HDFC Bank Saga: New chapter unfolding or end to a great story?

In our saga series, after the Paytm Saga, Zomato Saga and Yes Bank Saga, we bring you the HDFC Bank Saga. Today, many people are betting on the company for the bank's growth, which will give them profits on their equity investment. But have you ever wondered how the bank became the fourth-largest bank in the world? How are returns for its investors? If you are interested in the bank's history, this article is the best use of your time. Let us get started.

The Start: Formation of HDFC Bank

It should not come as a surprise to you that HDFC Bank came after the Housing Development Finance Corporation (HDFC). HDFC, the mortgage company, was established in 1977 and has been a prominent player in the segment ever since. 

In the early 1990s, the Indian government initiated economic reforms to liberalize the country's financial sector. It included opening up opportunities for private players in banking. Recognizing the potential for expansion beyond housing finance, HDFC's management, led by its chairman, Deepak Parekh, decided to venture into banking. The Reserve Bank of India (RBI), India's central banking institution, had begun issuing licenses for private banks as part of its liberalization efforts.

HDFC applied for a banking license and received approval from the RBI to set up a new private-sector bank. Thus, HDFC Bank was incorporated in August 1994 as a wholly-owned subsidiary of HDFC Limited. It commenced operations in January 1995 after receiving the necessary regulatory approvals.

The start cannot be complete without the mention of one name: Aditya Puri. The man took the bank to where it is today. We also need to give credit to Deepak Parikh. He persuaded Mr Puri to come and run the bank. Mr Puri was working in Malaysia and earning a handsome salary back then. There was no reason for him to leave the lucrative job, come to India, and start the bank from scratch. However, he did. Deepak Parikh gave him the free hand to run the bank, and the rest, as they say, is history.

Growth: Creating the Success Blueprint

After joining the bank, Aditya Puri and the team drafted the blueprint for HDFC Bank's early strategy. It changed the game forever. Let us understand the landscape of banks in India back in the 1990s. The banks were divided into categories:

• Foreign banks in India offer a range of diversified products and services to customers. The products on offer were innovative and personalized, and they came with good customer service.
• The second category of banks was public sector banks, or PSUs. They had the advantage of large distribution networks and huge capital.

Mr Puri and HDFC planned to form a bank that takes the features of both categories - and offers diversified products with a large distribution network.

Well, the plan on paper is different. Success depends on the execution part. A bank needs funds and a strong balance sheet. 

The bank started lending only to AAA-rated companies, or what we call blue-chips. It ensured that there were no major setups on the balance sheet in the initial years. They lent money to the Ambanis, Tatas, and Birlas. Yes, it was a low-risk bet, but space was competitive. 

To have an edge, the bank started creating company-specific products, which was a game-changer. For example, the bank provided Asian Paints with a service that allowed the company to have all their vendors online. On top of that, they decided to offer all vendors that come on board, loans at a relatively cheaper rate.

Apart from what we have discussed above, the bank also did the following things in the initial years:

• Customer-Centric Approach: HDFC Bank has always prioritized understanding and meeting the needs of its customers. By focusing on providing excellent customer service, tailored products, and convenient banking solutions, the bank was able to attract and retain a large customer base.
• Innovative Technology Adoption: HDFC Bank has been a pioneer in adopting technology to enhance its operations and customer experience. From early on, it invested heavily in building robust IT infrastructure, introducing Internet banking, mobile banking, and digital payment solutions. These innovations have not only improved efficiency but also enabled the bank to reach customers in remote areas and offer seamless banking services.
• Aggressive Expansion: HDFC Bank has pursued a strategy of aggressive expansion, continually increasing its branch network and ATM presence across India. This widespread network has enabled the bank to penetrate deeper into the market and reach untapped segments, contributing to its growth trajectory.
• Brand Reputation: HDFC Bank leveraged the strong brand reputation established by its parent company, HDFC Limited, which was already well-regarded in the financial services sector. This credibility helped HDFC Bank gain trust and credibility in the market, attracting customers and investors alike.

The Masterstroke: Entry into the retail sector

All the above worked well for the bank. However, with the above strategies and approach, Mr Puri knew that they could not become a super-large bank. 

The opportunity for the banks back then and even today is with the retail sector. The current and savings accounts, or CASA, are goldmines for every bank. In simple terms, CASA offers them low-cost deposits, meaning the banks get the funds for lending at a lower rate. Therefore, they can increase their margins.

The retail banking sector in India was experiencing significant growth due to rising income levels, urbanization, and increasing consumer spending. By tapping into this burgeoning market, HDFC Bank positioned itself to capitalize on the expanding middle class and their evolving banking needs, including savings accounts, personal loans, mortgages, and credit cards. By expanding into retail banking, the bank diversified its revenue streams, reducing dependency on a single segment. It helped HDFC Bank mitigate risks associated with economic downturns or fluctuations in corporate lending demand. 

The Secret: How It Became Investors' Favorite

Look at the returns, since inception, the bank has delivered over 26,000% returns to its investors. Not only that, many mutual funds have an allocation in the bank. It is also a mutual fund's darling. What is the reason behind it?

The bank has been able to compound at a 25% annual growth rate since 1995. According to the study, HDFC Bank is the most profitable among all domestic commercial banks. Its return ratios, return on assets (RoA) of 1.78% and return on equity (RoE) of 15.94%, are the best, complemented by a good net interest margin (NIM), which is again the best among the top 10 banks (before the merger).

The Problem: Recent Stock Performance

In the last five years, the bank has only given 37.11% returns, and in the last three years, the returns have been flat - no return for the investors. 

What could be the reason for it? For starters, the success story of the bank has been associated with Mr Puri. He left the bank in October 2020. For the next few quarters, the investors were cautious about the future of the bank. How will it perform under the new leadership?

Next, the bank announced a merger with the parent company, HDFC Limited. No one was sure how it would turn out. For nearly two years, the bank did not receive any significant interest from institutional investors, the main drivers for the stock price increase. Everyone wanted to play the wait-and-watch game. Now, post-merger, the concerns are over the declining net interest margins, and even the growth rate has come down marginally. For everything combined, the returns have been muted.

The future: Is it the end of a great story?

Most likely not. If you look at the fundamentals, nothing has changed for the bank. The leadership transition and the merger went smoothly. The most crucial parameter for the bank - the asset quality - remains the best among peers. 

The only thing wrong at the moment is the share price. The lower NIM and other marginal falls in deposit growth rate are temporary. There is nothing wrong with the story. Perhaps, as an investor, you are in a phase that you are not enjoying. But the story will go on.