HDFC Financial institution: Turning A New Chapter Put up RBI Restrictions (NYSE:HDB)

With the Reserve Financial institution of India (RBI) lastly lifting restrictions on the launch of HDFC Financial institution’s (NYSE:HDB) digital initiatives (~15 months after imposing these restrictions in Dec 2020), the financial institution’s long-term progress story seems to be to have regained momentum. Whereas the inflationary and geopolitical headwinds might weigh on the financial restoration close to time period, HDFC Financial institution’s observe report of sustaining mortgage and web curiosity revenue progress by the cycles, whereas additionally sustaining best-in-class asset high quality, ought to enable for a re-rating. Whereas the inventory has underperformed in current months, the lifting of the RBI restrictions (first on bank cards and now on the digital aspect) and the financial institution’s robust market positioning makes the present valuation at ~2.6x 2024 P/BV (vs. high-teens ROE), significantly profitable at this level within the cycle.

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Supply: Market Information, Writer

RBI Restrictions Lifted; Digital 2.0 Initiatives to Start

In a current launch, HDFC Financial institution disclosed the RBI’s resolution to raise the ban on its Digital 2.0 program. For context, the RBI had beforehand restricted HDFC Financial institution from onboarding new bank card prospects (lifted in August final yr) and implementing its Digital 2.0 plans because of repeated system outages. The announcement was a very long time coming – in its 2021 Annual Report, CEO Sashi Jagdishan acknowledged the financial institution’s shortcomings on the know-how entrance and outlined large-scale investments to scale-up its IT infrastructure, together with accelerating its cloud shift and migrating core information facilities to state-of-the-art services to deal with any potential load for the subsequent three to 5 years.

If its post-ban bank card exercise is something to go by, the lifting of the digital ban ought to kickstart a brand new wave of progress – new bank card issuance by the financial institution noticed a spike within the subsequent months, hitting 1.3m new bank cards issued in Jan 2022. This has pushed the financial institution’s bank card market share to 22.8%, though there stays some strategy to go earlier than it regains its ~25% share peak in 2020. That stated, the influence of its digital initiatives ought to be extra gradual – the brand new business-generating actions underneath Digital 2.0 will doubtless hit the P&L just a few quarters down the road, however over the long run, accelerating buyer acquisition within the digital channel and gaining pockets share ought to show extremely accretive. Key digital initiatives within the pipeline over the subsequent 12-18 months embody a funds hub, a buyer expertise hub, a neobank (inside HDFC Financial institution), and an built-in ecosystem spanning the auto, healthcare, and rural banking segments.

Governance Enhancements Led by Slowing Attrition and Higher Aligned Incentives

The RBI ban has had favorable implications for the financial institution’s transparency as effectively – the financial institution’s annual report now discloses particulars of senior and junior administration workforce members with incomes over the Rs10m mark. Relative to the 2017-2019 interval, when the financial institution noticed a big discount in ESOPs (i.e., HDFC Financial institution’s worker inventory possession plan) in absolute phrases, 2021 disclosures additionally highlighted a shift towards extra ESOPs being granted to the employees. Apparently, ESOPs exercised throughout the yr additionally got here down, and thus, choices excellent now stand at ~168m (~3% of excellent shares). In step with its ESOP-heavy compensation coverage shift, attrition ranges have additionally moderated in 2021 – a welcome improvement after the CEO’s retirement in 2020 and the resignation of the Deputy CEO in 2018. With a better-aligned incentive plan in place and no high-profile exit during the last yr or two, I see no purpose why the financial institution ought to have problem retaining prime expertise going ahead.

Anticipate Earnings Development Amid Retail Momentum and Bettering Asset High quality

With the continued inflationary atmosphere set to drive charges greater within the coming months, NIMs ought to profit, with HDFC Financial institution’s comparatively excessive share of floating charge loans doubtless to assist the financial institution as effectively. That stated, the important thing to the general enchancment rests with asset yields, in my opinion. On this regard, HDFC Financial institution has excelled – its asset high quality has been industry-leading for years now, and even by the worst of the NPA (non-performing property) company recognition interval, the financial institution was capable of preserve its best-in-class asset high quality. The financial institution’s capacity to successfully handle asset high quality was additionally evident by the worst of the COVID influence, with its NPA ratios staying resilient all through. As of Q3 FY22, HDFC Financial institution’s gross NPA ratio has additional declined to 1.26% (down from 1.42% within the prior yr), making a stable platform for the financial institution to spice up its NIM towards the higher finish of the guided 4-4.4% vary.

Because the post-COVID financial restoration in India continues, retail mortgage ebook progress will doubtless be a key earnings driver. Sequential progress charges during the last two quarters have been robust, and assuming this continues, I feel retail mortgage progress might fairly simply hit a high-teens % CAGR over the 2022/2024 interval – barely above the general financial institution’s mortgage ebook progress pattern. Including to the retail mortgage progress potential is the launch of latest merchandise equivalent to BNPL (Purchase Now/Pay Later) and a totally revamped funds providing in addition to enhancements to its different client merchandise. Whereas the funding in know-how and progress might result in a near-term rise in price ratios, this ought to be greater than offset by automation advantages kicking in, with a sustained ~38% price/revenue ratio representing a really possible end result, in my opinion.

A High quality Franchise on the Restoration Path

With the lifting of the RBI’s ban on HDFC Financial institution’s Digital 2.0 program, a lot of the unfavorable sentiment ought to fade from right here. To be clear, the brand new companies deliberate underneath Digital 2.0 will doubtless not contribute visibly to progress and profitability anytime quickly, however over the long run, the ramp-up of digital buyer acquisition and pockets share bodes effectively for the sustained profitability of the financial institution. Plus, the financial institution’s franchise energy stays intact, and issues round its tech capabilities and administration churn have been addressed, with asset high quality additionally resilient by the cycles. Given the best-in-class RoE, market management throughout a number of segments, and its established observe report of managing progress with asset high quality, I consider a wider premium to closest peer ICICI Financial institution (IBN) is justified. At ~2.6x 2024E P/Ebook, the inventory gives traders good worth, in my opinion.