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More prudent and efficient; smooth management transition holds the key

* Despite the sharp decline in fee income amid the disruption in business activity, HDFCB reported a healthy 20% yoy growth in PAT to Rs67bn on lower opex/contained provisions. The GNPA ratio inched up to 1.4% as a result of a prudent and proactive NPA recognition policy vs. actual formation.

* Overall loan moratorium stands at 9% (in terms of number of customers), with nearly 97% in 0 DPD. Resolution rates have accelerated back to 65-67% and bounce rates are far lower than the system. As a prudent measure, the bank now carries a higher specific PCR of 76% and a contingent provision buffer of Rs54.5bn (54bps of loans).

* Clarity on new MD should emerge soon, with the probability of choosing an internal candidate being higher. Though Mr Aditya Puri brushed aside concerns around recent exits and personal misconduct in the auto division, we believe that the bank needs to keep attrition/compliance in check to maintain management premium after the top management transition.

* We maintain our Buy rating/OW stance in EAP, with a revised TP of Rs1,300 vs. Rs1,100 earlier (new TP based on 3x FY22E core ABV and subs value of Rs53 vs. 2.6x FY22E core ABV earlier), given its proactive risk management, strong shock absorption capacity and still reported superior return ratios among large-cap banks.

Retail growth slows amid Covid-19-led disruption, but NIMs remain steady: Despite the decline in the retail book (-4% qoq), overall loan growth in Q1 was healthy at 21% yoy/1% qoq aided by corporate growth, mainly toward better-rated corporates and epidemic-resistant businesses. Fresh origination/disbursement is picking up again more in the VF business, including Tractors/TWs and cars. Within SME, opportunity under the govt’s guarantee scheme is Rs200bn, of which it has disbursed Rs100bn and the balance is in the pipeline. Overall, NIM stood stable at 4.3%, led by better investment yield/lower CoF, and the bank does not see any risk to its margins.

Prudently accelerated NPA recognition, provisioning buffer: The bank’s ongoing stress testing suggests that experience till now has been better than anticipated at the beginning of the lockdown, but it would prefer to be proactive in the recognition of stress, leading to a higher GNPA ratio in Q1 despite the moratorium at 1.36% (up 10bps qoq), and also create a strong provisioning buffer. Overall moratorium rate in Phase 2 stands at ~9%, including 90% continuing from Phase 1. The bank has also redeployed 20K additional employees toward collections, and resolution rates have improved significantly to 65-67% in select segments. The bank has created a contingent provision buffer of Rs54.5bn (54bps of loans) and believes that if the situation does not deteriorate materially from hereon, these provisions will be largely sufficient.

Outlook and valuations: Management has guided for stable/healthy NIMs and a structurally better cost-income ratio, while the higher provisioning buffer should help absorb ensuing asset-quality risk. Maintain Buy/OW stance in EAP with a revised TP of Rs1,300, valuing core bank at 3x + sub value of Rs53 per share. Key risks to our call are slow loan growth, higher-than-anticipated NPAs in retail loans and a disruptive management transition.