller exposure to highly levered corporate groups, compared with peers’. As of September 2016, business banking constituted 12.5% of HDFC Banks retail loan book. In Ind-Ra’s view this portfolio could see some pressure on account of the rising stress levels across this segment. Additionally, commercial vehicle and business banking portfolios could come under some stress on account of the demonetisation of old currency in circulation. Nevertheless, HDFC Bank’s strong pre-provision profitability and robust capitalisation provides a strong cushion to absorb the elevated levels of stress under Ind-Ra’s stress scenarios.
Unsecured Portfolio’s Asset Quality a Key Monitorable: While on an overall basis HDFC Bank maintains a well-diversified loan book, across the retail and corporate sectors (domestic loan mix - retail: 54%, corporates: 46%), there has been a gradual increase in the share of its unsecured portfolio (September 2016: 18.3%; September 2014: 15.3%). Within unsecured book, the personal loan portfolio contributed 16.9% to the overall loan book growth over the 12 months ended September 2016. A considerable part of HDFC Banks large unsecured loan book has been built by leveraging its internal customer base. Historically asset quality of its unsecured portfolio has been stable. HDFC Bank’s ability to maintain the inherent risks in this segment will be a key monitorable.
Cost Control to be a Key Driver of Profitability: HDFC Bank’s income diversity, stable costs and controlled asset quality have provided it with a strong earnings buffer, against stressed credit costs in times of crisis. HDFC Bank has maintained a return on asset above 1.8% over the last five years, while its stable dividend has contributed strongly to the internal capital accretion rate. With the sluggish loan off-take impacting net interest income growth, and credit costs staying close to cyclical lows, focus on cost control would be a key driver for managing profitability in line with asset growth. The bank’s thrust towards enhancing its offering of digital banking products could turn out to be beneficial in reducing its operating costs.
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