On 4 April 2022, HDFC Ltd, India's largest housing finance company (HFC) announced a merger with HDFC Bank Ltd, the country's largest private sector bank. Shareholders of HDFC will get 42 shares of HDFC Bank for 25 shares of HDFC held by them. Upon completion of the merger, HDFC will cease to exist as a separate entity and be amalgamated into HDFC Bank. Shareholders of HDFC will own about 41% of the shareholding of HDFC Bank after the merger, and the Bank will be fully owned by public shareholders and will cease to have a promoter. The group expects the merger to be completed within 18 months. While HDFC Bank will remain the second-largest bank in India post-merger, it will be twice the size of ICICI Bank Ltd, the third-largest bank in the country.
HDFC Bank's larger balance sheet could enhance its wholesale lending opportunities, says S&P Global Ratings. The merger will allow the combined institution to effectively tap into the customer base of both institutions to cross-sell a large number of financial products of the HDFC group.
According to the management, only 30% of the customers of HDFC have bank accounts with HDFC Bank and the amount of loans availed by HDFC Bank's customers from other banks is equivalent to the balance sheet size of the Bank itself.
This illustrates the large cross-selling opportunity, especially for high-yield products such as unsecured loans, that will be unlocked for the combined entity after the merger. It would generate more fee income from insurance and investment products.
To leverage this, HDFC's branches will be converted into full-service banking outlets of the Bank, wherever possible. The merger will also enable the seamless delivery of the group's mainstay product, home and allied loans, to the large customer base of over 65 million customers of HDFC Bank.
Additional benefits such as a lower cost of funds, disappearance of the holding company discount for HDFC and mitigation of a single product risk have also been highlighted by the group's management.
Geographically, more than 95% of HDFC Bank's branches are less than 15 years old and over 50% of the branches are currently in rural and semi-urban areas.
HDFC has developed strong underwriting skills in the mortgage lending sector and has built significant technological capabilities to improve the quality of its underwriting.
A combination of HDFC Bank's deep rural and semi-urban distribution network with HDFC's underwriting capabilities places the combined entity in a sweet spot to supercharge its growth in the affordable housing sector in rural and semi-urban geographies.
The merger announcement comes on the back of robust performance by HDFC Bank in fourth quarter (Q4) of FY21-22. Its advances grew 21% year-on-year (y-o-y) and about 9% quarter-on-quarter (q-o-q). This growth was led by a 30% growth in commercial and rural banking. HDFC's rural housing network and its experience in financing affordable housing will be key for the Bank to maintain this growth momentum.
"The merger will raise HDFC Bank's loans by 42% to Rs18 trillion (or about US$237 billion), increasing the bank's market share to about 15%, from 11% currently," says S&P Global Ratings. "The merged entity will have one-third of its portfolio in mortgage loans, compared with a reported 11% now. HDFC's mortgage portfolio largely comprises individual housing loans. Such loans tend to be granular. Moreover, HDFC's insurance, asset management, and securities subsidiaries will further diversify the combined entity's revenue profile."
Currently, commercial and rural loans account for 35% of HDFC Bank's loan book, corporate loans account for 26%, retail loans account for 28% and mortgage loans (purchased as a direct assignment from HDFC) account for only 11% of its loan book compared to 30% to 40% for its competitors.
On the other hand, individual mortgage loans account for 77% of HDFC's loan book and corporate loans, and construction finance and lease rental discounting account for only 5% and 9% each of its loan books, respectively.
The merger will enable diversification of the Bank's loan book, reducing its risk significantly. On a proforma basis, the combined loan book has 33% contribution from mortgage loans, 24% contribution from commercial and rural loans, 21% from retail loans, 19% from corporate loans and 3% from construction finance.
The long tenor of home loans provides the Bank with a high customer lifetime value (LTV). These loans, typically, last for 20 years, allowing the Bank to cross-sell additional unsecured, lower tenor credit and other products from group firms such as insurance and asset and wealth management products.
HDFC Bank was incorporated in 1994 as a subsidiary of HDFC Ltd. Currently, HDFC serves as a promoter of the Bank and holds around 26% of the Bank's shareholding directly and through its subsidiaries.
The two companies have been exploring a possible merger for years. However, regulatory issues such as higher statutory liquidity ratio and cash reserve ratio for the combined entity and priority sector lending (PSL) norms were key impediments for the two companies.
Over the past six years, falling interest rates have made reserve requirements less of a drag on a Bank's balance sheet growth. Additionally, the classification of affordable housing as a priority sector, tightening of regulatory frameworks for non-banking financial companies (NBFCs) and the moves of the Reserve Bank of India (RBI) to facilitate the conversion of NBFCs into full-service banks have been cited by the management for creating the opportune time for a merger now.
After the merger, the Bank will continue to be run by its existing management. Deepak Parekh will not be a part of HDFC Bank's board as RBI has instituted an age cap of 75 years for directors of a bank. The management has highlighted the possibility of Keki Mistry, the current vice-chairman and chief executive officer (CEO) of HDFC joining the Bank's board as a director.
After the merger was announced, HDFC's shares increased as much as 19% but gave up half the gains. HDFC Bank was up over 14% at one time and closed with a gain of 10%. S&P expects "the combined entity's capitalisation and asset quality to be broadly in line with those of HDFC Bank on a stand-alone basis.
"About 9% of HDFC's portfolio comprises loans to real estate developers, where the asset quality is weaker than what it is for the rest of the bank's portfolio. In our view, HDFC Bank should be able to absorb incremental risks from this portfolio given its adequate capital and provisioning buffers," the rating agency concludes.