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Accelerated provisions suppress PAT in Q4; constant tech outages remain an irritant

* Despite stable NIMs and higher fees leading to a beat on PPoP, the bank reported slightly lower PAT at Rs81.8bn (up 18% yoy) vs. est. of Rs83bn, mainly due to additional contingent provisions of Rs8bn amid raging second Covid wave and Rs5bn for interest-on-interest waiver.

* Retail credit growth remained subdued at 8% yoy due to the bank’s cautious stance and the RBI’s suspension of new card acquisition. Corporate growth remains very strong, leading to retail share slipping to 47%. As a strategy, the bank would continue to capture market share in corporate loans and has built a strong SME portfolio (20% of the total portfolio). It expects this to be a strong earnings driver, going forward.

* Reported NPAs were lower qoq at 1.3% vs. 1.4% (pro forma) in Q3, but the bank sees rising incidence of EMI bounces in the system due to localized lockdowns implemented after Covid19 second wave. The bank remains confident of its superior portfolio quality but as a matter of prudency, it carries a reasonable contingent buffer (Rs68bn; 0.6% of loans) after consuming Rs36bn in Q4, as NPA recognition has begun.

* We maintain Buy on the bank with a TP of Rs1,850 given its cross-cycle best asset-quality, strong franchisee/capital profile, better growth outlook and superior return profile. However, the RBI’s suspension of new card acquisition due to continued tech outages remains an overhang on the stock

Retail growth remains sluggish but is up scaling corporate, SME book to drive growth:

Retail credit growth remains sluggish at 8% yoy vs. systemic growth of 9% yoy due to the bank’s cautious stance, continued RBI suspension of new card acquisition and part sell-off of the portfolio. We believe retail growth could remain lackluster in the near term, as localized lockdowns due to the raging second Covid wave could delay growth/asset-quality normalization. Corporate growth remains healthy at 22% yoy, as the bank continues to capture market share from PSBs. It expects corporate capex cycle to revive from H2FY22 with early signs of capex visible in select sectors, including auto-ancillary, food industry, pharma and metals. In our view, the rising share of corporate book may be margin-negative in the interim, but it should yield good fees and further bring down the cost ratios for the bank. That said, the bank has also built a healthy SME book (18-20% of portfolio) in which revenue per customer is far higher (>2x) than corporate, and thus should partly offset the pressure on NIMs.

Stable asset quality but prefers to maintain reasonable contingent buffer as asset-quality normalization could be delayed due to second Covid wave:

The bank has reported a slight improvement in its GNPA ratio at 1.32% vs. pro forma GNPA ratio of 1.38% in Q3, while its NBFC subsidiary HDB Financial Services also has reported a reduction in GNPA to 3.9% vs. pro forma GNPA of 5.9% in Q3, mainly led by heavy w-offs. After witnessing meaningful improvement in Jun’20-Mar’21 period, the bank is seeing rising incidence of EMI bounces in the system due to localized lockdowns induced by the second Covid wave. HDFC Bank has done stress testing similar to last year and believes that there will be limited asset-quality disruption in its portfolio. However, as a matter of prudency, it has made additional contingent provisions of Rs8bn, and thus carries a reasonable contingent buffer (Rs68bn; 0.6% of loans) after consuming Rs36bn in Q4 toward specific provisions/w-offs.

Outlook and valuations:

The RBI’s suspension of new card acquisition due to continued tech outages remains an irritant. Management clarified that the net/mobile banking outage in Mar’21 was mainly due to compatibility issues between hardware and software rather than capacity constraints, and that it has already detailed plan to minimize such outages but is awaiting clearance from the RBI. We retain Buy/OW stance in EAP with a TP of Rs1,850, valuing the core bank now at 3.6x FY23E P/ABV and subs at Rs57/share. Key risks: delay in lifting credit card issuance suspension, tail-end asset quality risks and management attrition.

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