Banking and Financial Services
The Mega Merger
Rumours around the HDFC–HDFC Bank merger date back to 2014. Finally on Monday, 4th April 2022, HDFC Bank and HDFC Ltd announced the merger of the two entities, setting the stage for one of the biggest deals ever in the Indian financial sector. While HDFC Bank will remain as the second largest bank in India after SBI, it will end up with a balance sheet size of twice that of ICICI Bank.
The Merged Entity at Glance
| HDFC+HDFC Bank
[Merged Entity] |
INR 25.61 Lakh Crore
( ~15% Market Share) |
SBI
INR 45.36 Lakh Crore (~25% Market share) |
| ICICI Bank | INR 17.74 Lakh Crore
(~8% Market Share) |
Source: S&P Ratings
- HDFC Ltd. (the parent) is the largest financier of mortgages in India. The merger will raise HDFC Bank’s loans by 42% to Rs.18 trillion, increasing the bank’s market share to about 15%, from the current 11%
- HDFC Ltd.’s mortgage portfolio largely comprises individual housing loans. the granular nature of these loans and the lender’s insurance, asset management, and securities subsidiaries will help further diversify the combined entity’s revenue profile
- The merger will increase the bank’s product portfolio and ability to cross-sell
- The merged company will benefit from economies of scale, ability to raise funds at competitive rates, and can leverage on HDFC Bank’s digital capabilities
- Profitability in the shorter term however could be hit due to statutory reserve (SLR) requirements and priority sector lending regulations. Macquarie estimates that HDFC Bank will have an excess SLR/CRR asset requirement of ~Rs700-800bn and will also need an incremental ~Rs900bn agriculture portfolio (based on 18% of borrowings) to meet PSL norms. These low-yielding portfolios could be a drag on the merged entity’s P&L. The Bank should be able to absorb incremental risks from this portfolio given its adequate capital and provisioning buffers
Why Now?
- Regulatory Pressures: HDFC Chairman Deepak Parekh says that the bank-like regulations for NBFCs was the final nudge for the merger. Ever since the 2018 IL&FS crisis, RBI has been pushing non-banking financial companies (NBFCs) to work like banks — that is, set aside reserves as a precaution, ensure a wider base of liabilities, and so on; beyond a certain threshold (₹50,000 crore), operating as an NBFC could become challenging.
- Business Synergies: HDFC and HDFC Bank have an agreement whereby the parent company will sell a certain portion of its loans to the bank every quarter. For the bank, this was the only exposure to the home loans business. Owing to the complementary nature of businesses and the cost synergies, particularly for the home loan business, the deal made sense to both.
Why does the Merger Make Sense?
- Inorganic Portfolio Growth: HDFC Bank’s loan book is currently at ₹12-lakh crore. Organically climbing to ₹18-lakh crore would involve tightrope walking between growth, profitability and asset quality. Shaking hands with HDFC Limited is an easier and economical option.
- Cementing HDFC Bank’s market leadership: The merger would make HDFC Bank India’s second largest bank. While the gap between HDFC Bank and SBI would be about ₹6–7-lakh crore, ICICI Bank would be a distant third with a gap of over ₹10-lakh crore.
- Cost Optimisation: In the long run (i.e. by FY 2026), cost of operations to cost of pricing loans and cost of running the establishment is expected to reduce
- Diversified Book: A large loan base acts as a natural shield against asset quality. If there is trouble in certain pockets of the business, say the agri loans or the MSME book, the asset quality of these loans will not disturb the overall asset quality of the bank
- Cross-selling opportunities: The merger will help the entity cross-sell products to a larger customer base, by leveraging their distribution across urban, semi-urban and rural geographies.
Transaction Structure and Timelines
- All HDFC Group subsidiaries will now fold into the bank
- Shareholders of HDFC Limited, as on record date, will receive 42 shares of HDFC Bank for 25 shares of HDFC Limited
- The swap ratio works to 1:1.68
- The merger requires several regulatory okays and could take up to 18 months to be completed. Target completion date is end of FY2024
- Post the merger, HDFC Limited’s shareholding in HDFC Bank will be extinguished and HDFC Bank will be 100 per cent owned by public shareholders. Existing shareholders of HDFC Limited will own 41% of HDFC Bank
Potential Impact on the Indian Financial Services Sector
The merger will make HDFC nearly two times the size of ICICI Bank and ICICI could start to look around for other assets in the market to try and gain scale, driving more M&A activity within the sector.
There is a need for India to have fewer large-size institutions, which can be counted amongst global banks. HDFC Bank is already the largest in terms of market capitalization and after the merger, it may be amongst top five-six banks globally. The merger action augments the ability to take big ticket loans and comes at a time when the capital investment is picking up
NBFC Sector – Borrowing Costs Likely to Fall
HDFC accounted for nearly 1/10th of the bonds sold in the country. Insurance and pension funds find HDFC Ltd bonds a preferred destination to deploy their money. In the just-ended fiscal year, HDFC Ltd accounted for 9%, or ₹50,157 crore, of the total bond sales, compared with just 0.9% by HDFC Bank (₹5,016 crore), show data compiled by JM Financial.
Post merger, the entity will have access to cheaper deposits to fund its mortgage business. Also, now the merged entity will be a banking services provider which means that it will have lesser regulatory headroom compared to a Housing Finance Company to raise funds from long term institutional bond investors including insurance companies.
This could be a blessing for NBFCs whose cost of funding could fall as there would be limited alternatives for fund managers now to invest in top-rated financial services bonds.
RBI Policy
Inflation Before Growth – Shift in Policy Stance
The RBI’s Monetary Policy Committee (MPC) decided to keep the repo rate unchanged in its first bi-monthly policy meeting of FY23 on Friday. This is the 11th time in a row that the central bank has maintained a status quo on the key policy rate. However, the RBI has finally crawled towards a change in policy stance by being ‘less accommodative’ even as it kept the policy repo rate unchanged with a unanimous vote. The move towards the stance adjustment has come from adding overnight SDF (standing deposit facility) as a new instrument to liquidity management framework at (-) 25 basis points (bps) of repo rate to absorb liquidity, symmetric with MSF rate (marginal standing facility) which is (+) 25 bps higher than repo rate. However, RBI also maintained that they will continue to adopt a nuanced and nimble approach to liquidity management even as they move towards normalisation going ahead.
Other highlights of the week
Tata Digital starts testing UPI payments in closed user group
Tata Digital has started testing online payments through the Unified Payments Interface (UPI) on its ‘super app’ Tata Neu. The test is being conducted with a closed user group in partnership with ICICI Bank, sources briefed on the matter said. Tata Digital is set to launch the super app for all consumers on April 7.
Joining the UPI network is a natural extension of the Tata Group’s ambitious digital commerce play as it can help improve the experience of shopping online. Amazon India also has its own UPI service through which it offers cash back and other incentives.
FAQ on taxation of cryptocurrencies, virtual digital assets in works – says Government
The 2022-23 Budget has brought in clarity with regard to levy of income tax on crypto assets. From April 1, a 30 per cent income tax plus cess and surcharges will be levied on such transactions in the same manner as the tax law treats winnings from horse races or other speculative transactions.
The Budget 2022-23 also proposed a 1 per cent TDS (tax deducted at source) on payments towards virtual currencies beyond Rs 10,000 in a year and taxation of such gifts in the hands of the recipient.
The DEA, Revenue Department and the Reserve Bank are working to ensure that the taxation aspect is clear both for field tax offices as well as those who deal with cryptocurrencies and other virtual digital assets.
