Home / Companies / People /  Why investors aren’t buying into HDFC Bank CEO Jagdishan’s optimism

NEW DELHI: Braggadocio, normally the exclusive preserve of motor-mouth politicians, seems to have infected some of the country’s leading bankers over the past few years as well.

The latest example of self-aggrandizing emanates, surprisingly, from an institution that has built its reputation on the back of prudent risk management and effective investments in systems and processes. In an interaction with analysts, Sashidhar Jagdishan, MD and CEO of HDFC Bank, waxed eloquent about future business prospects, adding almost breathlessly that the bank’s merger with parent HDFC Ltd will double profits in the next five years. And then, somewhat as an afterthought, he also added that liabilities growth could be a problem.

It might serve to untangle both the thoughts.

The HDFC Bank merger with its parent HDFC Ltd – which will take another 12-15 months to complete, provided all the regulatory approvals are in hand – is likely to produce a behemoth in the financial services industry. If the two had merged at the end of March 2022, the combined entity would have impressive numbers – a capital base of 360,344 crore, a balance sheet size of 27,10,000 crore and net profits upwards of $6 billion, or over 50,000 crore. If we look at net profit alone, it is a lot of money with the capability to add extra juice to the balance sheet.

Jagdishan claimed to analysts that this level of net profit could easily double to $14-15 billion over the next five years, indicating a compound annual growth rate (CAGR) of slightly over 20% every year. To be fair, he is justified in using this projection: HDFC Bank’s net profits have grown at a CAGR of 20.5% over the past five years. It might be instructive to remind him of the cautionary note crafted by market regulator Securities and Exchange Board of India: past performance is not necessarily indicative of future performance.

This is where hubris overtakes restraint. Three points stand out.

One, Jagdishan’s prospect of gang-buster growth is predicated on the pending merger with parent HDFC Ltd and the economy growing by 7-8% every year. The GDP prospect looks uncertain in view of the Russia-Ukraine conflict exacerbating the economic slowdown inflicted by the pandemic. The World Bank’s latest edition of the Global Economic Prospects report also issues dire warnings about stagflation threatening the world economy. In such a situation, the claim that any financial institution will be able to grow its balance sheet by over 14-15% every year, or achieve a CAGR of over 20% in net profits, over the next 5-7 years seems slightly foolhardy.

Second, there has to be some realistic assessment of what the merger brings to the table. Is it good in general and should they go through with it? Of course, the merger is undoubtedly desirable in terms of synergies and efficiencies. But, will it comprehensively alter the game for HDFC Bank, creating a step-change in its fortunes? The jury is out on that one.

Here is why. At its core, HDFC Ltd is an over-grown, oversized housing finance company. It has no other financial products in its portfolio. It is reaching the limits of its growth potential. This is despite the Indian mortgage market having adequate headroom for future growth. The core problem is funding and HDFC’s increasing reliance on market borrowings – 65% from debentures, securities and term loans; 32% from public deposits – limits the company’s ability to extract higher yields. Hence, merger with a bank gives the mortgage business access to cheaper funds.

But, at the same time, a critical factor for HDFC Bank will be deciding what percentage of the asset book should comprise mortgage business to enable the bank to achieve a healthy blended yield on its mix of assets. The efficiency of capital allocation will be the key deciding factor here. Using the principle of ceteris paribus, or assuming that all other things are remaining constant, the post-merger mortgage book is likely to be around 30% of the total asset book, give or take. Even assuming that the mortgage book is maintained at a constant 30% of the overall asset book, which is expected to grow upwards of 15% annually, it will still require HDFC Bank to consistently divert additional money from its other businesses to maintain the mortgage book at this steady state. The question then is: will it be worthwhile for the bank and its shareholders?

Finally, the point about liabilities, which is banker-speak for deposits. This is supposed to be the secret sauce behind the merger, a key raison d’etre, and Jagdishan is already expressing doubts about this. Even before the game has begun.

Commercial banks with wide branch networks have access to current accounts and savings accounts (CASA), which are low-cost liabilities; in addition, due to marginal fluctuations in volumes, they are considered almost akin to perpetual liabilities, making the task of asset-liability management easier. In contrast, most time deposits – better known as fixed deposits – have a maximum maturity of only 5 years while housing loans are typically between 15 and 20 years, thereby leading to potentially adverse maturity mismatches. Which is why, on the face of it, HDFC Bank’s CASA deposits at over 48% of its total deposits look attractive. The problem is that much of this is already spoken for. To feed the ravenous mortgage business, Jagdishan will need to aggressively source additional liabilities.

Two problems arise here. HDFC Bank has been hitting a wall on digitization; it has not been able to compete with peers in using the digital platform to extract additional efficiencies. The sprawling institution has become exceedingly bureaucratic and needs a deep organizational reset if it is to compete with its peers or the newly consolidated public sector banks. Digitization will be key to reducing liability origination and administrative costs.

The other problem lies in Jagdishan claiming to analysts that he plans to add 1,500-2,000 new branches every year. Going by the reports of the conference in newspapers, it is surprising that none of the analysts challenged Jagdishan on this. HDFC Bank already has 6,300 branches and opening another 2,000 branches is adding over 30% capacity in one year. This is a huge capital investment, which will leave the bank with reduced funds to pursue additional businesses or chase incremental revenues. That then puts the whole assumption of 20% CAGR for net profit under a cloud.

The market has consistently hammered down the prices of both HDFC Ltd and HDFC Bank ever since the merger was announced. Both the stocks have lost close to 19% of their value since 4 April 2022, the day the respective boards approved the merger. The continuing conflict in Europe, heightened commodity prices, an impending economic slowdown and a general environment of uncertainty have a definite role to play in the value erosion. But when viewed against the BSE 30-stock Sensitive Index (which has lost only 10.5% during this period), or against the S&P BSE Bankex (which has fallen by 9.7%), it is evident that a class of investors is antsy about the merger.

Jagdishan should be talking to these guys, trying to find out what haunts them and perhaps craft a clearer communication strategy to address specific concerns. Exaggerated claims, in the style of bombastic politicians, are unlikely to sway hard-nosed investors.

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