HDFC Bank, HDFC merger is a win-win deal

After the merger, HDFC will be able to access HDFC Bank’s low-cost funding franchise
After the merger, HDFC will be able to access HDFC Bank’s low-cost funding franchise


  • The merger deal is likely to enable cross-selling opportunities for HDFC Bank
  • Mix of mortgage portfolios could increase from 11% now to more than 30% after the merger

MUMBAI/BENGALURU : Big is better, going by the euphoria of investors on Monday following the merger announcement of India’s largest housing finance company, HDFC Ltd, with its subsidiary, HDFC Bank Ltd. The Nifty Financial Services index gained 4.6% with shares of both closing more than 9% higher each, after seeing sharp intraday spikes.

The deal brings many cross-selling opportunities for HDFC Bank because of the large customer base and product portfolio of HDFC. After all, about 70% of HDFC’s customers do not bank with HDFC Bank, according to the management. Further, nearly 70% of HDFC Bank’s customers are without any mortgage products and this untapped lot is expected to increase the mix of mortgage portfolios from 11% at present to more than 30% after the merger. Also, after the merger, HDFC will be able to access HDFC Bank’s low-cost funding franchise.

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Becoming bigger

HDFC Bank’s loan book is expected to be up by about 40% to 18 trillion after the merger. Also, foreign shareholding in HDFC Bank will be 65-67%, implying 7% headroom for foreign investors in the merged entity, which is a positive, said Jefferies India’s analysts in a report. What is more, the development also addresses concerns over the succession problem at HDFC to a great extent.

The management expects this merger to be earnings per share (EPS) accretive from the first year itself. However, the proof of the pudding is in the eating. The timelines of the integration process and incremental costs involved, if any, are key monitorables. HDFC’s shareholders would get 42 shares of HDFC Bank for every 25 shares in HDFC. The merger is scheduled to take around 18 months to complete and is subject to a slew of regulatory approvals.

Analysts caution that the merged entity’s profitability could be hurt in the initial period because of Reserve Bank of India’s (RBI’s) statutory liquidity ratio (SLR), cash reserve ratio (CRR), and priority sector lending (PSL) norms. Under the PSL norms, RBI sets targets for banks to lend to the priority sectors of the economy. According to the central bank, all financial companies are required to maintain liquidity buffers in cash with it.

HDFC Bank will have an excess SLR/CRR asset requirement of 70,000 crore- 80,000 crore and will also need an incremental around 90,000 crore agriculture portfolio to meet PSL norms, according to Macquarie Capital Securities’ estimates. “These low-yielding portfolios could be a drag on the merged entity’s P&L," said the Macquarie report.

That said, the HDFC Bank management is confident that with the combined entity’s overall funding cost dropping, it will offset additional costs related to CRR, SLR, and PSL.

That’s not all. “The biggest hurdle in the merger process is bringing down the insurance stake of the bank in HDFC Life Insurance Company to 20%," pointed out Shweta Daptardar, analyst at Elara Securities (India). HDFC Bank holds around 48% stake in HDFC Life.

Daptardar notes that as part of the Axis Bank-Max Life Insurance deal, the former was not allowed the direct acquisition of 17% of equity of Max Life. “In such a scenario, either RBI compels HDFC Bank to reduce its stake in HDFC Life at or under 30% or allows owning the current 48% under the non-operative financial holding company structure," she said. This could delay the timeline of completing the merger.

Monday’s jump in the HDFC Bank stock helps to reduce its underperformance over the past one year.

“With today’s steep rise, the HDFC Bank stock has covered some ground. The news-based rally is over. Any meaningful upside from here on depends on smooth transition and the pace of regulatory approvals for this merger," said an analyst requesting anonymity.

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