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Erstwhile HDFC Limited under the spotlight

We participated in the Analyst Day Meet held by HDFC Bank (HDFCB) and gleaned the following key takeaways (1) The networth of the erstwhile HDFC Limited would be reduced by a gross quantum of Rs 324bn as of 1st July due to various adjustments (2) For HDFC Limited, the IGAAP RoA for FY23 would have been about 1.9%, which is about 75% of IndAS RoA of 2.4% for FY23 (3) Management explained that the excess liquidity being held would be unwound in 2-4 quarters (4) The return on assets for the merged bank in 1QFY24 on pro forma basis is 1.9-2% compared with 2.1% for the standalone bank

The networth of the erstwhile HDFC Limited would be reduced by a gross quantum of Rs 324bn as of 1st July due to various adjustments 

The reduction in networth is (1) Rs 118bn due to alignment of IGAAP (2) Rs 76bn due to credit policy harmonization in order to adhere to RBI standards as well as bank standards (3) Rs 49bn due to deferred tax liability reserve as per RBI’s 2013 circular (4) Rs 81bn due to dividend payout before 1st July 2023. On the other hand, (1) there was an accretion to networth over 1QFY24 due to income, warrants, ESOPs, etc amounting to Rs 62bn and (2) there was also a positive impact of Rs 40bn due to tax effects of harmonization. As a result, the net negative impact on the erstwhile HDFC Limited's networth is Rs 222bn as of 1st July compared with March 2023. The opening networth of unmerged HDFC Bank for July 2023 is Rs 2938bn, which translated to a standalone BVPS of Rs 525. The negative impact due to share swap and elimination of stake amounts to Rs 142bn. After adding the adjusted HDFC Limited networth, the networth of the merged entity amounts to Rs 3914bn as of 1st July 2023, which translates to a standalone BVPS of Rs 519.

For HDFC Limited, the IGAAP RoA for FY23 would have been about 1.9%, which is about 75% of IndAS RoA of 2.4% for FY23 

Half of this reduction is the bank dividend that HDFC Limited used to get but is now eliminated. The remaining half is equally due to deferred acquisition cost being taken upfront and the tax rate change

Management explained that the excess liquidity being held would be unwound in 2-4 quarters

The incoming Day 0 margin for HDFC Limited is 2.0% due to the additional liquidity that HDFC Limited is carrying. This is 70 bps lower than its 1QFY24 IGAAP margin of 2.7%. The total impact on merged entity 1QFY24 NIM (based on total assets) is 4.1% declining to a pro forma NIM of 3.7-3.8% due to the additional liquidity being carried. It will take 2-4 quarters to run down the excess liquidity. Longer-term, loan mix change will also aid margin. Share of retail, which used to be 54% even before a fully-fledged mortgage business, had dipped to 45% but has recovered to 47%

The return on assets for the merged bank in 1QFY24 on pro forma basis is 1.9-2% compared with 2.1% for the standalone bank 

The impact from decline in margin would be partly offset by a decline in cost to income ratio and a marginal decline in credit cost. The cost to income ratio of the standalone bank for 1QFY24 was 43%, which would be ~40% on pro forma basis for the merged entity. The credit cost would be marginally lower at ~0.6% compared with 0.7%. There are certain pockets such as small-ticket unsecured and MSME which are under stress at the system level but not necessarily for the bank. Pre-merger, the mean credit cost was 90-100 bps whereas, post-merger, it is about 10 bps lower

We maintain a less-than-outright bullish ADD rating with a revised price target of Rs 1950

We value the standalone bank at 2.5x FY25 P/BV for an FY24E/25E/26E RoE profile of 16.4/17.1/17.0%. We assign a value of Rs 207 per share to the subsidiaries, on SOTP. We had begun with an ADD rating for HDFCB in our in our Sector Initiation Report dated June 2021 before we upgraded it to BUY in our Sector Report dated May 2022 and then downgraded the stock back to ADD in our 4QFY23 result report.

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