1/ Most folks see HDFC Bank as a bank and analyse it as such; I see a fee generating machine which also runs a bank. A thread on why I made this a decent position some months back despite what appears to be a rich valuation
2/ Over the last 10y the Bank has grown its other income from 3.7k cr to 15.2k cr (CAGR 17%). This includes fees commissions (~75% mix in FY18) , forex & derivative revenue, etc. So large was the other income that 1136 cr was booked under “Miscellaneous”.
3/ To put that in perspective the Banks “miscellaneous” income of 1136 cr is a respectable PAT for a large cap, and a respectable market cap for a small cap co.
4/ The cost for this income is marginal / negligible being incidental to the lending business. I doubt the outer limit cost for generating this fee will be more than 500 cr. It can be safe to say that fee income contributes 50%+ of the Banks PBT
5/ So if fee income growth matches your ROE, all you need to do is not screw up on your lending. That is relatively easy since you cherry pick borrowers with CIBIL score of 750+. Hence its likely that fee income drives the strategy rather than being like cream on the cake
6/ So where does this fee come from? Large part from cash management for corporate supply chains (incl vendors, distributors, dealers). HDFC is a leader in the space. Once you have your vendors and distributors on the system moving banks is not easy, its impossible. Strong moat!
7/ So when payments are processed, the money doesn’t leave the bank, even better it’s a float for a day, on which the bank pays no interest, in fact gets a fee! More transactions, more float, lesser cost of funds and more fee
8/ Then, it’s the largest collector of direct and indirect taxes with 22% share. This also contributes to float. As tax collections rise the Bank will benefit even more. This is probably the most direct play you can have on unorganised to organised
9/ Beginning with NSE when it started, HDFC is also a large player in clearing services for stock and commodity exchanges. Again as direct a play as possible on higher equity participation in India and a deepening commodity market
10/ Another good part of other income (~12-15%) is distribution of financial products – home loans to HDFC Ltd, MF to HDFC AMC, insurance to HDFC Life/ Ergo, etc and to their competitors also
11/ Unlike other banks treasury income / assets is lowest, implying they are very conservative on treasury.
12/ All this makes me quite comfortable that fee income will continue to grow at 18% if not higher. It is like a positive feedback loop. The more it grows, the stronger it becomes. Given the trends on tax compliance, unorg to org, insurance pen., the runway is really long
13/ This strength allows HDFC to select the best credits. It doesn’t need to run behind lower CIBIL scores. Its an added strength that the Bank is nimble, smells a troubled loan from afar.
14/ Long before fintech crawlers the bank kept a hawk eye on account balances and inflows. Then if your vendors and distributors are also on the system you can tell if something is wrong months before it becomes a sticky issue.
15/ In conclusion, I think (my view, feel free to differ) the Bank is a better risk adjusted alternative to most of the other derivative stories on India’s growth. The retail service sucks most of the time, but that is a small part of the larger story (end)
