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On Sep 26, we downgraded our long-term recommendation on HDFC Bank (HDB - Analyst Report) to Underperform from Neutral. This was based on the company’s persistently rising operating expenses.

Why the Downgrade?

Increasing operating expenses remain a major cause of concern at HDFC Bank. In particular, we are concerned about the impact of rapid rise in compensation expenses. A continuous increase in operating expenses is expected to drag down the company’s bottom line in the coming quarters.

Moreover, like most of the Indian banks, HDFC Bank will likely encounter higher cost of funds as it would be necessary for the company to raise deposit rates to meet the increasing loan demand. This is expected to keep margins under pressure.

The estimate for HDFC Bank has been declining ever since it reported fiscal first-quarter 2014 results. The Zacks Consensus Estimate for fiscal 2014 has gone down 9.8% to $1.75 per share. The Zacks Consensus Estimate for 2015 has also declined 5.1% to $2.22 per share. With both these downward revisions, the company now has a Zacks #4 Rank (Sell).

Moreover, the changing regulatory landscape could adversely affect growth at HDFC Bank. The company’s ability to offer loans may be limited by regulatory restrictions on capital adequacy. Further, though HDFC Bank’s growth pipeline for both retail and corporate sectors remains solid, competition has been intensifying with other peers recently re-entering the retail space after a long hiatus.

Other Stocks to Consider

Better-performing foreign banks worth considering include Banco Bilbao Vizcaya Argentaria, S.A. (BBVA - Snapshot Report), Grupo Financiero Galicia S.A. (GGAL - Snapshot Report) and Sumitomo Mitsui Financial Group, Inc. (SMFG - Snapshot Report). All these stocks carry a Zacks Rank #1 (Strong Buy).

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