Explained: HDFC Bank merger with HDFC does not make great economic sense
Some of the hurdles for merging HDFC and its bank are gone with the relief given from CRR and SLR requirements. But an immediate merger wouldn't deliver benefits beyond size and valuations
The Reserve Bank of India (RBI)'s decision to allow banks to float long-term infrastructure bonds free from reserve requirements, and the surprise inclusion of affordable housing as a beneficiary, technically clears the path for a merger of HDFC and HDFC Bank-an idea, which has been in the air ever since ICICI Bank merged with its parent in 2001-2002.
The only major hurdle for the HDFC-HDFC Bank merger, as publicly highlighted by Deepak Parekh and Keki Mistry, is the huge burden that would fall upon them on account of cash reserve ratio (CRR) and statutory liquidity ratio (SLR) norms, which a bank has to comply with but not a non-bank finance company. Under RBI norms, a bank needs to set aside 4 percent of its deposits as CRR and 22.5 percent in government bonds. The burden would have been huge if HDFC had to transfer its business to the bank without regulatory exemptions.
With RBI permitting banks to float bonds with a minimum of seven years' maturity without CRR and SLR requirements, an HDFC merger with its bank is no longer infeasible with proper preparation.
If this comes to be, this will create the largest private bank in the country, surpassing ICICI Bank. With a combined loan base of Rs 5 lakh crore, it will be way ahead of the Rs 3.4 lakh crore loan book of ICICI. At Thursday's closing market prices of Rs 831 and Rs 973 for HDFC Bank and HDFC, the merged entity would be India's most valuable bank. Their combined market valuation could top Rs 3,50,000 crore, leaving both State Bank of India (Rs 1,93,000 crore) and ICICI Bank (Rs 1,67,000 crore) far behind.
However, beyond size and scale, the merger might not make too much economic sense to the combined entity, at least in the initial two or three years. This is because it will take the combined entity that much time to fully utilise the leeway provided by the central bank to raise long-term funds and generate cheaper current and savings liabilities matching its assets.
As at end March 2014, the housing finance company had a book size of about Rs 2 lakh crore. Out of this, approximately Rs 1.4 lakh crore, or 70 percent, was retail lending for home loans; the remaining money was lent to realtors and developers. Since the CRR/SLR exemption only applies to loans up to Rs 50 lakh per borrower, only about Rs 98,000 crore of HDFC loan book would qualify.
Here is why there isn't yet a strong case for merger to happen.
First, HDFC is one of the very few housing financiers which enjoys AAA rating. Hence the firm is able to raise money through longer maturity papers at much cheaper rates below 10 percent even now, competing with banks. HDFC had total borrowings of Rs 1.84 lakh crore till March, more than half of which comes from the issue of debentures and securities. About 51 percent of the borrowing comes through that route, 31 percent comes from retail fixed deposits and 18 percent from term loans from financial institutions.
The average cost of borrowing for HDFC, as at end March, stood at 9.5 percent. Beyond a few basis points here and there, it is unlikely that an infra bond issue can fetch a significant cost benefit, given that there won't be any takers for a 7-10 year bond that offers returns below 9.5 percent. Hence, the decision to merge may not make much economic sense, unless the combined entity can generate savings deposits in larger quantities.
Second, there will be a huge rush for issuing infra bonds from most of the state-run banks to cash in on the opportunity. Given the shallowness of Indian corporate bond markets,it will not be easy to find enough long-term lenders for Rs 1.84 lakh crore. In an interview to CNBC-TV18, HDFC's Managing Director Keki Mistry said the average tenure of HDFC's loans to housing projects was 5-5.5 years. Which means, there is no major room for longer term bond issues for HDFC.
Third, housing loans are a low-margin business. They work on volumes. It makes more sense for the combined entity to raise money from infra bonds and use and lend it for infra projects at 13-14 percent than spending it on affordable housing. But, in this case, HDFC would be sacrificing its own core competence segment.
There is no genuine need for both entities to merge since both are doing well on their own. A merger, in fact, could have a negative impact on earnings in the initial years.
The only attraction is size and scale and the leverage that comes from being India's most valuable bank.
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