Why Citi is opting out of HDFC; it wants the bank

The news that Citigroup is trying to whittle down its stake in Housing Development Finance Corporation (HDFC) below 10 per cent is a belated recognition that the Indian banking sector is not opening up to foreign ownership any time soon.

The logic is simple: Citigroup’s interest in HDFC stems from the latter’s 23.35 per cent promoter stake in HDFC Bank, not because it wants to invest in a housing finance company.

[caption id=“attachment_25343” align=“alignleft” width=“380” caption=“Citigroup’s interest in HDFC stems from the latter’s 23.35% promoter stake in HDFC Bank, not because it wants to invest in a housing finance company. Mike Segar/Reuters”]  [/caption]

But post-the Lehman Brothers crisis, the Reserve Bank has shown no great interest in opening up the banking sector for investment. This means Citi would have been sitting on an unproductive investment of nearly $2.4 billion in HDFC for years to come. It’s taking its cash out for putting it to better use elsewhere.

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HDFC is, in fact, an anachronism in India. Its prime business is housing finance, but with every bank getting into housing loans, its market share is steadily coming down. Apart from a hoary tradition in pioneering housing finance, HDFC has no real competitive advantage - beyond the brand name - when it comes to raising money for lending to home buyers. Banks can do that better.

The future clearly belongs to HDFC Bank, and this is clear from growth rates reported by the bank and its parent. In 2010-11, while HDFC Bank saw net profits grow 33 per cent, HDFC’s grew at around 25 per cent.

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HDFC’s market value is around Rs 95,000 crore, the bank’s around Rs 1,11,000 crore. But HDFC’s value is clearly overstated, for embedded in it is the bank’s value too. Take the 23.35 per cent holding in HDFC Bank out, and HDFC’s valuation would be under Rs 70,000 crore.

The problem in the HDFC-HDFC Bank relationship is that it is the opposite of what it should be. When banks want to grow housing finance in a big way, they set up a subsidiary. In HDFC’s case, it is the housing finance company (HFC) that set up the bank.

When banks float HFCs, they handle the fund-based business and the housing finance subsidiaries earn fees for originating loans. In HDFC’s case, HDFC Bank originates loans and earns fees, and HDFC does its own funding.

But for the historical fact that HDFC floated the bank, the relationship would have been exactly the reverse. That shows us what the future could be: the two will have to merge at some point of time.

HDFC’s brand franchise is huge, but its business survives and still thrives on the inefficiencies of the public sector banking system.