Why HDFC Bank is beating the hell out of State Bank of India

On Tuesday, an astonishing thing happened. HDFC Bank briefly overtook the State Bank of India (SBI) and became India’s most valuable bank when SBI’s balance-sheet is five times bigger than HDFC Bank’s- even without counting the former’s five major subsidiaries.

Though Wednesday saw things reverse a bit, the fact is investors now think the two banks are worth more or less the same - around Rs 1,10,000 crore each, give or take a bit. It is only a matter of time before HDFC Bank overtakes it permanently.

How did this happen?

[caption id=“attachment_132553” align=“alignleft” width=“380” caption=“Since the bank was set up in 1994, it has had only one boss - Aditya Puri, who remains its managing director even today. The SBI, in the same period, has had around 10 bosses. Reuters”]  [/caption]

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We can look at the numbers the two banks put out and give ourselves a lot of joy on that account, but there are only two real reasons for it: One, HDFC Bank is not government-owned; SBI is. And two, superior strategy.The two, of course, are related. You often don’t get a superior strategy when you have netas and babus in Delhi dictating your decisions.

HDFC Bank built on the pedigree of its parent- Housing Development Finance Corporation- to a stage where it is now twice as big as its parent. The bank’s balance-sheet size as on 31 March 2011 was Rs 2,77,352 crore; the housing finance company’s was at Rs 1,32, 726 crore.

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The child is clearly the father of the man.

However, it’s worth underlining how HDFC Bank made it to the top, and why it is likely to remain India’s most valuable bank.

First, it’s had a steady, focused leadership. Since the bank was set up in 1994, it has had only one boss - Aditya Puri, who remains its managing director even today. The SBI, in the same period, has had around 10 bosses. The only SBI chief who had a decent stint was the previous incumbent, OP Bhatt (who got five years), and for most of his tenure the bank was indeed riding high.

Second, a scrooge-like respect for equity and shareholder funds. Throughout its history, HDFC Bank has been ploughing back earnings to boost capital and grow its business. This is why despite the 1:5 difference in scale, its free reserves per share - at Rs 419 - are almost as large as SBI’s Rs 468. Net result: SBI needs more capital from the government for growth, HDFC Bank does not. It is coasting along without nicking shareholders for funds.

Ajay Shah, economist and professor at the National Institute of Public Finance and Policy, compares HDFC with Bank of Baroda to show how the difference between private and public sector attitudes to capital makes all the difference.

In 1999-00, HDFC Bank was a small bank with “a balance-sheet of just Rs 11,731 crore while BoB was roughly five times bigger. By the end (2010-11), HDFC Bank was at a balance-sheet size of Rs 277,429 crore while BoB was at Rs 358,397 crore.”

Says Shah: “HDFC Bank did this while being more prudent: they deleveraged in this period. They went from a leverage ratio of 15.33 to a leverage ratio of 10.93. In contrast, BoB stayed at a much higher leverage (18.12 at the start and 17.07 at the end). The bottomline: BOB grew net worth by 6.5 times and the balance-sheet by 6.11 times. HDFC Bank grew net worth by 33.17 times and the balance- sheet by 23.65 times.”

Third, HDFC Bank has converted a handicap into an advantage. The bank’s handicap is that it’s parent is into housing loans. This means it cannot directly compete with its parent in this business - which has been the biggest growth segment in banking during the last decade. But the bank did a smart thing. It now originates loans for its parent HDFC, and collects a fee for the same. Net result: it gets to earn unencumbered income, and doesn’t have to carry all the loans on its books or account for non-performing loans on its balance sheet.

Fourth, HDFC Bank’s sheer consistency in performance. An SBI may report huge profits one quarter and barely scrape though in the next, but not HDFC Bank. As noted by _Firstpost_ , “in the last 26 quarters, net profit growth has never fallen below 30 percent. The average for the quarters is 34.2 percent, and in the latest quarter (30 September 2011) the net profit growth is 31.4 percent.”

No one - barring the number-crunchers - knows the secret of this consistency. At some level, it probably means the bank’s accountants massage the numbers at the margin to retain earnings predictability for investors. The bottomline is that the bank’s bottomline is made of cast-iron: its net profits have been compounding at nearly 30 percent for the past five years. Which is why we have called it the best annuity scheme in the share markets.