What makes HDFC Ltd-HDFC Bank merger an attractive proposition now

Topics HDFC | HDFC Bank | mergers

Merger would also take care of the intermingled equity raise related issue.
Speculations around a merger of HDFC Limited (HDFC) and its banking subsidiary HDFC Bank aren’t new to the industry or the markets. 

With the Reserve Bank of India’s (RBI’s) internal working committee recommending that well-run large non-banking financial companies (NBFCs) may be considered for conversion into banks, there is buzz over the merger of the HDFC twins. The report has also resuscitated the idea of having a non-operative financial holding company (NOFHC) structure for the banks. 

For HDFC, with an asset size of Rs 4.6 trillion, there are more reasons this time to merge with HDFC Bank. 

“It is definitely an attractive idea to go for the merger. The arbitrage that housing finance companies (HFCs) enjoyed has gone with HFCs now under RBI’s supervision and having to follow its norms,” says Jignesh Shial, research analyst, Emkay Global. Those at Kotak Institutional Equities note that with clarity on NOFHC structure for banks, “we are likely to see new discussions on HDFC and HDFC Bank merger”. 

Keki Mistry, vice-chairman and chief executive officer, HDFC Limited, however, has clarified that there are no such merger talks on the table now.

But why does a merger make sense?

Over the past four years, HDFC Ltd has brought down the share of its non-housing portfolio (including builder loans) to close to 18 per cent, from over 27 per cent. Pure retail loans account for 75 per cent of its book, and penetration in the affordable housing segment makes its loan book more compliant on the priority sector lending requirements.

For HDFC Bank, the share of retail loans has plunged to less than 44 per cent in the past two years, from over 55 per cent. Merging with HDFC thus, makes sense on many counts. 

Not only will its retail book get a fillip, concerns over a chunky unsecured book will also recede. Among peers with 40–50 per cent exposure to home loans, for HDFC Bank, they don’t add up since it buys this portfolio from its parent.

The merger will also take care of the intermingled equity raise-related issue. Holding over 21 per cent stake in the bank, every time HDFC Bank goes for an equity raise, there is capital pressure on HDFC to maintain its stake in the private lender. 

With the widening valuations between HDFC (1x its 2021-22 estimated core housing book) and HDFC Bank (3x), the merger makes sense.

What can be an impediment, however, is the cost of funds. With 35-per cent deposit book, even if HDFC accesses the bond market at 3-5.5 per cent — the lowest among NBFCs — its blended cost of funds was around 7 per cent in the July-September quarter (second quarter, or Q2) due to its deposits. 

At HDFC Bank’s blended 4.3-per cent cost of funds in Q2, the difference between the two looks prohibitive. 

With the cost of statutory reserves adding upon the merger, it could distort the profitability of the merged bank.

While there are business advantages, cost synergies will be critical. Overall, it can be a win-win for both.

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