A Merger of Equals: HDFC

Update on the Indian Equity Market:

On Tuesday, the Nifty closed lower at 17,957 (-0.5%) as indices were trading on a weak note amid profit-taking in HDFC twins following a sharp rise in the last session. CONSUMER DURABLES (+2.4%), FMCG (+1.3%), and AUTO (+1.2%) were the top sectoral gainers. FINANCIAL SERVICES (-1.6%), PRIVATE BANK (-1.5%), and BANK (-1.5%) were top losing sectors. The top losers were HDFCBANK (-3.1%), BAJAJFINSV (-2.4%) and HDFC (-2.2%), while ADANIPORTS (+3.1%), NTPC (+2.8%) and TATAMOTORS (+2.4%) were the top gainers.

 A Merger of Equals: HDFC

Edited excerpts of an interview with Deepak Parekh, Chairman, HDFC with ET on 5^th April 2022:

• The merger between HDFC and HDFC Bank is a merger of equals and comes at the right time as the latest Reserve Bank of India (RBI) regulations have narrowed the operational arbitrage for non-bank lenders.
• Both the institutions have been evaluating the pros and cons of a possible merger for mutual benefit.
• Over the past two years, there have been regulatory changes for Banks and Non-Banking Financial Companies (NBFCs), considerably reducing the barriers for a potential merger.
• A host of guidelines issued by the RBI in the last three years on harmonizing regulations between banks and NBFCs include guidelines requiring large NBFCs to conversion into commercial banks, particularly those with more than Rs 500 bn of asset bases.
• Non-Performing Assets (NPA) classification has been harmonized, NBFCs are now required to provide liquidity coverage ratio, and scale-based regulation has been introduced where the upper layer of NBFCs will have a much stricter regulatory watch.  These measures have considerably reduced the risk arbitrage that was there between a Bank and an NBFC.
• The Liquidity Coverage Ratio (LCR) requirements are a big drain on NBFCs same as Cash Reserve Ratio (CRR) & Statutory Liquidity Ratio (SLR).
• NBFCs need to keep their maturities in the next 30 days in a separate bank account. It needs to take all loan repayments, bond repayments, deposit repayments, and estimated disbursements in one account and transfer it to a liquid fund accruing a 2% return.
• The strategic rationale for the proposed merger includes SLR and CRR for banks, which was 27% and has now been reduced to 22% (18% for SLR and 4% for CRR).
• Interest rates are more favorable at present. Banks have an option to invest in priority sector lending (PSL) certificates, to meet the PSL requirements.
• The merger makes the combined entity strong enough, countering competition and making the mortgage offering more competitive. The funding challenges both in quantum and cost will be minimized by the combined entity.
• The bank has requested a phased-in approach in respect of SLR and CRR, priority sector lending as well as grandfathering of certain assets and liabilities and in respect of some of its subsidiaries. These requests are under consideration by RBI in terms of a letter received on April 1.
• In a letter to RBI, HDFC has also asked for time, to be compliant on existing assets of HDFC, a specific period of 2-3 years, with new loans complying with SLR and CRR regulations.
• The bank is aware that Developer finance, apart from earning a higher rate of interest, gets retail loans. When a builder launches a product and a construction finance is being offered, HDFC captures the first few days’ business, which emanates into large mortgage loans. However, loans given for the purchase of land will have to stop.
• Chairman believes that the HDFC brand is not disappearing, and the brand will live through HDFC Life, HDFC MF, and HDFC Bank.
• The time for a merger has come because of regulatory changes. NBFCs are being regulated like a bank but don’t enjoy the advantages of a bank like an overdraft, and lower cost of funds.

Asset Multiplier Comments

• Benefits like an increase in product coverage, cross-selling opportunities to HDFC’s customers, the ability to raise funds at competitive rates, and loan book expansion will boost the performance of the Bank in long term.
• We think the merger will be able to extract synergy benefits and will aid the competitive positioning of the combined entity as it will have the same cost structure as other banks.

Consensus Estimate (Source: market screener website)

•  The closing price of HDFC was ₹ 2,623/- as of 05-April-2022. It traded at 3.7x/3.4x the consensus book value per share estimate of ₹ 716/ 785/- for FY23E/FY24E respectively.
• The consensus target price of ₹ 3,200/- implies a PBV Multiple of 4x on the FY24E BVPS estimate of ₹ 785/-.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”