HDFC Bank Limited: "Melioration in Asset Quality Marginal Compression in NIM Initiating Coverage With HOLD"

March 01, 2011
HDFC Bank Limited

“Melioration in Asset Quality; Marginal Compression in NIM; Initiating Coverage with HOLD”
We initiate coverage on HDFC Bank Limited with a HOLD rating and an
CMP Rs. 2139.0 intrinsic value estimate of Rs. 2,446.8/share.
1Yr Target Price Rs. 2446.8
Valuations: According to our Shareholder Value Analysis, HDFC Bank is
Primium/Discount 14.4%
currently trading at a 14.4% discount to our intrinsic value estimate. The stock is
Stock Information currently trading at a P/ABV of 3.5x and 2.99x FY12 and FY13 estimated
BSE HDFCBANK adjusted book value, respectively. We believe the stock will trade at a target
NSE HDFCBANK
price of Rs. 2446.8 in the next 12 to 15 months assuming a target multiple
(P/ABV) of 4.01x at FY12E adjusted book value (We have arrived at this
Bloomberg HDFCBIN
multiple using residual income Model).
Factset 500180-IN
Face Value Rs. 10 Our Rating is Based on the Following Factors:
Equity Capital (Rs. Million) 215,225 1) Marginal compression in NIM followed by expansion in NIM due to low
Market Cap (Rs. Million) 1,033,444 cost of fund.
Average Volume (NSE) 923,113 2) Strong non-interest income to support net income growth in the time of
adverse interest rate movement.
Shareholding Pattern (%) 3) Cost to income ratio to fall irrespective of increase in operating
expenses, indicating further improvement in profitability.
Promoter & Promoter Group 23.4% 4) Firm NII growth irrespective of marginal compression in NIM.
Institutions 40.1% 5) Melioration in asset quality to tame credit cost.
6) Robust growth in loan portfolio.
Public 19.1% 7) RoA to improve further in the long term.
Total Shares held by custodians 17.4% 8) Further space for leverage.
9) ROE to improve further in the long term.
Key Financial 10) Adequate capital to support growth.
Year 2010 A 2011E 2012E Risks to our Rating:
Income (Rs. Million) 121942.1 143168.3 178188.4 1) Any lower economic growth than anticipated may have adverse impact
Operating Profit ( Rs. Million) 64297.3 76834.7 104058.2 on profitability.
PAT ( Rs. Million) 29487.0 30729.8 43119.8 2) Fair valuation.
P/E (x) 31.7 30.4 21.7
Chart 1: Stock Price History
P/ABV (x) 4.4 4.0 3.5
ROE (%) 16.12% 13.53% 16.85% 5000 2500
4500
4000 2000
3500
Contact Information 3000 1500
Analyst: Janaki Ballav Panigrahi
In Rs.
2500
Phone: 215-568-5500 2000 1000

1500
Fax: 215-568-5588
1000 500
www.boegroup.com 500
0 0
Volume (in ' 000 )LHS Share Price (RHS)
Source:NSE
Copyright © 2011 BOE

HDFC Bank Limited BOE RESEARCH REPORT PAGE 2
CONTENTS PAGE No.
1) Company Background 3
2) Operating Segment 3
3) Sector Overview 4
a) Macro Economic Headwind to Stay in Near Term 4
b) Inflation a Primary Concern 4
c) NIM to get Compressed Marginally 5
d) Credit Cost to Soften on Melioration of Asset Quality 6
e) Interest Rate Deregualation 7
f) New Banking License to Increase Competition 7
4) Recent Quarter Performance 8
5) Investment Merits 9
a) NIM marginal Compression Followed by Expansion 9
b) Strong Non-interest Income to Support Net Income 10
c)Cost to Income Ratio to Fall 10
d)Firm NII Growth 10
e) Melioration in Asset Quality 11
f) Loan Portfolio to Grow at a CAGR of 24% 11
g) ROA to Improve in Long run 12
h) Space for Leverage 12
i) ROE to Improve Further 13
j) Adequate Capital to Support Growth 13
6) Investment Concerns 13
7) Outlook And Valuation 14
8) Financial Statement Exhibits 15
9) Disclosures 17

Company Background:
HDFC Bank along with its subsidiaries is engaged in providing banking and other
HDFC Bank was incorporated in financial services primarily in India. HDFC Bank was incorporated in August 1994 in
August 1994 in the name of 'HDFC the name of 'HDFC Bank Limited', with its registered office in Mumbai, India.
Bank Limited', with its registered Housing Development Finance Corporation Limited (HDFC) received an 'in principle'
office in Mumbai, India. approval from the Reserve Bank of India (RBI) to set up a bank in the private sector.
HDFC Bank commenced operations as a Scheduled Commercial Bank in January
1995.
Management Team:
Mr. C.M. Vasudev
Mr. C.M. Vasudev assumed charge as the Chairman of the HDFC Bank from 6th July
2010 subject to the approval of the RBI and the shareholders. He has been a director
Chairman of the bank since October 2006. A retired IAS officer, he has had an illustrious career
in the civil services and has held several key positions in India and overseas,
including Finance Secretary, Government of India, Executive Director, World Bank
and Government nominee on the Boards of many companies in the financial sector.
Mr. Aditya Puri
Managing Director Mr. Aditya Puri, has been a professional banker for over 25 years, and prior to joining
HDFC Bank in 1994 he was heading Citibank's operations in Malaysia.
Operating Segment: HDFC Bank primarily operates in three business segments,
Wholesale Banking is one of the namely Wholesale Banking, Retail Banking and Treasury.
primary business segments as it
contributed around 26.6% to total Wholesale Banking: Wholesale Banking provides commercial and transactional
revenue in FY10. banking services including working capital finance, trade services, transactional
services, cash management, etc. This is one of the primary business segments as it
Retail Banking is the major business contributed around 26.6% to total revenue in FY10 (See Chart 2, Below).
segment of the bank as it contribute d Retail Banking: This business segment is responsible for providing a full range of
around 50.7% to total revenue in financial products and banking services to retail customers. This is the major business
FY11. segment of the bank as it contributed around 50.7% to total revenue in FY11 (See
Chart 2, Below).
Treasury Segment accounted for Treasury: The Treasury segment is primarily responsible for dealing with Foreign
15.1% of total revenue in FY10. Exchange and Derivatives, Local Currency Money Market & Debt Securities, and
Equities. The Treasury Segment is responsible for managing the return and market of
SLR and other investments. Treasury Segment represented 15.1% of total revenue in
FY10 (See Chart 2, Below).
Chart 2 : Revenue by Business Segment
15.1%
7.6%
50.7%
26.6%
Treasury Retail Banking Wholesale Banking Other Banking Operations
Source: Compa ny & BOE

Sector Overview
Macro Economic Headwinds to Stay in Near Term: The Indian banking sector has
Macro economic factors like
already bounced back from the eventuality of corruption charges against some of the
inflation and policy rates to tame
very highly placed people in the industry and 2G scam. However, macro economic
inflation will remain a concern.
factors like inflation and policy rates to tame inflation will remain concerns in the
first half of FY12. Higher inflation may put pressure on deposit growth rate and
attract policy tightening measures by the central bank. However, we believe
inflationary pressure with reduce from mid of the fiscal year.
Inflation a Primary Concern: The Indian economy has experienced a stable and low
inflationary environment during FY 00 and FY05. Inflationary environment became
volatile and high during the recent years, primarily driven by high food and
commodity prices.
Average primary article inflation remained at 14.5% during January FY09 and
Food inflation to remain moderate to February FY11. It has reached a peak of 22.16% in March FY10. However, it has
high as the food inflation is a result experienced moderation since March FY10 to 14.79% in February FY11 (See Chart
of changes in food habit and 3, Below). Primary article inflation was mainly driven by higher price of all of its
reduction of food productive land components (Food Articles, Non-Food Articles and Minerals); however, food article
due to industrialization and inflation contributed maximum as it has higher weightage ( 14.34% of WPI and
urbanization. 71.27% of Primary Article Inflation) in the primary inflation index. Average inflation
for food article remained at 15.10% during January FY09 to February FY 11.
Food article inflation eased from 20.97% in June FY11 to 10.16% in February FY11.
However, we believe food inflation will remain moderate to high as the food inflation
is a result of changes in food habit and reduction of food productive land due to
industrialization and urbanization. Along with the structural changes, increase in
income level of people also played a significant role in the price increase.
Chart 3: Primary Inflation and Its Components
25%
20%
15%
10%
5%
0%
J a n-08
J a n-09
J a n-10
J a n-11
Feb-08
M a r-08
May-08
Jun-08
Jul-08
Sep-08
Oct-08
Nov-08
Dec-08
Feb-09
M a r-09
May-09
Jun-09
Jul-09
Sep-09
Oct-09
Nov-09
Dec-09
Feb-10
M a r-10
May-10
Jun-10
Jul-10
Sep-10
Oct-10
Nov-10
Dec-10
Feb-11
Apr-08
Aug-08
Apr-09
Aug-09
Apr-10
Aug-10
Food Articles (Wtg: 14.34% in WPI , 71.26% in PA )

Non Food Articles (Wtg: 4.26% in WPI, 21.16% in PA) WPI: Wholesale Price Index
Minerals (Wtg: 1.52% in WPI, 7.57% in PA) PA: Primary Article Inflation
Primary Article (Wtg:20.12% in WPI, 100% in PA) Wtg: Weightage
Source: MOSPI

Fuel and Power inflation remained stable in a range of 11.02% to 11.49% from
September FY11 to February FY11, after reaching a high of 14.42% in May FY11.
Agitations in the Middle East and Agitations in the Middle East and North Africa (MENA) and its impact on oil prices
North Africa (MENA) and its impact are a primary concern for fuel and power inflation in the near term.
on oil prices are a primary concern
Irrespective of increasing labor cost, inflated price of commodities in international
for fuel and power inflation in the
markets and increasing raw material prices manufactured product inflation remained
near term. moderate. Highest level of manufactured product inflation was 6.43% in April FY11
during the financial year. It has softened to 3.75% in January FY11 and again
bounced back to 4.94% in February 2011. However, we believe manufactured product
inflation to stay in a reasonable range going forward in Q4 FY11 and FY12, due to
base effect.
Following the above discussion, we believe WPI inflation will remain moderate to
high in Q4 FY11 and first half of FY12, driven by pr imary article inflation and fuel
WPI inflation to remain moderate to and power inflation. Hence, it may attract the central bank to tighten the policy rate by
high in the first half of FY12 driven 50 basis point during the first half of the FY12. However, further policy rate
by primary article inflation and fuel tightening during the second half of FY12 cannot be ignored. We expect inflation to
and power inflation. be moderate in the second half of FY12 following Kharif (Monsoon Crop) agro
production and the effect of political turmoil will start subsiding in the MENA
region.
Chart 4 : WPI Inflation and Its Components.
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
-2.00%
Primary(Wtg:20.12%) Fuel & Power (Wtg:14.91%) Manufactured (64.97%) WPI All (Wtg. 100%)
Source: MOSPI
Net Interest Margin to Get Compressed Marginally: The banking sector NIM is
likely to fall marginally , primarily following the below stated reasons:
1. Upward Re-pricing of Deposit Rates: In a fast growing economic
environment, credit uptake is likely to pick up with the increase in credit
Following slower deposit growth
demand from industrie s for capital expenditure to fulfill the increasing
than the credit growth and with very
product demand in the economy. Same time in a high inflationary
less excess SLR investment, banks
environment saving growth is likely to moderate as people will always search
are likely to compete for attracting
alternative investment opportunities to get higher return for protecting the
new deposits by increasing the
value of saving from inflationary pressure. Following slower deposit growth
deposit rate.
than the credit growth and with very less excess SLR investment, banks are
likely to compete for attracting new deposits by increasing deposit rates.

2. Term Deposits to Grow Faster Than Low Cost CASA Deposits: We believe
investors will convert some portion of CASA deposits to term deposits and
new deposits are most likely to be channeled to high yielding deposits rather
than low-yielding CASA deposits in a continuous high inflationary
environment. As a result of conversion of some portion of CASA deposits
Increasing credit demand by the and inflow of major portion of new deposits as term deposits, we believe term
corporate sector and slow deposit deposits will grow faster than CASA deposits.
growth rate as compared to credit 3. Banks are Unlikely to Hike Lending Rate Significantly: Banks are unlikely
growth rate is likely to empower to hike lending rate significantly due to the following reasons: (1) Though
banks to increase lending rate to the inflationary environment in FY12 is likely to remain moderate to high, we
some extent expect it to remain below the average inflation of FY11, implying the real
lending rates at the present normal lending rate level likely to harden in FY12.
(2) Significant interest rate differentials among various countries will likely to
increase fund flow among the economies. As a result, India will see more
foreign debt flow to its market.
However, increasing credit demand by the corporate sector and slow deposit
growth rate compared to credit growth rate is likely to empower banks to
increase lending rate to some extent. We believe the lending rates will harden
by 100 basis points in FY12.
Credit Cost Likely to Soften Due to Melioration in Asset Quality: Asset quality of
banks significantly deteriorated during FY08 to FY11 due to impact of the recent
Following expected GDP
global economic turmoil. However, the banking industry has experienced
growth of more than 8%,
improvements in assets quality in recent quarters following growing corporate
slippage is likely to
financial health along with the economic growth. Asset quality for private sector
improve.
banks are likely to remain strong compared to public sector banks due to conservative
credit policy opted by private sector banks. Historically, we have seen slippages are
highly correlated with GDP and IIP with a lag (See Chart 5, Below). Following
expected GDP growth of more than 8% , slippage is likely to improve.
Chart 5: Trend in Slippage GDP and IIP.
3.0% 11.5%
10.5%
2.5% 9.5%
8.5%
7.5%
2.0%
6.5%
5.5%
1.5% 4.5%
3.5%
1.0% 2.5%
FY04 FY05 FY06 FY07 FY08 FY09 FY10
Slippage (%) LHS GDP Growth One Year Before (%) RHS IIP Growth One Year Before (%) RHS
Source: MOSPI, RBI, Company & BOE

Interest Rate Deregulation: In March 2003, the RBI deregulated interest rate on all
kind of deposits except saving bank deposits. Savings bank deposits are the only kind
of deposits where the interest rate remained constant at 3.5% and is regulated by the
RBI. At a low cost of deposits of 3.5% saving banks deposits became an attractive
Savings bank deposits are the only
source of funds for banks.
kind of deposits where the interest
rate remained constant at 3.5%
In most of the developed economies like the U.S, the U.K and Japan have deregulated
and is regulated by the RBI.
saving bank deposit interest rates and commercial banks decide interest rate on saving
bank deposits. The RBI has indicated to deregulate saving bank interest rate by
announcing the proposal of posting a discussion on this topic with general public on
the RBI website. We believe the RBI may deregulate the interest rate on saving banks
deposits partially to tame irregular competitions among banks.
Probable Impact of Interest Rate Deregulation: We believe the following would be

the most likely impact of deregulating interest rate on saving bank deposits.
(i) Cost of fund likely to increase significantly in the near term following
irregular competition among banks with low CASA ratio to attract savings
deposits. However, we believe saving banks deposits rate will come to an
equilibrium rate in the long term.
(ii) We believe public sector banks will get effected more than private sector
banks as component of other income in total income is less in public sector
bank.
(iii) Banks like HDFC Bank, AXIS Bank will be less impacted as current account
deposits consist of a significant portion of CASA for these banks.
Aggressive strategies of the new
players in the market most likely to New Banking License to Increase Competition: New banking license is likely to
increase deposits rate, Increase increase competition in the banking sector. Once the RBI is ready with the
operating expense due to enhanced requirement norms to get a license for operating a bank, we believe many of the
customers service facilities, thus corporate houses and NBFC are likely to qualify for the requirements of the RBI. We
resulting less profitability for the believe banks with huge branch network like SBI,PNB,HDFCB and ICICI Bank will
banking sector. be less impacted by new bank licensing. Impact of new bank licensing will be visible
in case of banks with less number of branches and new private sector banks like YES
Bank, Indusind Bank, etc.

Recent Quarter Performance:
HDFC BANK Limited reported a 29.6% y-o-y increase in total interest income to
Rs.52,299.6 million in Q3 FY11. The increase in interest income was mainly due to a
Increase in net interest income was
30% y-o-y growth in interest on advances/bills and a 330.6% growth in interest on
supported by asset growth and a
balances with the RBI and other interbank fund. Net interest income rose 24.9% y-o-y
NIM of 4.2%.
to Rs.27,766.9 million in Q3 FY11. Increase in net interest income was supported by
asset growth and a NIM of 4.2%. Other income grew 32.2% y-o-y to Rs.11,278.2
million in Q3 FY11, primarily due to a 22.5% y-o-y growth in fees and commissions.
Operating expenses were up 22.2% in Q3 FY11. The core cost to income ratio stood
at 46.5% in Q3 FY11 compared to 47.6% for the same quarter of previous year. Net
income increased 32.9% y-o-y to Rs.10,878.3 million in Q3 FY11 from Rs.8,185
million a year earlier (See Table 1, Below).
Table:1 Quarterly Performance

(Amount in Rs. Million except EPS ) Q3FY11 Q3FY09 % Change Q2FY11 % Change
Interest/discount on advances/bills 39503.8 30389.2 30.0% 36731.8 7.5%
Income on Investments 12258.3 9801.6 25.1% 11002.6 11.4%
Interest on balances with RBI and Other Inter Bank Fund 517.1 120.1 330.6% 354.6 45.8%
Others 20.4 37.2 -45.2% 11.0 85.5%
Total Interest Income 52299.6 40348.1 29.6% 48100.0 8.7%
Interest Expended 24532.7 18109.0 35.5% 22837.2 7.4%
Net Interest Income 27766.9 22239.1 24.9% 25262.8 9.9%
Other Income 11278.2 8530.1 32.2% 9607.0 17.4%
Total Income 39045.1 30769.2 26.9% 34869.8 12.0%
Operating Expenses 18318.2 14532.2 26.1% 16798.8 9.0%
Operating Profit 20726.9 16237.0 27.7% 18071.0 14.7%
Provisions and Contingencies (Excluding Tax) 4658.7 4477.2 4.1% 4544.8 2.5%
Tax Expense 5189.9 3574.8 45.2% 4404.8 17.8%
Net income 10878.3 8185.0 32.9% 9121.4 19.3%
Basic earnings per common share: 23.5 18.7 25.7% 19.8 18.7%
Diluted earnings per common share 23.1 18.4 25.5% 19.5 18.5%
Source: Company & BOE
The bank reported a growth in total deposit of 24.2% y-o-y to Rs.1,922,015.6 million
in Q3 FY11. CASA ratio remained at 50.5% driven by a 30.7% y-o-y growth in
saving deposits to Rs.160,380.0 million in Q3 FY11. Gross advances grew by 32.7%
CASA ratio remained at 50.5%
y-o-y to Rs.160,6190.0 million in Q3 FY11. Asset quality in Q3 FY11 remained
driven by a 30.7% y-o-y growth in
healthy with GNPA to gross advances ratio of 1.1% and NNPA to net advances ratio
saving deposits.
at 0.5%.
As on December 31, 2010, the Bank’s distribution network was 1,780 branches and
5,121 ATMs in 833 cities as against 1,725 branches and 3,898 ATMs in 771 cities as
of December 31, 2009.
The Bank’s total Capital Adequacy Ratio as at December 31, 2010 (computed as per
Basel 2 guidelines) remained strong at 16.3%, against the regulatory minimum of 9%.
Tier-I CAR was 12.1% as of December 31, 2010.

INVESTMENT MERITS:
NIM, Marginal Compression Followed by Expansion on Low-Cost of Deposits:
HDFC Bank experienced compression in net interest margin of 59 basis points to
4.4% in FY10 from 4.9% in FY09 (See Chart 7, Below). HDFC Bank’s deposit
composition is one of the lowest cost compositions having 48% of CASA deposits
Demand deposits represent a (See Chart 8, Below). A significant amount of CASA deposits constitutes of demand
significant amount of CASA deposits deposits(43.65% of CASA). Low-cost CASA deposits have grown at a CAGR of
(43.65% of CASA). 29.8% from Rs.264,935.5 million in FY06 to Rs. 7,52,317.7 million in FY10. As a
result of low-cost of fund and high yielding loan portfolio, the bank has highest NIM
among its peers. We believe NIM of the bank may experience a marginal
compression in FY11 following macroeconomic headwinds. NIM is likely to expand
in the long term as the effect of deposit reprising would not be significant following
high demand deposits in deposit composition of the bank. HDFC Bank have a
deposit market share of 3.7% (among schedule commercial private, public and SBI &
its Associates), which has expanded 100 basis point from 2.7% in FY 06.
Chart 6 : Trend in CASA Ratio: Chart 7 : Net Interest Margin of Peers:

800 48.1% 5.0%
48.0%
700
4.5%
600 48.0% 48.0%
Rs. in Million
500 4.0%
48.0% 48.0% 48.0%
400 48.0% 3.5%
300
3.0%
200
100 2.5%
0 47.9%
2.0%
FYO9 FY 10 FY11 FY12E FY13E FY14E
FY O6 FY 07 FY 08 FY 09 FY 10 FY 11 E
CASA Per Branch (LHS) CASA Ratio (RHS)
HDFCB ICICIB AXIS SBI PNB
Source: Company Filings & BOE Source: Company Filings & BOE
Chart 8 : Composition of Deposits:
CASA 48.04%
20.97%
51.96%
27.07%
Demand Deposit Saving Deposits Term Deposits
Source: Company Filings & BOE

Strong Non-Interest Income to Support Net Income: A major portion of net income
consists of non-interest income for HDFC Bank, which makes net income stable in an
adverse interest rate scenario (See Chart 9, Below). Non-interest income consists of
Non-interest income consists of 31.2% of total income and grown at a CAGR of 35.7% from Rs.11,239.8 million in
31.2% of total income. FY06 to Rs.38,076.1 million in FY10. Core fee-based income constitutes 28.4% of
total income. Considering the growth in advances, fee and commission is likely to
increase in the coming years.
Chart 9 : Composition of Total Income
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Net Interest Income Other Non-Interest Income

Core Fee Based Income
Cost to Income Ratio to Fall, Irrespective of Rise in Operating Expenses:

Historically , operating expense have shown a trend of steady growth following branch
expansion. Operating expenses of HDFC Bank has grown at a CAGR of 35.9% from
Rs.16,910.0 million in FY06 to Rs.57,644.8 million in FY10. However, cost to income
ratio has shown a falling trend in recent years (See Chart 10, Below). Cost to income
has started declining from 48.6% in FY07 to 47.3% in FY10. We expect the trend to
continue following the bank’s branch expansion, as the marginal cost of operating
Marginal cost of operating expenses would be less than the marginal income received by expanding branch
expenses would be less than the network resulting a fall in cost to income ratio. We have factored an 80 basis point fall
marginal income received by in cost to income ratio and 15.1% y-o-y growth in operating expenses for FY11.
expanding branch network
Chart 10: Trend in Operating Expenses
resulting in a fall in cost to income
ratio. 100000 60%
90000
50%
80000
70000
Rs. in Million
40%
60000
50000 30%
40000
20%
30000
20000
10%
10000
0 0%
Operating Expenses Cost to Income Ratio
Firm NII Growth Irrespective of Marginal NIM compression: NII has grown at a
Regardless of marginal NIM CAGR of 34.7% from Rs.25,458.4 million in FY06 to Rs.83,866.0 million in FY10.
compression, NIM of HDFC Bank We have factored NIM compression of 25 basis point in FY11, following the adverse
is likely to distinctly stand out of its impact of macroeconomic headwinds. Regardless of marginal NIM compression, NIM
peers. of HDFC Bank is likely to distinctly stand out of its peers. Firm NIM along with
robust growth in advances results 17.9% y-o-y growth in NII for FY11 and 25.5%
CAGR for FY11 to FY14 (See Chart 11, Below).

Chart 11: Trend in NII and NIM
250000 5.2%
4.9% 5.0%
200000
4.8%
Rs. Million
150000 4.6%
4.4%
4.2%4.4% 4.4%
100000 4.1% 4.4% 4.2%
4.0%
50000
3.8%
0 3.6%
NII NIM

Fast growing economic
environment is likely to impact Melioration in Asset Quality: Historically , HDFC Bank maintains less non-
positively for reduction in slippage performing assets among its peers due to conservative nature and effective credit
in coming years. approval process. Further, fast growing economic environment is likely to impact
positively for reduction in slippage in coming years. HDFC Bank maintains 78.4% of
provision coverage ratio, which is significantly high than 70% of provision coverage
ratio stipulated by the RBI (See Chart 13, Below). Due to significantly high provision
coverage ratio and less new slippage would enable HDFC Bank to make less provision
for loan losses in the coming years. At the end of FY11, % GNPAs stood at 1.43% and
% NNPA stood at 0.3%.
Chart 12: Trend in Slippage
Chart 13: Trend in Asset Quality and Provision Coverage
6%
5.38%
6% 2.5% 91%
5%
Slippage 2.0% 86%
5% Increased
Significantly
4% in FY 09 1.5% 81%
4%
3% 1.0% 76%
2.64%
3% 2.22% 2.45%
2.56% 0.5% 71%
2% 2.35% 2.40% 2.45%
FY07 FY08 FYO9 FY 10 FY11 FY12E FY13E FY14E
0.0% 66%
Slippage FYO9 FY 10 FY11 FY12E FY13E FY14E
Gross NPA (%) Net NPA (%) Provision Coverage Ratio (%)
Loan Portfolio to Grow at a CAGR of 24%: Historically , HDFC Bank’s growth in

advances remained high compared to sectoral (Private, Public and SBI & Associates)
growth in advances. Sectoral advances grew at a CAGR of 23.8% from FY06 to FY10
and HDFC Bank’s loan portfolio grew at a CAGR of 37.7% for the same period. We
believe growth in advances to moderate in the coming years. We estimate HDFC
Bank’s loan portfolio will grow at a CAGR of 24% between FY11-FY14 (See Chart
15, Below).

Chart 15: Growth in Loan Portfolio

Chart 14: Growth in Advances (Sectoral & HDFC Bank)
Due to
60%
Merger With
Centurion 3500000
Bank of
50% Punjab
3000000
40%
2500000
n
30% oi 2000000
li
M
.s 1500000
20%
R
1000000
10%
500000
0%
FY-06 FY-07 FY-08 FY-09 FY-10 0
Sectorial(Private+ Public+ SBI & Associates) HDFCB
Source: Company Filings, RBI & BOE Source: Company Filings & BOE
Return on Assets to Improve Further in the Long Term: HDFC Bank ROA stood at
1.45% (Yearly Average) at the end of FY 10. It stands well above the industry average.
Comparing with its peers it stands next to AXIS Bank’s ROA (See Chart 16, Below).
We believe marginal ROA compression in FY11 following marginal compression in
NIM. We have factored a 20 basis point compression in ROA for FY11. However,
ROA of HDFC Bank will improve further following strong business growth and
profitability in the coming years. We anticipate an expansion in ROA of 45 basis point
to 1.7% in FY14 from 1.25% in FY11.
Chart 16: ROA, Peer Comparison
Chart 17: Dupont Analysis with Respect to Average Assets
1.8% 1.67% 6.0%

7%
1.53%
1.6% 1.44% 6%
5% 4.1%
1.4% 4%
3% 1.9%
1.2% 1% 1.5%
2%
1.0% 0.88%
1%
0.8% 0%
-1% -0.7%
-1.1%
0.6% -2%
0.4% -3% -2.8%
Non-Interest Income
Total Income
Tax
ROA
OPEX
P&C
NII
0.2%
0.0%
ROA (%) Source: Company Filings & BO E
Source: Company Filings & BO E

Space for Leverage: HDFC Bank’s leverage ratio stood at 10.8x at the end of FY10.
HDFC Bank’s leverage ratio is lower than its peer average leverage ratio of 12.3x (See
Chart 18, Below). However, ICICI Bank’s leverage is significantly lower than its peer
average leverage ratio, thus pulling down the average peers leverage ratio. SBI and
PNB’s leverage ratio are significantly above the peer’s average. We believe HDFC
Bank has sufficient space to leverage its balance sheet in the coming years. Further,
leverage of balance sheet is likely to improve ROE of HDFC Bank.

Chart 18:Leverage, Peer Comparison
HDFC Bank has sufficient space to

18 16.7
leverage its balance sheet in the 15.5
coming years. 16
14
11.0 11.5
12
10
7.1
8
6
4
2
0
Return on Equity to Improve Further: ROE of HDFC Bank is 16.1% (Yearly

Average) for FY10, which is likely to go up following robust net income growth. The
primary reasons for robust growth in net income would be (i) growth in other income
(ii) growth in net interest income , irrespective of marginal compression in NIM (iii)
Provision for substandard assets are likely to come down following melioration in
asset quality and (iv) further space for leverage.
Chart 19: Return on Equity: A Peer Comparison
25%
20%
15%
10%
5%
FY O6 FY 07 FY 08 FY 09 FY 10 FY 11 E
Sufficiency of Capital to Support Growth: The bank is sufficiently capitalized to

support growth. As on Q3 FY11, the Bank’s total Capital Adequacy Ratio remained
strong at 16.3% (computed as per Basel 2 guidelines), against the regulatory minimum
of 9%. Tier-I CAR was 12.1% as on December 31, 2010. Capital adequacy is unlikely
to be a hindrance to growth.
INVESTMENT CONCERNS:
In the Case of Slower-than-anticipated Economic Growth: Economic growth and
growth of banking industry are highly related to each other. HDFC Bank has grown at
a faster pace than that of the industry in recent years. Slower economic growth than
anticipated may affect the growth of the bank adversely. Irrespective of HDFC Bank’s
sound financial, rising interest rates, higher cost of fund and compression in NIM may
pose a concern.

Table No. 2: Outlook and Valuation:
Assumptions FY11E FY12E FY13E FY14E
To arrive at our target price, we have used two stage residual
NII Growth (%) 18.4% 28.5% 28.0% 25.5%
income model to get the residual income per share and we have
NIM (%) 4.1% 4.2% 4.4% 4.4%
used (P/B) = (ROE-g) / (Ke-g) to get terminal value.
Other Income Growth (%) 15.2% 15.3% 18.3% 23.0%
Cost to Income Ratio (%) 46.3% 41.6% 37.4% 33.8%
We have used CAPM model i.e Ke= Rf+ß(Rm-R f) to calculate
Total Income Growth (%) 17.4% 24.5% 25.3% 24.8%
Net Income Growth (%) 4.2% 40.3% 38.6% 35.9%
cost of equity by taking R m (market return) as return on Nifty
EPS ( Rs.) 70.4 98.8 136.9 186.1 since April 2000 till the date. We have calculated ß value of
Deposit Growth (%) 22.5% 25.3% 21.5% 20.0% HDFC Bank stock as 0.83 by taking covariance of the stock
Loan Growth (%) 29.8% 23.9% 22.4% 24.4% with Nifty, upon variance of Nifty. Our assumption for risk
GNPA (%) 1.5% 1.5% 1.5% 1.5% free rate is 8%.
NNPA (%) 0.3% 0.3% 0.3% 0.2%
Slippage Ratio (%) 2.4% 2.4% 2.5% 2.5% The stock is currently trading at a P/ABV of 3.5x and 2.99x
ROE (x) 13.5% 16.9% 20.2% 23.2% FY12 and FY13 estimated adjusted book value, respectively.
ROA (x) 1.1% 1.3% 1.4% 1.6% We believe the stock will trade at a target price of Rs. 2446.8
P/E (x) 30.4 21.7 15.6 11.5 in the next 12 to 15 months assuming a target multiple
P/ABV (x) 4.0 3.5 3.0 2.5 (P/ABV) of 4.01x at FY12E adjusted book value (We have
arrived at this multiple using residual income Model).
Table No. 3:
Valuation Estimates ROE (%) ROA (%) P/E (x) P/ABV (x)
(A Peer Analysis) FY11E FY12E FY11E FY12E FY11E FY12E FY11E FY12E
HDFC Bank 13.5% 16.9% 1.1% 1.3% 30.4 21.7 4.0 3.5
ICICI Bank 11.8% 12.7% 1.1% 1.2% 19.3 16.4 2.2 2.0
Punjab National Bank 22.0% 22.5% 1.4% 1.4% 10.0 10.5 2.1 2.0
AXIS Bank 19.3% 20.0% 1.6% 1.5% 13.9 11.5 2.5 2.1
State Bank of India 16.3% 17.2% 1.0% 1.1% 11.2 9.2 1.7 1.5
Source: Bloomberg & BOE
Chart 20: P/ABV Band.

3600
3100
2600
2100
In Rs.
1600
1100
600
100
Closing Price 2x 3x 4x 5x 6x
Source: Company Filings, NSE & BOE
Chart 21: P/E Band

4000
3500
3000
2500
In Rs.
2000
1500
1000
500
Closing Price 11x 11x 16x 21x 26x 31x 36x
Source: Company Filings, NSE & BO E

FINANCIAL STATEMENT EXHIBITS:
Exhibit I: Income Statement (in millions of Rs. Except Per Share Data)
2009 2010 2011E 2012E 2013E 2014E
Interest income 163,323 161,729 207,133 269,932 345,983 433,385

Interest Expenses 89,111 77,863 107,835 142,306 182,563 228,278
Net interest income 74,212 83,866 99,298 127,626 163,420 205,108
% Change 42% 13.0% 18.4% 28.5% 28.0% 25.5%
Non-Interest Income 32,906 38,076 43,870 50,562 59,816 73,571
% Change 44.1% 15.7% 15.2% 15.3% 18.3% 23.0%
Total Income 107,118 121,942 143,168 178,188 223,236 278,679
Operating Expenses 55,328 57,645 66,334 74,130 83,466 94,161
Profit Before Provision & Contigency 51,790 64,297 76,835 104,058 139,770 184,518
Prov. & contingency 18,797 21,406 30,274 38,725 49,229 61,438
PBT 32,992 42,891 46,560 65,333 90,541 123,080
Provision Fot Tax 10,543 13,404 15,830 22,213 30,784 41,847
PAT 22,449 29,487 30,730 43,120 59,757 81,233
Earning Per Share 52.85 67.56 70.41 98.80 136.92 186.13
Shares Outstanding 424.78 436.44 436.44 436.44 436.44 436.44
Exhibit II: Balance Sheet (in millions of Rs.)
2009 2010 2011E 2012E 2013E 2014E
Assets
Cash 15,862 24,353 32,820 62,641 97,562 121,729
Chart 22: Sources of Fund balance with Reserve Bank of India 119,410 130,480 169,630 208,979 256,895 312,035
Balances with banks and money at call and short notice 39,794 144,591 169,630 229,203 291,147 365,835
5,000,000 Investments 588,175 586,076 697,604 887,152 1,099,509 1,342,828
Advances 988,830 1,258,306 1,633,418 2,024,398 2,478,723 3,083,359
4,000,000
Rs. Million
Fixed Assets 17,067 21,228 20,344 18,067 15,054 12,748

3,000,000 Other Assets 63,568 59,551 71,462 82,181 94,508 103,959
2,000,000 Total Assets 1,832,708 2,224,586 2,794,908 3,512,622 4,333,398 5,342,493
1,000,000
Capital and Liabilities
0 Equity Capital 4,254 4,577 4,577 4,577 4,577 4,577
Equity Shares Warrants 4,009 0 0 0 0 0
Reserve & Surplus 142,209 210,618 234,517 268,051 314,524 377,699
Employee Stock Options 55 29 28 26 25 24
Deposits 1,428,116 1,674,044 2,050,081 2,567,996 3,120,115 3,744,138

Total Equity Deposits Borrowings
(i)Demand Deposits 284,449 372,271 432,977 554,687 681,433 826,706
(ii)Saving Bank Deposits 349,147 498,768 551,062 677,951 816,222 970,481
(iii)Term Deposits 794,519 803,006 1,066,042 1,335,358 1,622,460 1,946,952
Borrowings 91,636 129,157 258,314 387,471 581,206 871,809
Other Liabilities and Provision 162,428 206,159 247,391 284,500 312,950 344,245
Total Liabilities & Equity 1,832,708 2,224,586 2,794,908 3,512,622 4,333,398 5,342,493

Exhibit III: Ratio Analysis
2009 2010 2011E 2012E 2013E 2014E 5 Yr Avg.
Income Statement Ratios

Net Interest Income Growth (%) 42.0% 13.0% 18.4% 28.5% 28.0% 25.5% 22.7%
Net Interest Margin (%) 4.9% 4.4% 4.1% 4.2% 4.4% 4.4% 4.3%
Non-Interest Income Growth (%) 44.1% 15.7% 15.2% 15.3% 18.3% 23.0% 17.5%
Net Profit Growth (%) 41.2% 31.3% 4.2% 40.3% 38.6% 35.9% 30.1%
Interest Expenses/ Interest Income Ratio (%) 54.6% 48.1% 52.1% 52.7% 52.8% 52.7% 51.7%
Non Interest Income/Total Income Ratio (%) 30.7% 31.2% 30.6% 28.4% 26.8% 26.4% 28.7%
Cost-Income Ratio (%) 51.7% 47.3% 46.3% 41.6% 37.4% 33.8% 41.3%
Balance Sheet Ratios
C/D Ratio (%) 69.2% 75.2% 79.7% 78.8% 79.4% 82.4% 79.1%
Incremental C/D Ratio (%) 84.1% 109.6% 99.8% 75.5% 82.3% 96.9% 92.8%
CASA (%) 48.0% 48.0% 48.0% 48.0% 48.0% 48.0% 48.0%
Growth in Advances (%) 55.9% 27.3% 29.8% 23.9% 22.4% 24.4% 25.6%
Growth in Deposits (%) 41.9% 17.2% 22.5% 25.3% 21.5% 20.0% 21.3%
Credit Quality Ratios
%GNPA 2.0% 1.4% 1.5% 1.5% 1.5% 1.5% 1.5%

%NNPA 0.6% 0.3% 0.3% 0.3% 0.3% 0.2% 0.3%
Provisioing Coverage(%) 68.4% 78.4% 81.8% 80.9% 81.4% 85.4% 81.6%
Slippage Ratio (%) 5.4% 2.6% 2.4% 2.4% 2.5% 2.5% 2.5%
Employee Related Ratios
Employees Per Branch 37.3 30.1 30.0 29.0 29.0 28.0 29.2
Costs per employee (Rs.Million) 0.4 0.4 0.5 0.5 0.5 0.6 0.5
Profit per employee (Rs. Million) 0.4 0.6 0.5 0.7 0.9 1.2 0.8
Business per employee (Rs. Million) 45.9 56.5 64.6 77.2 87.8 101.6 77.5
Staff Cost / Operating Expenses (%) 40.5% 39.7% 40.2% 39.8% 40.2% 39.7% 39.9%
Staff Cost /Total Income (%) 20.9% 18.8% 18.6% 16.5% 15.0% 13.4% 16.5%
Business Per Branch (Rs. Million) 1,711.7 1,699.9 1,938.7 2,240.2 2,544.9 2,844.8 2,253.7
Valuation Ratios
P/E ratio (x) 40.5 31.7 30.4 21.7 15.6 11.5 22.2
P/BV (x) 6.0 4.3 3.9 3.4 2.9 2.4 3.4
P/ABV (x) 6.3 4.4 4.0 3.5 3.0 2.5 3.5
ROA (%) 1.4% 1.5% 1.2% 1.4% 1.5% 1.7% 1.4%
Leverage (x) 11.9 11.1 11.0 12.3 13.3 13.8 12.3
ROE (%) 16.9% 16.1% 13.5% 16.9% 20.2% 23.2% 18.0%

CONTACT INFORMATION:
Analyst: Email: Phone: Fax: Website:

Janaki Ballav Panigrahi jpanigrahi@boegroup.com 215-568-5500 215-568-5588 www.boegroup.com
IMPORTANT DISCLOSURES:
Certifications:
The BOE Group (BOE) is comprised of BOE Securities, Inc., BOE Research Services, Inc. and BOE Research Private Limited. BOE hereby certifies that the views
expressed in this research report accurately reflect the company’s independent personal views about the subject stocks and issuers. This report was prepared by Janaki
Ballav Panigrahi. BOE also certifies that no part of BOE’s or the analyst’s respective compensation was, is, or will be, directly or indirectly, related to the specific
recommendations or view expressed in this research report.
BOE’s financial analysts are not subjected to NASD rule 2711 and NYSE rule 472 which provide guidance on communications with subject company, public appearances
and trading securities, held by BOE Research Private Limited or its affiliates. However, BOE makes its best efforts to ensure the highest professional and ethical standards
are adhered to its analysts.
BOE’s distribution of stock ratings is:

Rating BUY HOLD SELL Not Rated
Distribution 32% 45% 23% 0%
Stock Ratings:
Buy: Stocks whose total return is expected to exceed the S&P 500 Index average over the next 12 months.
Hold: Stocks whose total return is expected to be in line with the S&P 500 Index average over the next 12 months.
Sell: Stocks whose total return is expected to be below the S&P 500 Index average over the next 12 months.
Not Rated: BOE has decided not to publish a rating on this stock due to unusual or extraordinary business circumstances.
Other Disclosures:
The information, tools and material presented in this report are provided to you for information purposes only and are not to be used or considered as an offer or the
solicitation of an offer to sell or to buy or subscribe for securities or other financial instruments. BOE will not treat recipients as its customers by virtue of their receiving
the report. The investments or services contained or referred to in this report may not be suitable for you and it is recommended that you consult an independent investment
advisor if you are in doubt about such investments or investment services. Nothing in this report constitutes a personal recommendation to you.
Information and opinions presented in this report have been obtained or derived from sources believed by BOE to be reliable, but BOE makes no representation as to their
accuracy or completeness, except with respect to the Disclosure Section of the report. Additional information is available upon request. BOE accepts no liability for loss
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regulations applicable to BOE. This report is not to be relied upon in substitution for the exercise of independent judgment. BOE may have issued, and may in the future
issue, other reports that are inconsistent with, and reach different conclusions from the information presented in this report. Those reports reflect the different assumptions,
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Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future
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HDFC Bank Limited: "Melioration in Asset Quality Marginal Compression in NIM Initiating Coverage With HOLD"

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HDFC Bank Limited: "Melioration in Asset Quality Marginal Compression in NIM Initiating Coverage With HOLD"

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March 01, 2011

HDFC Bank Limited

Phone: 215-568-5500 2000 1000

Volume (in ' 000 )LHS Share Price (RHS)

Copyright © 2011 BOE

CONTENTS PAGE No.

Copyright © 2011 BOE

Treasury Retail Banking Wholesale Banking Other Banking Operations

Source: Compa ny & BOE

Copyright © 2011 BOE

Food Articles (Wtg: 14.34% in WPI , 71.26% in PA )

Copyright © 2011 BOE

Chart 4 : WPI Inflation and Its Components.

Copyright © 2011 BOE

Chart 5: Trend in Slippage GDP and IIP.

Source: MOSPI, RBI, Company & BOE

Copyright © 2011 BOE

Probable Impact of Interest Rate Deregulation: We believe the following would be

Copyright © 2011 BOE

Table:1 Quarterly Performance

Source: Company & BOE

Copyright © 2011 BOE

Chart 6 : Trend in CASA Ratio: Chart 7 : Net Interest Margin of Peers:

Demand Deposit Saving Deposits Term Deposits

Source: Company Filings & BOE

Copyright © 2011 BOE

Net Interest Income Other Non-Interest Income

Cost to Income Ratio to Fall, Irrespective of Rise in Operating Expenses:

Operating Expenses Cost to Income Ratio

Source: Company Filings & BOE

Copyright © 2011 BOE

Source: Company Filings & BOE

Loan Portfolio to Grow at a CAGR of 24%: Historically , HDFC Bank’s growth in

Copyright © 2011 BOE

Chart 15: Growth in Loan Portfolio

1.8% 1.67% 6.0%

ROA (%) Source: Company Filings & BO E

Source: Company Filings & BO E

Copyright © 2011 BOE

HDFC Bank has sufficient space to

Source: Company Filings & BO E

Return on Equity to Improve Further: ROE of HDFC Bank is 16.1% (Yearly

Source: Company Filings & BO E

Sufficiency of Capital to Support Growth: The bank is sufficiently capitalized to

Copyright © 2011 BOE

Chart 20: P/ABV Band.

Source: Company Filings, NSE & BOE

Chart 21: P/E Band

Closing Price 11x 11x 16x 21x 26x 31x 36x

Source: Company Filings, NSE & BO E

Interest income 163,323 161,729 207,133 269,932 345,983 433,385

Exhibit II: Balance Sheet (in millions of Rs.)

2009 2010 2011E 2012E 2013E 2014E

Fixed Assets 17,067 21,228 20,344 18,067 15,054 12,748

2,000,000 Total Assets 1,832,708 2,224,586 2,794,908 3,512,622 4,333,398 5,342,493

Deposits 1,428,116 1,674,044 2,050,081 2,567,996 3,120,115 3,744,138

Copyright © 2011 BOE

Exhibit III: Ratio Analysis

2009 2010 2011E 2012E 2013E 2014E 5 Yr Avg.

Income Statement Ratios

%GNPA 2.0% 1.4% 1.5% 1.5% 1.5% 1.5% 1.5%

Copyright © 2011 BOE