HDFC Bank is in the news since the announcement of its merger with Housing Development Finance Corporation or (HDFC) on April 4. However, three weeks post the announcement, the initial enthusiasm from market participants about the merger seems to be waning.

HDFC Bank also announced its Q4FY22 results, which were largely in line with the market expectations and Trendlyne’s Forecaster estimates. But this did not enthuse the street. HDFC Bank is down nearly 20% from the high point it reached after the merger was announced, in contrast with rival ICICI Bank, which jumped post result announcement and is up overall this month.

Deepak Parekh, Chairman of HDFC, said in a press conference following the merger announcement, “after 45 years in housing finance, providing nine million homes to Indians, we had to find a home for ourselves.”

S&P Global Ratings expects HDFC Bank’s market share to rise after the merger, which will be completed by 2024. If regulatory approvals are not delayed, its success will depend a lot on the smooth integration of its system, staff and processes.

Quick takes on the merger:

• HDFC Bank’s home loan AUM (asset under management) is set to increase by 40% after the merger with HDFC
• HDFC Bank could gain not just from HDFC’s core business, but also its insurance, asset management and broking business subsidiaries. The bank will also have wide access to HDFC’s customer base.
• Large mergers succeed or fail in the implementation. Execution is key to the merger’s success. With a sizable network of branches and offices across the country, operational parameters will have to be carefully monitored to avoid hassle and confusion.
• RBI and IRDAI’s approvals play a key role in the merger as HDFC Bank’s stake in HDFC’s subsidiaries will be decided upon by these two regulators.

Before we dive into the merger, let’s take a look at HDFC Bank’s Q4FY22 results.

Street was not enthused with Q4FY22 results being in line with expectations

HDFC Bank’s Q4FY22 revenue rose 7.5% YoY to Rs 43,960 crore and net profits by 23.8% to Rs 10,443 crore in Q4FY22. Supported by robust loan growth, its market share in terms of advances improved to 11% during the quarter. The market share in terms of deposits also improved by 70 bps to 9.5%. 

The bank’s NII stood at Rs 18,800 crore, a YoY growth of 10.2%. However, NIMs or net interest margin was down to 4.0% (vs 4.2% in Q4FY21 and 4.1% in Q3FY22). Post Covid-19, HDFC Bank saw a shift in its portfolio mix from unsecured (retail) loans to high-rated secured (commercial/wholesale) loans. This seems to have impacted its NIMs. 

The shift in the portfolio mix has not only led to NIM compression but also resulted in a drop in credit costs. The management believes the return ratios will not be impacted by slower NII growth. They expect shareholders’ return to stay intact despite the trade-off between lower provision and slower NII.

The bank has also announced a dividend of Rs 15.50 or 1,550% per equity share with a face value of Re 1 each for FY22, the highest in rupee terms in the last 11 years. 

With the results behind us, there are still concerns about the merger, on its execution due to the large scale of both entities as well as on the regulatory front with multiple regulators involved.

HDFC Bank’s business prospects post-merger look robust

HDFC Bank’s loan assets under management (AUM) are likely to increase by 40% after it merges with HDFC, according to Jefferies. This is because of improved chances of cross-selling as HDFC Bank’s customer base will increase once it merges with HDFC and can then push home loans to a larger customer base. Seeing the trend for the last four years in home loan AUM in HDFC Bank, home loan AUM is pretty much stagnant in FY20 and FY21.

HDFC Bank’s home loan AUM  nearly doubled to Rs 70,210 lakh crore from FY 18-21 FY18, while HDFC’s individual home loan AUM segment grew 51% during the same period. According to this article, HDFC Bank’s home loan portfolio is likely to increase to 33% of the combined entity’s overall loan AUM mix. With the real estate sector now gaining momentum, HDFC Bank has good scope to improve its AUM in this segment. 

HDFC Bank to gain HDFC’s customer base from this mega-merger 

If the merger gets the regulatory go-ahead, HDFC Bank will be twice the size of the third largest lender ICICI Bank. All other HDFC subsidiaries are proposed to be HDFC Bank’s subsidiaries.

HDFC Bank is set to become a financial service behemoth, with strengths not only in mortgage, but also in life and general insurance, asset management, broking business and other subsidiaries of HDFC. A significant number of HDFC customers (approx 70%) are not customers of HDFC Bank and this gives the bank a massive opportunity for new customer acquisition.

One more advantage of this merger is the larger pan India footprint with opportunities across banking services in urban, semi-urban, and rural areas. With the combined network of branches, the distribution strategy for the merged entity gains with higher presence in urban micro markets areas as well as tier-3 and tier-4 cities across the country.

Post Covid-19, the real estate sector is witnessing a revival, and this gives HDFC Bank an opportunity to grow its developer loan portfolio. The past few years are seeing changes in regulations that make real estate more conducive to investments in real estate. The combined strength of HDFC and HDFC Bank will be in a position to underwrite large ticket infrastructure loans and accelerate credit growth in the economy. 

HDFC’s rural and affordable housing lending portfolio would also help HDFC Bank comply with the priority sector lending requirements. Lower cost of funds and operating expense benefits will be derived on account of operating leverage & scale.

Regulatory, technology challenges need to be addressed

On the face of it, the merger is a landmark event in Indian corporate history as one of the largest mergers in India. However, there are a lot of complexities involved in the process and these are across areas like operations, human resources, and dealing with the various regulators. 

On the operational side, both HDFC and HDFC Bank have a sizable network of branches and offices across the country. HDFC Bank had opened 563 new branches in Q4FY22. Its plans for the future include adding another 10 to 15 every year for every 100 branches. The objective is to have a branch within 1-2 kms of its customers, from the current level of 5-6 km. Analysts say this will likely lead to a rise in operating expenditure for the bank as each branch typically costs up to Rs 6 crore to operate. The merger also gives scope to meet the ambitious branch target, where HDFC branches can be converted into the bank’s branches.

A key risk here is the technology integration of the two behemoths, alongside HDFC Bank’s ongoing tech challenges. Investment in the integration of databases and operations within the new structure needs to be dealt with on priority. HDFC Bank has a history of issues with its legacy tech systems –  it was barred by the RBI from issuing credit cards for a while due to server failures and frozen processes in its credit card systems.

Human resource issues also generally crop up in a merger of this scale. One of the most common exercises post a merger is the rationalisation of staff. Whether they will choose to do so is not known at this time, but the prospect of rationalisation creates employee concern. Valuable resources may also leave if they are reassigned a role in the merged entity which might not meet their expectations. 

The biggest hurdle to cross will be the approvals by the regulators, especially the RBI (Reserve Bank of India) and insurance regulator IRDAI (Insurance Regulatory and Development Authority of India). RBI regulations define putting a limit to a bank’s ownership stake in non core businesses. Similarly the IRDAI’s approval for the bank's stake in a general and life insurance company would be a critical factor.

HDFC wrote to the RBI seeking time and a phased approach to meet SLR, CRR, and priority sector lending regulations. It also sought permission to continue holding a stake in HDB Financial Services, as well as increase its stake in HDFC Life Insurance to meet regulatory compliance. However, this might prove to be a hurdle as in the past RBI did not allow Axis Bank to directly own more than a 10% stake in Max Life. Similarly, RBI asked ICICI Bank to reduce its shareholding in ICICI Lombard to less than 30%. 

With a timeline of eighteen months for completion of the merger, regulatory approvals will define what the final structure of the merged entity will be like. This is also likely to be accompanied by huge swings in share price with news on the progress of the merger at every step. If all hurdles are crossed, investors in HDFC Bank are likely to witness its transformation from just a bank into one of the world's largest financial services companies.