'A merger with HDFC Bank is too expensive'

HDFC chairman Deepak Parekh talks about how rising interest rates will impact his company and whether this could lead ultimately to a merger with HDFC Bank.

The air is thick with talk of banking sector consolidation. Whether it is foreign banks gobbling up stakes in local banks or Union Bank's merger with Bank of India, the market is sensing action.

But missing in all this talk of M&A are two of the most eligible candidates: home loan major HDFC and HDFC Bank. The two businesses are seen as complementary: mortgages are the fastest growing segment in the loan market and HDFC is a strong player while HDFC Bank has access to cheaper deposits.

Though the two have worked out an arrangement, a merger might work better. Both stocks are favourites of foreign investors and are now among the two most expensive in their universe.

HDFC trades at a forward price-earnings (P/E) multiple of 20 while HDFC Bank trades at a multiple of 17. To get a glimpse into the future, The Smart Investor spoke to Deepak Parekh, HDFC chairman, on how rising interest rates will impact the housing finance business. Excerpts:

Where do you see interest rates headed?

I think interest rates will remain steady till March after which they will move up again, perhaps by about 50 basis points. I feel the impact of the higher prices of raw materials has not been felt yet.

Do you see pressure on HDFC's spreads?

No, the core business will not be impacted; we will pass on the costs. When interest rates were at 17 per cent we earned a spread of 2.2 per cent, at seven per cent also we are earning the same spread.

What will HDFC's growth trajectory and market share look like going forward?

In the last seven years we have grown at over 25 per cent a year. We will continue to grow at 25 per cent-- we can't handle more than that. Home loans will continue to be our core business as the opportunity in mortgages is still huge. I don't know about market share because today every bank is in the business.

Isn't there a case for merging HDFC and HDFC Bank?

It would be too expensive; we would need to borrow Rs 9,000 crore for SLR and CRR on a balance-sheet of Rs 30,000 crore and probably lose 1-1.5 per cent on it. I don't know if we can afford that.

Is that the only reason? Perhaps, you could get SLR forbearance, like IDBI.

That's the major reason, yes, but we'll look at it more positively (if we get forbearance). I don't think we will get SLR forbearance.

What kind of corporate structure would suit the group?

Ideally, I would like a holding company which would be the listed entity with stakes in all the subsidiaries. But we are not being allowed to do that.

HDFC's stake in HDFC Bank is coming down continuously...

Yes, it will go down to around 21 per cent after the ADR issue, but we will not let it fall below 20 per cent. It made sense to do an ADR issue for HDFC Bank because of the premium valuation that it will get overseas.

When will the insurance subsidiaries get listed?

We will list them in two or three years.

Will you continue to depend more on wholesale funding?

Actually, though we have reduced our dependence on retail deposits we may actually cash in on our franchise and start borrowing more from this source. The cost will not be very much higher since most of the operations are fully automated.

Wouldn't you like to be in more fee-based businesses?

We saw an opportunity in real estate where we could have rented properties to big IT firms but since we were not allowed to buy real estate valued at more than 10 per cent of our net worth, we could not make much progress. We continue to offer brokerage services to corporates but there is no money in advisory services.

What about securitisation?

Securitisation has not worked for us; we have been able to securitise only a small amount. The problem is that only five states have passed the special legislation for lowering the stamp duty. I don't see any big opportunity for fee income in securitisation.

What is your latest venture?

We have applied for a property fund, like a real estate venture fund of around Rs 500 crore. This will be privately placed, not for retail investors but for larger investors with a minimum investment of Rs 5 crore. We will manage the fund for a fee.