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NIM compression transitory, expect it to recover

Strong traction in the Individual space, Non-Individual will follow suit

* HDFC reported a PAT of INR36.7b in 1QFY23 (8% miss), up 22% YoY. It reported a NIM compression of ~10bp YoY and 30bp QoQ at 3.4%. Credit costs rose ~7bp QoQ to ~36bp.

* Disbursements in the Individual segment grew 66% YoY to ~INR420b. Individual/total AUM rose 20%/17% YoY. The management guided at a strong pipeline in Non-Individual segment, which will translate into healthy AUM growth.

* With the merger announced, taking a view in isolation is difficult, but we feel that HDFC continues to have a strong ‘Right to Win’ in its standalone Mortgage business. We maintain our Buy rating on the stock with a TP of INR2,830 (premised on Mar’24E SoTP).

Transmission lag led to compression in NIM, efforts made to fix it

* NIM compression was due to: a) transmission lag in passing of higher borrowing costs, and b) absence of benefits of low rates on overnight interest swaps (OIS), which was present in 1QFY22.

* Adjusted for the one-time impact of the transmission lag and OIS, NII growth would have been 16% YoY (in line with AUM growth)

* HDFC has reduced the re-pricing frequency in incremental Retail lending to one-month from three-months.

Asset quality improved; credit cost should moderate from hereon

* Gross S2 + S3 (combined, 30+dpd) declined to 6.5% from 6.7% QoQ. GS3 fell 15bp QoQ to 2.1%. ECL/EAD declined by 8bp QoQ to 2.3%.

* GNPA fell by ~13bp QoQ to 1.8%, led by ~32bp decline in Non-Individual GNPA to 4.4%.

* Total restructured pool stood at 0.77% of AUM (v/s 0.8% as of 4QFY22).

* Asset quality should exhibit strengths and continue to improve. We model lower credit costs of ~30bp/25bp in FY23/FY24.

Merger on track; equity infusion in HDFCLIFE

* HDFC has received approval for the merger from RBI and is awaiting approvals from the CCI.

* From a regulatory perspective, HDFCLIFE wanted to increase its solvency ratio to over 200%. With this preferential issue of equity shares of INR20b, the shareholding of HDFC in HDFCLIFE will increase by 1%, but it will still remain below 50%.

* HDFC is awaiting clarity from RBI on whether it can increase its stake above 50% before the merger is consummated.

Highlights from the management commentary

* Cost-to-income ratio was higher because of the increased Retail business and expansion of the branch network. Increased legal costs also contributed to higher OPEX.

* The management said there is no evidence from the past to suggest that rising interest rates have resulted in higher delinquencies.

* Within Individual/Retail loans, the back book gets re-priced over a period of three months, while it happens with a lag of one month in Non-Individual loans.

* Dividend income is higher YoY due to dividend received from HDFC AMC, HDFCLIFE, and Credila. Dividend received from HDFCB will be recognized in 2QFY23.

Impact of higher interest rates on NIM and asset quality will be key

* We expect credit costs to moderate from hereon. Asset quality exhibited strength across both Individual and Non-Individual segments.

* We expect margin to recover over the remainder of FY23. With overall provisions at 2.3% of EAD, HDFC has made adequate provisions for any contingencies in asset quality.

* We have cut our FY23 EPS estimate by 3% to factor in lower reported margin in 2Q. We expect HDFC to deliver an AUM and PAT CAGR of ~14% each over FY22- 24, which will translate into a core RoA/RoE of 2%/14% in FY23/FY4. We reiterate our Buy rating on HDFC with a TP of INR2,830 (premised on Mar’24E SoTP).

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