Alliances: Why Did the HDFC Bank Chase Chase?

ALLIANCES
Why Did the HDFC Bank Chase Chase?

So that the would-be retainer banker could use Chase's savvy in corporate banking to sustain its new thrust.

By Gautam Chakravorthy

D Parekh and R E Fallon In October, 1978, when Deepak Parekh quit Chase Manhattan Bank (Chase), he had no idea that, two decades later, they would become business partners. On February 2, 1999, the Chairman of the Housing Development Finance Corporation (HDFC) was instrumental in the signing of a strategic alliance between HDFC Bank and Chase. According to the deal, the latter will pick up a 14.99 per cent stake--formerly held by NatWest Securities--in HDFC Bank.

Forged at a time when other alliances in the financial services sector are in trouble--the break-up between J.P. Morgan and I-Sec (February, 1998), and the parting of ways between CS First Boston and J.M. Financial (December, 1997)--the agreement opens a new chapter for both partners. Declares R.E. Fallon, 51, Managing Director (Asia-Pacific Division), Chase: "Our relationship with HDFC Bank has all the elements of a mutually-beneficial and long-term relationship." True.

After making its mark in corporate banking, HDFC Bank (No. 8 on The BT Best Banks '98) is now trying to expand its retail banking business. To ensure that its corporate banking operations remain profitable--especially since the retail push will require additional investments which will start paying only after some time--HDFC Bank needs to improve its margins in niches, such as cash-management and derivatives.

It is there that Chase can help the Indian bank. Explains Parekh, 54: "As part of the collaboration, Chase will provide product-related technical support, training, and assistance as and when required by us." For Chase, which has been operating in India for more than 3 decades but has just 1 branch in the country, the deal signifies a medium-term strategy to offer more services to its global corporate clients. In this context, HDFC Bank's 56 branches in 18 cities will prove to be an asset.

CORPORATE BANKING. The mainstay of HDFC Bank has been its corporate banking business. The bank's loan portfolio to the corporate sector touched Rs 800 crore in 1997-98. More importantly, 80 per cent of its 200 corporate clients include blue-chip companies like Reliance Industries, ITC, BPL, and companies in the Tata Group. Agrees Rajiv Butalia, 46, Vice-President, IndusInd Bank: "HDFC Bank has followed a positive strategy of building up low-cost deposits, and good quality assets." Adds Paresh Sukhthankar, 35, Vice-President, HDFC Bank: "We have been able to attract large corporate clients because we have both access to funds (like the nationalised banks), and can offer better services (like the foreign banks)."

As HDFC Bank has also been able to garner deposits at low interest rates, its spreads--and net profit margins--are among the highest in the industry. In 1997-98, the bank's average cost of deposits was 6 per cent--nearly 2 per cent lower than that of the State Bank of India (SBI). The reason: interest-free demand deposits--or current accounts--constituted 31 per cent of its total deposits compared to the latter's 21 per cent. This resulted in an average spread of 4.49 per cent, and HDFC Bank's net profits zoomed to Rs 63.20 crore in 1997-98 compared to Rs 40.50 crore in the previous year. Naturally, its Price-Earnings ratio stands at between 17 and 18 compared to the industry average of 4.

With rising competition, while the cost of deposits is expected to increase, the average spreads will drop. For instance, a Credit Suisse First Boston Research report (August, 1998) stated that HDFC Bank's share of demand deposits is "expected to decline to 23.80 per cent by 2001," leading to higher deposit costs. Couple that with the fact that the slowdown in the economy has adversely affected the corporate banking business.

In addition, HDFC Bank's Non-Performing Assets (NPAs) are rising. In 1997-98, its Net NPAs--at 1.24 per cent of its total loan portfolio--were lower than those of the other private banks, like IndusInd Bank (3.96 per cent) and UTI Bank (5.63 per cent), but higher than IDBI Bank (0.32 per cent) and ICICI Bank (1.14 per cent). That explains why the bank is, consciously, diversifying from traditional areas to new value-added ones like cash-management and derivatives.

In 1997-98, fee-based income accounted for 10.06 per cent of HDFC Bank's total income--higher than ICICI Bank's 7.30 per cent, IDBI Bank's 5.30 per cent, and UTI Bank's 5.52 per cent. But in areas like cash-management, HDFC Bank has to compete with Corporation Bank and Citibank, which together control 75 per cent of the business. Segments like derivatives, trade services, and foreign exchange management require expertise that is available mainly with the foreign banks. Indeed, HDFC Bank joined hands with NatWest Securities for the same reason. But, after the Asian crisis in 1997, it was Chase that was advising HDFC Bank.

Could Chase, like the other foreign partners in the banking sector, also withdraw from the venture eventually? Especially since the 14.99 per cent stake in HDFC Bank has been picked up by 2 mutual funds, Indian Private Equity Fund, and Indocean Financial Holdings, advised by Indocean Chase Capital Advisors, the limited partner of the holding company, Chase Manhattan Corp.. Denies Arnold L. Chavkin, 47, General Partner, Chase Capital Partners: "Since we will be on the board, it is unlikely that we will invest in any other private bank."

The decision to invest through the venture capital arms was forced by the fact that no foreign bank will invest in an Indian bank as a minority partner, and still take on unlimited liabilities in its operations. The circuitous route not only helps the foreign bank reduce its liabilities, but also helps Chase grow while pursuing its plans to set up branches in Delhi and Bangalore.

THE RETAIL PUSH. Clearly, HDFC Bank's new focus is retail banking. Although the bank's Managing Director, Aditya Puri, 47, claims that "we are among the top banks in the retail business," HDFC Bank has a long way to go. While, in terms of liabilities, retail deposits constitute 70 per cent of its base, corporate banking accounted for 55 per cent of the bank's assets. To change this ratio, the HDFC Bank aims to launch new retail products this year.

In June, 1999, the loans-against-shares business will be linked to savings and fixed-deposits accounts to prevent defaults. The following month, a debit card launch is on the cards, followed by Internet banking. Puri explains that the decision to launch a debit card--rather than a credit card--was forced by the realisation that most Indians use the latter like a charge card. And confidently adds: "We'll offer top-end services at middle-level prices."

In the near future, the retail business is expected to grow at 40-50 per cent per annum compared to 20-25 per cent in the case of corporate banking. Still, the benefits will accrue to HDFC Bank only if volumes cross a critical point. Explains P.H. Ravikumar, 45, Executive Vice-President, ICICI Bank: "If HDFC Bank plans to enter the retail business, the agreement is only of cosmetic value." Possibly.

Which is why HDFC Bank is also hedging its bets by entering new areas like providing infrastructure for the capital markets. At present, nearly 60 per cent of the brokers in 4 stock exchanges--Ahmedabad Stock Exchange, Bombay Stock Exchange, Calcutta Stock Exchange, and National Stock Exchange--conduct their business through HDFC Bank. The bank has also emerged as the largest player in the dematerialisation of individuals' shares.

Clearly, Parekh is doing the right things to establish HDFC Bank as the most profitable bank in the country. While its corporate banking business will grow through the tie-up with Chase, the bank will also make inroads into the high-growth, high-potential retail business. And new growth segments will be explored to earn high margins. Not surprisingly, Sonali Sinha, 26, an analyst with SBI Caps, still recommends a "Hold" on the scrip even though the price of Rs 53.60 (on the Bombay Stock Exchange on February 8, 1999) seems pricey. That, probably, confirms the fact that Parekh is chasing the right risks in banking with Chase.

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