The HDFC Ltd.-HDFC Bank merger

What is the financial rationale of this merger? Is the stage ready for more mega deals?

What is the financial rationale of this merger? Is the stage ready for more mega deals?

The story so far: Mortgage lender HDFC Ltd. and India’s largest private bank, HDFC Bank, announced a mega merger on Monday.

The merger will create a financial behemoth that is expected to be more responsive to rising credit demand.

Under the terms of the deal, which is one of the largest in the Indian financial sector, HDFC Bank will be 100% owned by public shareholders, while existing shareholders of HDFC Ltd. Will own 41% of the shares in HDFC Bank.

THE CORE

Mortgage lender HDFC Ltd. and India’s largest private bank, HDFC Bank, announced a mega merger on Monday. Under the terms of the deal, HDFC Bank will be 100% owned by public shareholders, while existing shareholders of HDFC Ltd. Will own 41% of the shares in HDFC Bank.

After the merger, the mortgage lender will have access to HDFC Bank’s CASA deposits (current and savings accounts), which are cheaper funds. For HDFC Bank, any home loan customer can be tapped to become a bank customer.

The regulatory framework of the NBFC (Non-Banking Financial Company) sector is increasingly harmonizing with the regulatory framework of the banking sector. If you are a large NBFC, it makes more sense to merge with a bank as banks are more highly regulated and have a lot more oversight over the RBI.

What are the terms of the merger?

The two companies have announced that their respective boards have approved the merger. Next, the merger must go through a series of regulatory approvals.

It also needs to get approval from the shareholders of both companies. What has been announced by the two entities at this point is that it is an all-stock deal, so no cash transaction is involved.

The terms of the share exchange are such that HDFC Ltd. shareholders. will receive 42 shares of HDFC Bank for every 25 shares they hold in HDFC Ltd.

Following the merger, HDFC Ltd. will no longer be a separate mortgage lender, but will be placed with the bank. The bank, which is the progeny of HDFC Ltd. and the older legacy entity, is the one that the mortgage lender takes over. With the acquisition of the mortgage lender, it also acquires all of its subsidiaries, including a non-life insurance company, a life insurance company and an asset manager.

What will happen to existing customers and employees?

As far as the customers are concerned, the customers of HDFC Ltd. the bank’s customers. As for the employees, HDFC Bank plans to incorporate and retain all employees.

Neither entity is very heavy on employee numbers and has been fairly conservative in their workforce.

At the press conference to announce the merger, HDFC chairman Deepak Parekh specifically said that the employees of HDFC Ltd. become part of the bank.

Is it worth doing this exercise, which will take about 18 months to bear fruit? What is the reason for that?

Any merger, when it comes to two entities, takes a certain amount of time. But since both of these entities are from the same house or group, this won’t be much of a challenge for them. Since both HDFC Ltd. if HDFC Bank have had a pretty conservative credit culture for the most part, both fairly customer-friendly, customer-oriented, culturally speaking, there wouldn’t be much of a challenge. The integration part of it would just be a matter of making sure everything runs seamlessly and smoothly, mapping the books together, merging the IT systems and so on.

From the point of view of the rationale for the merger, Mr. Parekh said a few things, including that in recent years, the evolution of the regulatory framework for the NBFC (Non-banking financial company) sector has gradually moved closer, harmonizing with the regulatory framework of the banking sector. Previously, NBFCs had quite a different and much looser kind of framework for lending and deposits. This led to problems in the industry, with some NBFCs struggling and going under or being taken over by others. The Reserve Bank of India has tightened the regulatory structures for the NBFC industry over the years. Mr Parekh specified that the regulatory environment has been harmonized to the point where it makes sense, and the RBI will likely be happy too. If you are a large NBFC with the kind of size that HDFC Ltd. says, it makes more sense to merge with a bank because the banks are much more regulated and have a lot more oversight over the RBI.

Since the Basel III capital adequacy standards are in effect, the NPA (non-performing asset) book is followed very closely. Even from a regulatory perspective, the RBI is unlikely to be unhappy with this merger going through, as it wants NBFCs to be tightly regulated. And if you’re part of a bank, you’re better regulated.

What’s in it for HDFC Ltd. and HDFC Bank?

After the merger, the mortgage lender, HDFC Ltd., will have access to HDFC Bank’s CASA deposits (current and savings accounts), which are lower-cost funds. The cost of capital for mortgage lending will fall. As the cost of capital falls, it will automatically have the ability to borrow at a finer interest rate. For HDFC Bank, any home loan customer can be tapped to become a bank customer.

Was there any pressure or immediate need for the merger?

Competition in housing financing has increased, say from 30 years ago when HDFC Ltd. was one of a handful of home financing entities. Now entities providing loans for housing have risen significantly. The bigger ones are LIC Housing Finance, PNB Housing, Bank of Baroda Housing etc. SBI also has a housing company. Banks have also provided loans through subsidiaries — Canfin Homes is Canara Bank’s home financing subsidiary. So, in a sense for HDFC, it makes sense that HDFC Ltd. and HDFC Bank are under the same roof because borrowing from a banking perspective makes it easier for your money costs to come down as your balance sheet size grows. When you raise capital, your cost of capital also decreases.

For HDFC Bank, it’s about accessing a large number of customers for cross-selling purposes. For HDFC Ltd., or the mortgage lenders, it’s mainly about the lower cost of capital.

Does greater balance help in terms of the NPA situation?

As for HDFC Bank, bad loans are not a big pressure point as it has been a conservative lender compared to competitors. They have always withdrawn from lending big tickets to companies. Most of their lending is to private borrowers. What HDFC Ltd. As far as concerns, there may have been some pressure on home loans during the pandemic, but based on what they’ve disclosed so far, it’s not a big pressure point either. The merger with the bank also helps to alleviate some of the pressure ahead.

Is the borrowing pattern changing?

Infrastructure loans are a serious problem in India. With the government clearing the need for funding from the infrastructure segment, we’ll have to wait and see if the merged entity has the expertise to lend to infrastructure projects, which is a risky proposition. They do have a lot of money, and if they see concrete opportunities with good entrepreneurs and good government projects, then they can go for it.

What will be the impact of this deal?

We may see more NBFCs looking to merge with banks. The number of banks is already declining. So in a sense, HDFC Bank’s merger with HDFC Ltd. be a harbinger of what will happen in the state bank, where the government has said it will reduce the number of public sector banks.

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