Thematic Report [February 17, 2012] Sharekhan www.sharekhan.

com Summary of Contents THEMATIC REPORT Switch from HDFC Bank to HDFC Key points Tactical switch from HDFC Bank to HDFC: In the past one year, HDFC Bank has appr eciated by close to 30% as compared to the 14% appreciation in HDFC in the same period. This has usually been the case in a rising interest rate scenario due to HDFC?s dependence on bulk/wholesale deposits and corporate loans. On the other hand, HDFC Bank benefits from its strong retail deposit (current account/savings account) and asset base. However, it is the other way round when the interest r ate cycle reverses. HDFC tends to outperform relative to HDFC Bank in a declinin g interest rate scenario. The empirical evidence from the past interest rate cyc le supports our argument. Thus, we expect the discount in the valuation of HDFC Bank (vs HDFC) to revert to a mean of 20% plus (from around 6-7% now) over the n ext one year. HDFC?relatively better placed to gain from the reversal in the interest rate cyc le: As the interest rates ease out, HDFC?s cost of funds is expected to decline relatively faster due to its dependence on wholesale funds that constitute 75% o f its funding. Even on the assets side (advances), the bulk of its mortgage loan s are on a floating rate. Plus, the advances under the dual rate home loan schem e (Rs22,000 crore of teaser loans with a lower interest rate for the initial two years) are scheduled to get re-priced over the next one year). Going ahead, as the operating environment improves the performance of the subsidiaries (insuranc e, asset management etc) should also improve, boosting the overall valuations an d leading to a re-rating of the stock. In this note, we have revised our sum-ofthe-parts (SOTP) based price target for HDFC to Rs785 per share (valuing the sub sidiaries and investments at Rs235 per share) and upgraded our recommendation on the stock to Buyfrom Hold earlier. HDFC Bank?the best operational metrics among private sector banks but offers lim ited upside: While HDFC Bank is among the best private sector banks but tactical ly it can underperform HDFC in the next 6-12 months as seen in the past. This is due to the relatively slower rate of repricing of its assets and liabilities. T he bank is essentially current account and savings account (CASA) funded for whi ch the cost is fixed (4% for savings deposits) and is facing increased competiti on from the other private sector banks that are offering higher rates on saving deposits. The bank has also raised its deposit rates recently by 50-100 basis po ints to catch up with its peers; this will also affect its margins. In addition, 70% of its non-CASA deposits are from the retail segment where the cost is stic kier. Further, the valuations have run up over the three-year mean and further u pside seems limited from these levels.

HDFC Bank?the best operational metrics among private sector banks but offers li mited upside: While HDFC Bank is among the best private sector banks but tactica lly it can underperform HDFC in the next 6-12 months as seen in the past. This i s due to the relatively slower rate of repricing of its assets and liabilities. The bank is essentially current account and savings account (CASA) funded for wh ich the cost is fixed (4% for savings deposits) and is facing increased competit ion from the other private sector banks that are offering higher rates on saving

deposits. The bank has also raised its deposit rates recently by 50-100 basis p oints to catch up with its peers; this will also affect its margins. In addition , 70% of its non-CASA deposits are from the retail segment where the cost is sti ckier. Further, the valuations have run up over the three-year mean and further upside seems limited from these levels.