The secret at the world's most expensive bank

Bangalore: When reports surfaced in July that Indian newspaper publisher Deccan Chronicle Holdings was struggling for survival, several of its creditors were caught off-guard. Not HDFC Bank.

Even as Deccan, which also owned a glitzy cricket team, sought to reassure markets that it held enough assets to stave off a crisis, HDFC Bank was busy getting rid of the loans extended to the group, three sources with direct knowledge of the matter said.

That agility paid off: Deccan has since lost its cricket franchise and its lenders, including heavyweight ICICI Bank(ICBK.NS), Axis Bank(AXBK.NS) and a dozen others, have been left with bad loans totalling $750 million.

"Alertness and the ability to pick early signs of problems have helped," Paresh Sukthankar, executive director at HDFC Bank, told Reuters in an interview, pointing to the bank's low bad loans of 0.9 per cent of its book compared with 4.2 per cent expected for the industry by March.

At a time when lenders across the world are battling slowing growth and rising loan defaults, HDFC Bank's conservative business model and its knack of delivering returns are proving unique, and offer a lesson for its hard-pressed competitors.

HDFC Bank has posted profit growth of over 30 per cent every year for the last decade, richly rewarding its investors. India's No.2 private sector bank earlier this year climbed to be the country's biggest by market value, ahead even of State Bank of India, which controls a quarter of the country's loans and deposits market.

Since 2008, HDFC Bank's shares have risen nearly 87 per cent, while rival ICICI is down about 16 per cent.

Thomson Reuters StarMine's models also paint a flattering picture of its shares, a third of which are held by foreign funds. Trading at five times its book value, HDFC Bank is the world's most expensive lender and is among 15 banks globally to trade at a premium to its intrinsic value - a measure of how much shares should be worth when considering expected growth rates over the next decade.

So what is the secret sauce of a bank that has sky-rocketed from being a penny stock when it was launched in 1994 to a bellwether and which now features in Forbes Asia's 'fab 50' list of companies for its ability to weather the slowdown?

HDFC Bank has built its consistent growth through selective lending, diversified exposure and focus on low-cost savings deposits, Sukthankar said. It has also shunned risky, exotic products and is picky about its borrowers.

"We live in a volatile world," said Sukthankar, who has worked at the bank since its inception after moving from Citigroup Inc. "We don't chase higher yields and run into higher risks."

HDFC Bank is choosy about issuing credit cards, offering them mostly to existing customers to avoid delinquency, and it has steered clear of lending for two-wheeler purchases in some regions - risk-averse strategies that ICICI now emulates.

The lender expects non-performing loans to remain within its five-year average of 1.3-1.5 per cent.

Competition looms

For all its success, HDFC Bank faces stiff competition in its stronghold retail segment, where the default rate is low, as several lenders including ICICI, SBI and IndusInd Bank Ltd have rushed to expand into home and auto loans.

With the central bank planning to issue new banking licences, the landscape could become even more competitive for HDFC Bank, putting pressure on its margins, analysts say.

Its net interest margins - a key gauge of bank profitability - now stand at more than 4 per cent, one of the sector's highest.

"That would mean tougher competition for customer acquisition as well as pricing," said ASV Krishnan, an analyst at Ambit Capital, which rates HDFC Bank a 'sell' due to its high valuation.

The gloomy economic climate also poses a threat.

Loan growth in India is expected to ease to around 15 per cent in fiscal 2012/13 from over 20 per cent in 2009/2010 as a flagging economy and high interest rates dent demand.

Indeed, loan growth at the bank has slowed and retail deposits, its biggest strength, have shifted slightly to smaller competitors offering much higher interest rates.

"If balance-sheet growth remains slow, then maintaining 30 per cent profit growth will not be easy," said Manish Ostwal, a sector analyst with Mumbai-based brokerage K.R. Choksey.

HDFC Bank hopes to grow market share and is charging into India's hinterland, where millions still have no bank accounts.

Still, the lender's old-school approach will stand it in good stead when good times return, say analysts and investors.

It has largely stayed away from project finance, in contrast with several other banks that lent heavily to India's power and infrastructure projects during the pre-2008 boom period.

The bank's infrastructure funding is largely limited to working capital loans to contractors of project developers, keeping exposures smaller, shorter and relatively safer.

There is talk in trade circles that the country's No.3 lender may be losing money in its aggressive investment banking push. The bank insists the reality is "far from it."

"We don't do businesses to lose money," said Sukthankar.

Over the past year, HDFC Bank has hired five senior executives and has ambitions of soon getting into equity offerings. It already has several million-dollar deals to show from the country's top corporate houses and is intent on pushing old-time players off the league tables.

"HDFC Bank has been solid, other banks may have more risks coming," said Taina Erajuuri, a Helsinki-based portfolio manager at FIM India, which owns shares in HDFC Bank. "If you want peace of mind, this is the bank for you."