HDFC Bank and Kotak Mahindra Bank both reported a 20 percent post-tax profit in the December quarter, and kept at their consistency. Stand out features of the performance include a robust liability profile, market share gains, healthy capital position, strong asset quality and a positive commentary about credit pick up in the system.
A higher proportion of stable low cost retail deposits is a big positive in an environment where interest rates are set to trend higher.
Optically, the stocks look expensive. Still investors may not grudge paying more, given exceptionally strong growth outlook and the potential market share gains for large well-capitalised private sector entities.
For HDFC Bank, the growth in net interest income (difference between interest income and expenses) was driven by a heady cocktail of robust loan growth, stable interest margin and non-interest income growth. The last one in particular benefited from a low base (as the year-ago quarter was impacted by demonetisation).
While costs were well contained, provision was higher resulting in a more muted profit growth.
Kotak Mahindra Bank turned in a steady performance, but the sharp jump in profitability of the subsidiaries linked to the capital market — securities, investment banking, asset management and insurance — stole the show. In fact, total assets under management of the group grew an impressive 37 percent.
Kotak Mahindra Bank’s earnings growth was a tad lower than business growth. That was because margins were impacted by the excess liquidity maintained to comply with regulations, and because of competitive pressures in the lending market.
Impressive Business Growth
The loan book picture was especially impressive on account of the low base of the year-ago demonetisation quarter. Both banks grew their advances handsomely. HDFC Bank, for instance had 17 percent share in incremental loans in the past one year whereas its share in incremental deposits stood at 14 percent. For Kotak Mahindra Bank, the share in incremental advances and deposits stood at 4 percent and 7 percent respectively. The business mix remains well-diversified as they are capturing market share in retail as well as corporate although the growth in retail was faster in the quarter.
Strong Liability Franchise
The success of any banking entity depends mainly on liability profile. A healthy mix of deposits is key to competing in a market where most lending will take place on marginal cost of lending rate (MCLR). Both the bank now have a lion’s share of deposits coming from CASA (low cost current and savings account) and retail term deposits. The low cost stable liability will be a kicker for interest margin as rates start hardening. This will be a distinct competitive edge against wholesale funded NBFC (non-banking finance companies) with whom they compete for retail assets.
There is visible momentum in credit and the cannibalisation of bank credit by debt market is also falling. Both these entities exuded confidence about a strong credit growth outlook.
Asset Quality — Well-managed
Kotak Bank maintained its asset quality with negligible (0.23 percent) outstanding under restructured and SMA2.
For HDFC Bank, the asset quality had started worsening on the back of slippages in agriculture loans during the year. In addition, the quarter brought to fore a divergence of close to Rs 2051 crore (comprising of three accounts) from RBI’s audit. While two of the accounts had already slipped into NPA in the previous quarters, the third one was recognised as an NPA but later reversed and upgraded as per the decision of the JLF (joint lenders forum). Consequently, the divergence stands reduced to Rs 294 crore. The bank has a healthy provision cover and carries over Rs 1,326 crore of floating provision.
Strong Capital Position
Kotak Mahindra Bank has a strong capital position with CAR (capital adequacy ratio) of 18.7 percent (with Tier I at 18 percent) having recently raised capital. HDFC Bank’s CAR stands at 15.5 percent as on December 31, 2017 and it plans to raise another Rs 24,000 crore to augment its capital base to participate in the future opportunities.
Given the vantage position of these two entities and the growth opportunities ahead, investors got to stay invested in these stocks despite despite the optically expensive valuation (Kotak Bank at 3.7X FY19 book and HDFC Bank at 3.8X FY19 book).