HDFC Bank note – Outperformance: the merger may be a drag on the income statement

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HDFC Bank has announced a merger with HDFC Ltd, issuing 1.68 shares of HDFCB for 1 share of HDFC Ltd (as last closed). While the merger will increase the bank’s product portfolio and cross-sell ability, we believe there will also be a drag on its P&L due to higher PSL and SLR/CRR requirements. RBI’s approval will also be a controllable key, as the bank will eventually hold significant stakes in the life insurance, general insurance and AMC businesses.

A regulatory nod to a controllable key

Fusion creates a monster: The merger will expand product coverage for HDFC Bank. According to management, approximately 70% of HDFCB customers do not have HDFC Ltd mortgages. We believe the merger has direct implications for the industry, as it increases competitive intensity (as HDFCB’s capabilities will be enhanced). There is also a clear reading that large NBFCs will need to convert to banks to thrive.

Technical gains from FII margin expansion may be limited

FII’s stake in HDFC Bank (after the merger) will be approximately 66% compared to the cap of 74%. Therefore, there is an increased spread of 7-8% from ~4% currently for FIIs to hold the stock. However, we believe the inclusion of the merged HDFCB in the index may be difficult as MSCI India requires a larger FII margin (from the cap) for inclusion.

The requirements of the priority sectors and the SRR/CLR can be an obstacle to the P&L

According to rough calculations, HDFCB will have an excess SLR/CRR asset requirement of around Rs 700-800 billion and will also need an additional agricultural portfolio of around Rs 900 billion to meet PSL standards. These low-yielding portfolios could be a drag on P&L.

RBI approvals are a controllable key

RBI’s endorsement will also be controllable, as the bank will end up owning 48% in life, ~50% in general insurance and 69% in group AMC entities. Very recently, RBI did not allow Axis Bank to directly hold >10% of Max Life, and ICICI Bank was asked to reduce its stake in ICICI Lombard to

Merger solves succession problem at HDFC Ltd

The merged entity will include all HDFC management personnel. Keki Mistry will serve as non-executive director on board, while Deepak Parekh will not serve due to age restrictions. We believe that the merger largely solves the succession problem at HDFC Ltd.

The lessons of the merger of the ICICI group

ICICI had undergone a similar group merger in 2002. CASA for ICICI (as % of total funding) fell from 26% (FY01) to 9% in FY03 and only recovered to the 30% level in FY10. In our view, refinancing HDFC’s funding with low-cost deposits will be key to the merger’s success. HDFC Bank’s effective CASA could drop from ~47% to ~35% after the merger.

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