In today's Finshots, we explain why HDFC Bank's share price has fallen by over 10% this week.

The Story

Banks make money in a simple way:

  1. They raise money from the public. It could be via Fixed Deposits or through low-cost Current Accounts and Savings Accounts (CASA).
  2. They then lend money out to people and corporations that need it and charge a high interest rate

The difference between the two eventually gives them their Net Interest Margin (NIM)*.

If the NIM is higher than its rivals, it’s a great sign. It shows that the bank is running its business well and investors will flock towards it.

And for nearly 20 years, there was one bank at the top of this NIM food chain — HDFC Bank. It consistently earned 4% margins. No one else came close.

But right now, HDFC Bank seems to have lost its mojo. Its NIMs have dropped to below 3.5%. It has fallen off the pedestal and investors aren’t happy about it. After it announced its latest quarterly results earlier this week, the stock cracked by over 10%. Domestic investors are selling. Foreign investors are rushing to the exits. Everyone’s spooked.

So, what ails HDFC Bank exactly, you ask?

Well, it's hard to say precisely what wrong. But there are a few theories. The first one could be the merger.

Yup, the $60 billion merger with its housing loan parent company HDFC is still going through some teething troubles. And that could be hurting the combined entity.

We already told you that HDFC Bank had consistently scored a higher NIM than peers for years. A large part of that was thanks to its large base of current accounts where it didn’t have to pay out any interest and the savings accounts which paid out interest at a very low rate.

But then, HDFC Ltd came into the picture.

Since it wasn’t a bank, but a housing finance company, it couldn’t raise CASA deposits. It could only raise the Fixed Deposit kind. These are what you’d term high-cost. The entity had to shell out higher sums of interest on them. Its margins were weaker. Somewhere in the range of 2%-2.5%.

And all of that has landed on HDFC Bank’s table now. In fact, these high-cost borrowings were just 8% of the bank’s liabilities a year ago. But after the merger, they accounted for 21% of HDFC Bank’s liabilities. Just to be clear, a liability for a bank is typically the deposits that they raise and need to pay back.

So you can see how that automatically would’ve compressed margins a fair bit.

Now sure, everyone knew that the merger would have an impact on the bank’s financials. Most analyst reports had felt that the pain would remain for at least a few quarters.

So, if this was an expected result, why would the markets react so harshly?

Well, NDTV Profit believes the answer to that could lie in ‘communication’.

If we rewind to the previous quarter when the bank announced its results, the CFO had said that the margins would improve ‘over a period of time’. The problem now seems to be that investors somehow took that to mean the impact of the merger had been factored into the margins back then. And that it would slowly inch upwards.

Naturally, investors expected higher margins for this quarter. So when the NIMs remained flat, everyone was disappointed. Especially since some of the RBI rules that asked banks to keep aside higher buffers had also eased up.

The other thing here is regarding the growth of deposits. For a bank to be able to lend out money freely, they first need to raise deposits. If deposit growth is slower, it could impact its lending activities and ergo, the ability to make money as well.

And in October 2023, the bank’s CEO said: “So we are very sanguine and very confident that funding [deposits] is never going to be an issue.”

But cut to today and deposit growth has slowed down significantly. In fact to maintain a semblance of balance, it needs deposits to grow 3–4% faster than the credit growth. Since that’s not happening now, it could put some stress on the very ‘funding’ factor that the bank only recently pointed out would never be a problem.

So yeah, you can see why the stock cracked after its results were announced.

And this brings us to the question on everyone’s mind now — Is the HDFC story over?

Well, we doubt it.

For starters, let’s look at the growth in their market share over the years. Since FY15 the bank has doubled its share of Loans and Deposits in the industry — from roughly 5% to above 10% today. That is what made it the behemoth it is today.

But hold on, this doesn’t tell us what the future holds. For that, we need to look at the opportunity too. And as per a report by Banyan Tree Advisors, PSU Banks still hold around 65% of total deposits (short and long-term included). So just by that measure, the runway for growth for someone of HDFC’s pedigree is still long.

And HDFC could be well aware of this. They’ve doubled down on setting up branches all across India. In the past 5 years, the number of branches has risen by 60%. No other bank is launching new branches at this scale. They’re not even close.

Now here’s how this could play out — apparently, there’s a strong correlation between the age of HDFC Bank’s branches and the deposits they manage. There’s an inflection point or what’s called a J-Curve when a branch completes 10 years. The deposits suddenly take off. It’s something that research house Nomura pointed out as well.

But why does that happen?

We can’t be too sure but the common theory is that people prefer the status quo in banking. And it typically takes a bit of time for a branch to make inroads among the population. But once that trust builds, the surge in deposits can be like a tsunami.

Right now, HDFC Bank has over 2,000 branches that are in the 5–10 year vintage. The bet is that the J-curve kicks in soon enough for many of them.

Finally, don’t forget that one key opportunity is that 70% of HDFC Ltd’s customers don’t seem to bank with HDFC Bank. That itself provides a huge opportunity for the bank.

So, is this the right time to snag this beaten-down banking giant?

Unfortunately, we don’t dole out investment advice. But what we can tell you is that despite 5 years of underperforming the Nifty50 index, it still isn’t a cheap stock by any stretch of the imagination. It’ll still require a brave person to bet on HDFC Bank today even with the long-term opportunities that seem to be lying in wait.

So, what do you think about HDFC Bank's prospects?

Until then…

*NIM also includes income from other sources — say bonds the bank has invested in. And it is expressed as a percentage of the average assets that are used to make money.

Don't forget to share this article on WhatsApp, LinkedIn, and X (formerly Twitter)

📢Finshots is now on WhatsApp Channels. Click here to follow us and get your daily financial fix in just 3 minutes.