HDFC-HDFC Bank merger: Brokerages see return ratios improving by FY25-26

Analysts think there are multiple challenges such as impact of SLR/CRR/PSL compliance cost; the RBI's aversion to banks holding considerable stakes in para-banking businesses

Investors booked profit in HDFC and HDFC Bank shares, cashing in on Monday's stupendous rally. The shares of the former slipped 2 per cent while those of the latter declined 3 per cent on Tuesday. In comparison, the BSE Sensex settled 0.7 per cent lower.

Shares of both these companies soared up to 10 per cent on Monday after Housing Development Finance Corporation found a home within the family. HDFC Bank and HDFC Ltd are set to merge, creating India’s biggest lending behemoth in terms of market-capitalisation.

On a pro-forma basis, the merged HDFC Bank’s total advances will be around Rs 18 trillion, shrinking its gap with State Bank of India, whose total advances at the end of December 2021 stood at Rs 26.66 trillion.

While the underlying rationale for this merger is to create a strong bank with a formidable position in the mortgage segment, which complements HDFC Bank’s existing presence in retail assets (ex-mortgage), analysts say the cost of regulatory compliance remains a key concern.

Here’s what key brokerages said about the deal:

Morgan Stanley

The proposed merged entity will have a balance sheet of $330 billion on a pro-forma basis. HDFC Bank’s loan book will increase 41 per cent to around $230 billion, cornering 15 per cent of the entire banking system loans. Most importantly, the share of the retail loan book will increase to over 50 per cent compared with 40 per cent right now.

The merger would be EPS-accretive in the first full year of FY25. Return on equity (RoE) may fall in the near-term given capital accretion, but loan growth pick-up will imply pre-merger RoE by FY26.

Macquarie

We think the merger has direct implications for the sector, as it increases competitive intensity (as HDFC Bank’s capabilities will be enhanced). There is also a clear read-through that larger NBFCs will have to convert into banks to thrive as the regulatory gap between banks and NBFCs gets rationalised further.

ICICI Securities

While HDFC Ltd would benefit from the bank’s lower funding cost, HDFC Bank would gain product expertise in mortgage space and help reduce cost/income ratio. Better cross sell opportunities for the bank with direct access to HDFC Ltd’s customer base will also support growth. The proposed transaction will result in reducing HDFC Bank's proportion of exposure to unsecured loans.

Kotak Institutional Equities

From HDFC Bank’s perspective, the deal is positive as loan growth has been decelerating in recent years. The merger has come at a time when the bank’s size is larger than HDFC Ltd’s and at a valuation that is favorable. Hence the medium-term outlook for the bank’s business post this acquisition is likely to be favorable.

Although we do not see very large synergy benefits from this transaction, we believe it will benefit the bank in building a long-duration mortgage book – another lever for secured growth.

Emkay Global

As per the proposed merger, HDFC Ltd’s non-lending subsidiaries, including insurance and AMC, will be housed in the bank. However, as per the RBI’s policy, the bank has to reduce its stake in the existing insurance company to 30 per cent and is allowed to acquire a maximum 20 per cent in a new insurance business. Thus, the bank will have to sell its stake in the insurance business, including HDFC Life.

However, we believe the RBI may soon introduce holding structure norms, allowing non-lending businesses to be housed in the NOFHC. Thus, the bank’s stake in the insurance business needs not be diluted. 

Nirmal Bang

While the synergies look appealing, we think there are also multiple challenges such as impact of SLR/CRR/PSL compliance cost; the RBI’s aversion to banks holding considerable stakes in para-banking businesses will be a key concern.

Simultaneously, in the run-up to the merger completion, the bank’s excess liquidity is likely to increase from current levels so as to comply with the RBI’s requirements.

Given the scope for improvement in the operating expense ratio, the bank may choose to undertake aggressive investments in growth and customer acquisition, thus limiting improvement in cost/income ratio to only 33-35 per cent. We expect credit costs to decline. We also expect return on asset (RoA) accretion of 25-30bps over our existing estimate of 2.2 per cent and RoE accretion of 118-123bps over our existing estimate of 18 per cent by FY25.