HDFC Bank HDBK.NS HDFCB IN

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1 HDFC Bank HDBK.NS HDFCB IN EQUITY: BANKS Core revenue growth momentum picking up Earnings resilience highest in sector; better placed to deliver on growth as well Action: In-line PAT; retail growth momentum improves further HDFCB s PAT of INR27bn was in line with a PPOP beat being offset by higher provisions. Strong growth momentum is most retail segments and a robust core fee trend is driving core PPOP growth (26% y-y). The only marginal disappointment was on NIMs (down 7bps q-q), but management sees that as a trade-off vs growth. We maintain our Buy rating and TP of INR1,200. Strong retail growth: Loan growth rose to 22% y-y driven by ~25% y-y growth in retail book. Growth in cars/2ws sustained at +20% y-y and CV growth has inched to ~14% y-y growth vs contraction in 1HFY15, the asset mix is turning favourable. As well, core fee growth at ~22% y-y was better than expected and would indicate a reversal in core revenue/ppop growth. Core revenue/ppop trend encouraging: With pick-up in retail loan and core fee growth, HDFCB s core revenue growth of 24% and core PPOP growth of ~26% y-y is the highest in the past 10 quarters. While ~2-3% of this growth is driven by capital raise, we are finally seeing core PPOP growth outpace balance sheet growth and will likely lead to higher PAT growth of 23% in FY16F vs 20% y-y growth in the past 5-6 quarters. NIM performance a tad weaker: Calculated NIMs have contracted by ~7bps q-q despite the full quarter impact of capital issue. Management indicated that there has been a slight moderation in spreads in retail segment and balance sheet growth indicates that large part of the corporate growth for HDFCB is coming through bonds where NIMs are lower. We expect NIMs to stabilise at current levels. Quality of earnings improving; maintain Buy We estimate ~22% EPS growth over FY15-17F and floating provision of INR16bn provides certainty to earnings. Valuation at 3.3x FY17F BVPS of INR328 is ~10% below HDFCB s historical average. Global Markets Research 22 July 2015 Rating Remains Buy Target price Remains INR 1200 Closing price 21 July 2015 INR 1098 Potential upside +9.3% Anchor themes Prefered defensive pick: delivering on most underlying metrics; earnings most resilient. Nomura vs consensus Our FY16F/FY17F PAT are largely in line with consensus. Research analysts India Banks Adarsh Parasrampuria - NFASL adarsh.parasrampuria@nomura.com Amit Nanavati - NFASL amit.nanavati@nomura.com Year-end 31 Mar FY15 FY16F FY17F FY18F Currency (INR) Actual Old New Old New Old New PPOP (mn) 174, , , , , ,880 Reported net profit (mn) 102, , , , , ,078 Normalised net profit (mn) 102, , , , , ,078 FD normalised EPS FD norm. EPS growth (%) FD normalised P/E (x) 26.9 N/A 22.0 N/A 18.2 N/A 14.6 Price/adj. book (x) 4.5 N/A 3.9 N/A 3.3 N/A 2.9 Price/book (x) 4.4 N/A 3.8 N/A 3.3 N/A 2.8 Dividend yield (%) 0.7 N/A 0.9 N/A 1.1 N/A 1.3 ROE (%) ROA (%) Source: Company data, Nomura estimates Key company data: See next page for company data and detailed price/index chart See Appendix A-1 for analyst certification, important disclosures and the status of non-us analysts.

2 Key data on HDFC Bank Relative performance chart Source: Thomson Reuters, Nomura research Notes: Performance (%) 1M 3M 12M Absolute (INR) M cap (USDmn) 43,373.8 Absolute (USD) Free float (%) 90.3 Rel to MSCI India mth ADT (USDmn) 28.2 Profit and loss (INRmn) Year-end 31 Mar FY14 FY15 FY16F FY17F FY18F Interest income 411, , , , ,318 Interest expense -226, , , , ,848 Net interest income 184, , , , ,470 Net fees and commissions 57,359 66,168 79,402 96, ,252 Trading related profits 1,105 5,816 3,000 3,000 3,000 Other operating revenue 20,733 17,980 20,888 24,357 28,461 Non-interest income 79,196 89, , , ,713 Operating income 264, , , , ,183 Depreciation -6,716-6,563-7,219-7,941-8,735 Amortisation Operating expenses -71,916-85, , , ,598 Employee share expense -41,790-47,510-53,653-61,423-72,970 Pre-provision op profit 143, , , , ,880 Provisions for bad debt -18,539-20,198-25,354-32,226-37,907 Other provision charges 2, ,303-3,052-3,753 Operating profit 127, , , , ,219 Other non-op income Associates & JCEs Pre-tax profit 127, , , , ,219 Income tax -42,944-51,136-62,655-75,825-94,142 Net profit after tax 84, , , , ,078 Minority interests Other items Preferred dividends Normalised NPAT 84, , , , ,078 Extraordinary items Reported NPAT 84, , , , ,078 Dividends -19,227-24,134-28,746-34,788-43,192 Transfer to reserves 65,557 78,025 96, , ,886 Growth (%) Net interest income Non-interest income Non-interest expenses Pre-provision earnings Net profit Normalised EPS Normalised FDEPS Loan growth Interest earning assets Interest bearing liabilities Asset growth Deposit growth Source: Company data, Nomura estimates Balance sheet (INRmn) As at 31 Mar FY14 FY15 FY16F FY17F FY18F Cash and equivalents 214, , , , ,196 Inter-bank lending 180, , , , ,522 Deposits with central bank Total securities Other int earning assets Gross loans 3,051,6953,680,3714,457,7325,488,492 6,755,154 Less provisions -21,692-25,421-35,242-48,829-64,369 Net loans 3,030,0033,654,9504,422,4905,439,663 6,690,785 Long-term investments 1,209,5111,664,6001,827,4482,138,688 2,524,283 Fixed assets 29,411 31,229 34,788 38,347 41,906 Goodwill Other intangible assets Other non IEAs 251, , , , ,145 Total assets 4,916,0015,905,0376,924,4688,375,30310,159,837 Customer deposits 3,673,3754,507,9565,337,7426,574,073 8,111,350 Bank deposits, CDs, 394, , , , ,007 Other int bearing liabilities 0 30,000 48,000 66,000 84,000 Total int bearing liabilities 4,067,7654,960,0925,850,6117,149,015 8,749,357 Non-int bearing liabilities 413, , , , ,376 Total liabilities 4,481,2155,284,9436,207,9477,542,084 9,181,733 Minority interest Common stock 4,798 5,013 5,013 5,013 5,013 Preferred stock Retained earnings 429, , , , ,091 Reserves for credit losses Proposed dividends Other equity Shareholders' equity 434, , , , ,104 Total liabilities and equity 4,916,0015,905,0376,924,4688,375,30310,159,837 Non-perf assets 29,892 34,384 48,277 65,106 85,825 Balance sheet ratios (%) Loans to deposits Equity to assets Asset quality & capital NPAs/gross loans (%) Bad debt charge/gross Loss reserves/assets (%) Loss reserves/npas (%) Tier 1 capital ratio (%) Total capital ratio (%) Per share Reported EPS (INR) Norm EPS (INR) FD norm EPS (INR) DPS (INR) PPOP PS (INR) BVPS (INR) ABVPS (INR) NTAPS (INR) Valuations and ratios Reported P/E (x) Normalised P/E (x) FD normalised P/E (x) Dividend yield (%) Price/book (x) Price/adjusted book (x) Net interest margin (%) Yield on assets (%) Cost of int bearing liab (%) Net interest spread (%) Non-interest income (%) Cost to income (%) Effective tax rate (%) Dividend payout (%) ROE (%) ROA (%) Operating ROE (%) Operating ROA (%) Source: Company data, Nomura estimates 2

3 HDFCB conference highlights Strong momentum in vehicle loan portfolio: Retail loans grew by 26% y-y with car/cv loans growing by +20% y-y and CV loan up by ~13% y-y vs contraction in 1HFY15. CV growth pick-up is being driven by replacement demand in the MHCV segment largely by fleet owners rather than small CV operators. Marginal contraction in NIM: NIMs contracted by ~5bps q-q on a calculated basis in spite of the full quarter impact of capital issuance. The fall in NIM was a combination of 1) higher term deposit growth leading to lower CASA ratio; 2) base rate cut of 15bps in April-15 and 10bps in Jun-15 and 3) larger part of corporate assets are in CPs/bonds where spreads are lower. High term deposit growth: Term deposit grew by ~38% y-y and is much higher than HDFCB s expectations. Growth was driven by both retail and wholesale segment. While there could be some moderation given that part of the growth has been also wholesale and management believes that this opens more room for term deposit rate cuts going forward. Core fee growth different drivers vs FY15 Core fee growth has sustained at +20% y-y for two quarters now. While third-party fees was the key contributor of core fee growth in last few quarters, in 1QFY16, third-party fees was flat y-y and core fee growth was driven by retail assets and to some extent corporate fees. Opex growth high: 1) employee costs increased by 21% y-y and management indicated that the company has added ~9,000 employees in the past 12 monthsm which would explain the growth; and 2) overhead opex increased by 29% y-y and management explained that higher growth was due to larger part of the +600 branches being opened in metro/urban centres in the past 12 months and also pay-outs to intermediaries have increased due to higher retail disbursements. Management indicated that digital initiatives are largely using the backend/ data hubs created in the past and that is not driving overheads growth higher. Asset quality: Asset quality was largely stable with implied net slippages of INR6.8bn which was similar to slippages in 1QFY15 and higher credit costs in 1QFY16 was due to higher write offs. Floating provisions: HDFCB created a floating provision of INR650mn in 1QFY16 after having used some floating provisions in FY15. Management explained that it would look to increase floating provisions whenever it can move forward as well. 3

4 Fig. 1: Core revenue growth picked up on higher retail growth; bank continues to invest in expansion which led to in-line PBT vs our expectation INRm n 1Q15 4Q15 1Q16 y/y q/q Com m ents Interest income 112, , , % 8.0% Interest expenses 60,485 69,932 76, % 9.4% Net interest income 51,716 60,132 63, % 6.2% NII was marginally higher than our expectation Non-interest income 18,506 25,638 24, % -4.0% on stronger loan growth especially in retail Operating expenses 31,784 38,550 40, % 3.8% segment. This also led to pick up in core fee Pre prov profit 38,438 47,220 48, % 2.7% growth to 26% y/y Provisions 4,828 5,767 7, % 26.2% Profit before tax 33,610 41,453 41, % -0.6% The bank made INR650mn of floating provision Provision for tax 11,280 13,384 14, % 6.6% adjusted for which PAT would have been Profit after tax 22,330 28,069 26, % -4.0% slightly higher than our expectations NIMs 4.40% 4.40% 4.30% -0.10% -0.1% NIMs compressed due to base rate cuts done NII / GII 46.1% 46.2% 45.5% -0.6% -0.7% by bank in April/June 2015 Cost - Income 45.3% 44.9% 45.2% -0.1% 0.3% Prov / PPP 12.6% 12.2% 15.0% 2.5% 2.8% Cost - income ratio inches up as the bank adds Tax rate 33.6% 32.3% 34.6% 1.0% 2.3% higher share of branches in metro cities Balance sheet data Advances 3,121,087 3,654,950 3,820, % 4.5% Loan growth is supported by uptick in retail Deposits 3,720,740 4,507,957 4,841, % 7.4% loans which grew ~25% y/y. Term deposit grew Credit to Deposit 83.9% 81.1% 78.9% -5.0% -2.2% very sharply in 1Q16 as customers lock in rates Asset Quality Gross NPA 33,562 34,384 36, % 6.2% Asset quality remains stable adjusted for Net NPA 10,074 8,963 10, % 14.7% seasonality Gross NPA (%) (0.15) 0.05 Net NPA(%) (0.03) 0.07 Weak SA accretion and strong grow th in LLP/Loans (0.03) 0.12 term deposits led to a sharp compression in CASA Ratio (3.37) (4.40) CASA ratio Tier % 13.7% 12.8% 1.7% -0.9% CAR 15.1% 16.8% 15.7% 0.6% -1.1% Other Income: 18,506 25,638 24, % -4.0% Fees 14,065 18,348 17, % -6.6% Forex 2,242 3,287 3, % 5.9% Treasury 250 1,961 1,259 Others 1,950 2,043 2,750 4

5 Fig. 2: Retail loan growth improves to 25% y-y, led by auto loans; CV/CE growth (wholesale + retail) up 14% y-y (INRmn) 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 y/y q/q Car Loans 330, , , , , , % 7.2% 2 wheeler loans 33,370 34,330 36,240 39,590 41,570 43, % 5.7% CV/CE Loans 144, , , , , , % 4.7% Total Auto loans 508, , , , , , % 6.6% Personal loans 204, , , , , , % 11.7% Credit Cards 122, , , , , , % 4.4% Business Banking 250, , , , , , % 27.6% Home Loans 193, , , , , , % 11.5% LASS 11,210 9,740 10,500 11,940 13,530 9, % -27.6% Other Retail 166, , , , , , % -3.2% Kisan gold card 105, , , , , , % 2.9% Others 61,140 62,940 63,980 74,440 88,510 75, % -14.5% Gold Loans 40,420 38,510 38,600 39,010 40,570 42, % 4.1% Retail Total 1,496,740 1,502,470 1,581,260 1,648,340 1,728,420 1,872, % 8.3% Non-Retail Loans 1,533,263 1,618,617 1,691,468 1,822,540 1,926,530 1,947, % 1.1% Total Loan book 3,030,003 3,121,087 3,272,728 3,470,880 3,654,950 3,820, % 4.5% Fig. 3: NIM declines q-q on base rate cuts Fig. 4: Fee growth picks up on pickup in retail growth core fee growth grew 26% y-y 4.7% 4.6% 4.5% 4.4% 4.3% 4.2% 4.1% 4.0% Net interest margin 4.6% 4.6% 4.5% 4.5% 4.4% 4.4% 4.4% 4.4% 4.4% 4.4% 4.3% 4.3% 4.3% 4.2% 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 30% 25% 20% 15% 10% 5% 0% Fee growth y/y 25% 25% 24% 24% 21% 22% 15% 11% 12% 11% 12% 13% 10% 9% 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Fig. 5: Opex inches up as the bank invests in expansion Fig. 6: LLPs remain under check on stable asset quality adjusted for seasonality The bank has made floating provisions of INR650mn in 1Q16 50% 40% 30% 20% 10% 0% -10% Employee expense y/y Other opex y/y LLPs Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 5

6 Nomura HDFC Bank 22 July 2015 Quality of earnings improving; Maintain BUY: We estimate ~22% EPS growth over FY15-17F and floating provision of INR16bn provides certainty to earnings. Valuation at 3.3x FY17F book of INR328 is ~10% below its historical average. Thus we maintain our Buy rating. Risks: 1) A slower-than-expected pick-up in retail credit growth; and 2) any significant change in underwriting standards of retail loans. Fig. 7: TP of INR1,200 Fig. 8: Our TP implies 3.6x Mar-17 book Valuation assumptions 5.5 Cost of Equity 12.5% 5.0 HDFCB Terminal grow th 7.0% Stage 2 grow th 20.0% 3.5 Normalised ROE 23.1% 3.0 Mar-16 PT 1, Implied Mar-17 P/B Implied Mar-17 P/E Apr-05 Aug-05 Dec-05 Apr-06 Aug-06 Dec-06 Apr-07 Aug-07 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09 Aug-09 Dec-09 Apr-10 Aug-10 Dec-10 Apr-11 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Source: Nomura estimates Source: Bloomberg, Nomura estimates 6

7 Appendix A-1 Analyst Certification We, Adarsh Parasrampuria and Amit Nanavati, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company. Issuer Specific Regulatory Disclosures The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies. Materially mentioned issuers Issuer Ticker Price Price date Stock rating Sector rating Disclosures HDFC Bank HDFCB IN INR Jul-2015 Buy N/A A1,A2,A3,A4,A5,A6,A7 A1 A2 A3 A4 A5 A6 A7 The Nomura Group has received compensation for non-investment banking products or services from the issuer in the past 12 months. The Nomura Group had a non-investment banking securities related services client relationship with the issuer during the past 12 months. The Nomura Group had a non-securities related services client relationship with the issuer during the past 12 months. The Nomura Group had an investment banking services client relationship with the issuer during the past 12 months. The Nomura Group has received compensation for investment banking services from the issuer in the past 12 months. The Nomura Group expects to receive or intends to seek compensation for investment banking services from the issuer in the next three months. The Nomura Group has managed or co-managed a publicly announced or 144A offering of the issuer's securities or related derivatives in the past 12 months. HDFC Bank (HDFCB IN) Rating and target price chart (three year history) INR 1098 (21-Jul-2015) Buy (Sector rating: N/A) Date Rating Target price Closing price 16-Feb-15 1, , Sep-14 1, Jul-14 Buy Jul Jun-14 Suspended Apr Oct Jun-13 Buy Jun Oct For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology Our TP of INR1,200 is based on 3.6x Mar-17F book of INR328. The benchmark index for this stock is MSCI India. Risks that may impede the achievement of the target price 1) A slower-than-expected pick-up in retail credit growth; and 2) any significant change in underwriting standards of retail loans. 7

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