The merger between India’s largest mortgage lender Housing Development Finance Corp (HDFC) with HDFC Bank is expected to drive huge synergistic benefits and will significantly boost and diversify the later’s lending business. But, analysts also warn additional cash reserve ratio (CRR) and statutory liquidity ratio (SLR) requirements, as well as more priority sector lending could be a slight drag on its margins.
On Monday, the boards of the two companies had approved the merger of HDFC with the country’s largest private sector lender HDFC Bank. The $40 billion deal is the largest such merger in corporate India and will create a financial services powerhouse, which will be twice the size of ICICI Bank.
Up front this merger brings several advantages for HDFC Bank. It gets a sizeable scale in lucrative and sticky housing loans, which are typically spread over 15-20 years. HDFC Bank currently has just 11 percent in mortages, which post merger will jump to 33 percent. Only 30 percent of HDFC’s customers have HDFC Bank accounts. At the same time many HDFC Bank customers don’t have housing loans from HDFC. So, the merger will up open up multiple avenues for HDFC Bank to cross sell its diversified products and services to a larger customer base. It will enhance product diversity and its exposure to unsecured loans will also reduce, pointed Gaurav Jani and Palak Shah, analysts at Prabhudas Lilladher.
“Post the merger, HDFC Bank would be second largest entity in terms of advance share (15 percent), after SBI (20 percent),” they said.
HDFC’s mortage business also benefits from lower funding costs, as it can now access the low cost savings account and current account deposits of the bank. Furthermore, distribution of housing loans through HDFC Bank’s network of over 6,300 branches, could propel the business into a whole new orbit.
“One of the key challenges for HDFC Bank has been a shift in composition of the loan book in recent years. A very high share of short-duration loans from the retail side implies that the ability to replenish the book, which has a high repayment rate and also reports strong growth, is quite a challenge. The need to have a long-duration book is a key positive outcome from this deal. It brings stability to the loan book and also significantly reduces the pressure during periods of economic slowdown,” said analysts at Kotak Institutional Equities.
According to Anand Dama and Manjith Nair of Emkay Global Financial Services, HDFC Bank’s loan book will cross Rs 18 lakh crore and it will become the eighth largest bank globally by market capitalisation.
“HDFC Bank’s cost advantage will make the housing loan business much more competitive amid the rising dominance of banks in the segment,” said the Emkay analysts.
Even as there are multiple advantages, there are some areas of concern too, particularly the need for higher CRR and SLR requirements, post merger. Another area would be in regards to meeting priority sector lending (PSL) norms. As per RBI norms, 40 per cent of a bank’s total loans must be directed towards areas like agriculture and related activities, affordable housing, small businesses etc.
HDFC Bank has sought a phased approach for meeting the CRR, SLR and PSL requirements.
Assuming that CRR/SLR and PSL ratios for the merged entity are similar to HDFC Bank, the merger would call for additional SLR/CRR burden of Rs 1.02 lakh crore and PSL of Rs 1.17 lakh crore, leading to a net cost drag of Rs 2,000 crore, a 7 basis point impact on net interest margin and will be 3 per cent earnings per share dilutive, estimate the Emkay analysts.
“While the merger makes sense in terms of scale, we are watchful that margins could compress post the merger which could be a drag on the RoE (return on equity), said Jani and Shah of Prabhudas Lilladher.
There could be regulatory hurdles too. The HDFC and HDFC Bank merger is subject to multiple approvals – Reserve Bank, Securities and Exchange Board of India, Competition Commission, shareholders and National Company Law Tribunal - to name a few.
HDFC’s subsidiaries include a life insurance business, general insurance company and asset management. The deal envisages these will become subsidiaries of HDFC Bank. Whether the RBI approves this will have to be watched out for.
“In recent years, we have seen the RBI a lot less comfortable with the bank having a large stake in any of these investments where the direct oversight is lower. The RBI has preferred to have a structure where the bank operates as a standalone entity and the ownership in the non-banking business is done through a different structure,” said the analysts at Kotak.
Post merger HDFC Bank will have a 48 per cent stake in HDFC Life. As per norms, a bank could either have a stake of over 50 per cent or less than 30 per cent. While HDFC Bank has written to the regulator seeking permission to maintain a status quo, HDFC chairman Deepak Parekh has said that it could very well buy the additional stake to take its shareholding over 50 per cent.
The merger, for now, is expected to be completed by the second or third quarter of financial year 2023-24. But, analysts say this could get delayed if the regulators do require it to modify the deal, especially on this shareholding issue.
Overall though, analysts remain bullish on HDFC Bank’s medium to long-term prospects, given the huge opportunities to grow the mortgage business and also the cross-selling opportunities.
Analysts also say that the merger could open up space for foreign institutional investors to buy up to additional 8 per cent in the bank. Given that HDFC Bank has attracted lot of investor interest in the past too, this could be another booster for the stock.
Both HDFC and HDFC Bank shares had soared on Monday post the deal announcement. On Tuesday, while HDFC Bank was down around 2 per cent, HDFC shares traded 1 per cent lower in afternoon trade.
