>HDFC BANK: Best bank to own in the current environment (KOTAK SECURITIES)

■ Best bank to own in the current environment. We believe that banks with strong retail and CASA deposit franchisees are best placed at times of rising rates. HDFC Bank has been the best bank in terms of CASA growth and asset quality over the past few quarters. We believe that above-industry loan growth (20%+), 4%+ margins and lower provisioning should drive 30% PAT growth over the next 6-8 quarters. Upgrade our recommendation on HDFC Bank to BUY (from ADD earlier).

■ Upgrade to BUY, notwithstanding expensive valuations
While valuations for stock remain expensive at 19XFY2011E PER and 3XFY2011E, we believe that likely strong earnings growth of 28-30% over the next couple of years coming from core operational earnings, improving asset quality and better than industry growth is likely to sustain these high valuations. The stock has underperformed by 3% over the last 3 months and outperformed marginally over the last month. Given the strong economic outlook, on the
backdrop of high government deficit, we expect interest rate environment to remain challenging. HDFC Bank is one of the best banks to own in such an environment given its strong core liability franchisee; upgrade our recommendation to BUY.

■ Quality operational performance; will trade at a premium to others
We are extremely impressed by HDFC Bank’s recent operational performance—excelling on all key parameters. Margins improved sequentially by 10 bps to 4.3%, driven by strong traction in CASA deposits (up 38% yoy and CASA percentage now is 51%). We expect margins could further improve if interest rates rise as HDFC Bank’s high CASA franchisee would ensure lower deposit costs. The pace of new NPL formation has peaked, which is likely to result in lower absolute NPLs (only bank to report absolute lower NPLs, both at gross and net level over last couple of quarters) and credit provisioning requirement going forward. Quality of earnings has improved considerably as earnings now are being driven by core performance with negligible treasury contribution.

■ Superior CASA franchisee—would ensure strong margins in a rising rate environment
One of the key positives of HDFC Bank has always been its strong CASA franchisee. Over the last few quarters, CASA deposit growth has been spectacular for the bank; savings deposits grew by 41% yoy to Rs467 bn and current deposits grew by 34% yoy to Rs333 bn as of December 2009— this is the best in the industry. Reported CASA ratio has increased to 51%, while the core CASA ratio was at 49%, up from 40% last year. With interest rates set to rise, the power of CASA franchisee is likely to be reflected in superior margins and a steady loan growth. We expect margins to improve by 20 bps in FY2011E over FY2010E (as per our model). This is despite a likely increase of 15bps in deposit costs due to daily average working for savings deposits.

To read the full report: HDFC BANK