The golden boy of Indian finance faces its greatest threat

Live Mint

August 22, 2020

India’s largest lender has performed spectacularly against competitors, both state and private banks, and become a global investor darling. Its rapid growth model is now made precarious by India’s sour financial environment and economic slump.

HDFC Bank is one of the most popular emerging-market equities in the world. Its popularity has been justifiable: the bank hasn’t posted anything less than a strong double-digit return on equity in any year over the past 20. Its proportion of nonperforming assets is markedly lower than the competition and fewer than 10% of its loans are covered by the country’s moratorium on loan and interest repayments.

It is valued as if it isn’t going to stop. The company’s price-to-book ratio stands at 3.32 times, the second-highest world-wide among banks with a market capitalization of more than $50 billion. If HDFC Bank’s share price fell 30%, the company would remain the most expensive bank of its size or larger anywhere in the world on a price-to-book basis.

But as the bank has swelled in size, its ability to continue outperforming in an increasingly dismal banking market gets tougher. Its market capitalization is nearly twice that of all India’s 12 public sector banks put together. It is the country’s largest lender by market capitalization by some distance.

Even before the coronavirus pandemic began, the Indian banking system was in a miserable state. After rapid economic growth in the early 2000s, a considerable slowdown in the 2010s left a mounting pile of bad loans, illustrated brilliantly by economist Vivek Kaul in his recent book, “Bad Money."

The problem has been concentrated among state-owned public sector banks, though private banks haven't been completely immune. The Reserve Bank of India expects the gross nonperforming loan ratio across the banking system to rise to 12.5% in March 2021 from 8.5% as the pandemic began, with a severe stress scenario causing a rise to 14.7%. HDFC Bank concedes its nonperforming loan tally will grow. The pandemic has torn through India’s economy, even relative to other hard-hit emerging markets.

If the bank were to become less spectacular relative to its private peers, it remains to be seen how committed its small army of international investors would be. Steven Holden of Copley Fund Research has noted on publishing platform Smartkarma that the stock isn’t just widely owned by emerging-market fund managers, but is held heavily by growth investors specifically. If the company stops performing like a growth stock, a part of the existing investor base could be at risk.

The bank’s case for continued growth is that it has already shown the ability to grow its loan book more rapidly than the wider economy and beat its peers in the process. The bank’s market share has only grown and credit penetration in India is shallow. As long as there is more demand than supply, its rapid-growth model can continue.

But that task is now more difficult than ever before. The stock is priced for a continued spotless performance that increased size and a bleak macro-financial outlook may not allow for.

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