Banking on efficiency

HDFC Bank will benefit from higher scale

The merger between giant mortgage lender HDFC and its group company, leading private bank HDFC Bank, sets all kinds of records. It creates a financial services giant with advances amounting to nearly Rs 18 trillion, assets under management of over Rs 25 trillion, a net worth of over Rs 3 trillion, and the highest free-float market cap in India. Given that the group also controls a leading private insurance entity, and a top-rung mutual funds house, it’s a one-stop shop for financial services and products. The merged entity will be a very large bank, with investors in HDFC receiving 42 shares of HDFC Bank for every 25 shares they own in HDFC. Post-merger, HDFC shareholding in HDFC Bank will be extinguished and HDFC Bank will be 100 per cent owned by public shareholders. The existing shareholders of HDFC will own 41 per cent in HDFC Bank.

One overwhelming advantage for the umbrella entity is that the cost of funding drops considerably, which will enable it to offer cheaper mortgages, enhancing its already strong market share. HDFC Bank has a huge customer base across the 6,300 branches, which can now be targeted for mortgage lending, while the housing loan clients of HDFC can be targeted by HDFC Bank’s offers. Interestingly, it is believed that only 30 per cent of HDFC customers have HDFC Bank accounts —  so there’s plenty of room to increase cross-selling.  Apart from this, there may also be other operational and efficiency synergies from the merger in terms of sharing the same platform, streamlining workforces, etc. Investors would be interested in knowing the shape of the higher management after the merger. The bank, however, may have to address certain regulatory issues because the sector regulator, the Reserve Bank of India (RBI), disapproves of banks owning high stakes in insurance companies. If the RBI brings in regulation to restrict such ownership, there is a possibility that a stake sale in the insurance arm, HDFC Life, may be forced.  That apart, the merged entity will also have to allocate funds towards meeting new regulatory requirements since the balance sheet expands considerably and the erstwhile non-banking financial company did not have to fulfil the cash reserve ratio and statutory liquidity ratio requirements, unlike the merged entity.

This merger, which should complete in 18 months, underlines a trend towards creating scale in the financial services space. Bajaj Finserv, Axis Bank, ICICI Bank, and now HDFC all have giant footprints, with large retail customer bases, a wide range of high tech data-driven services, and reach across geographies. Market sentiment apart, this entity would qualify as a proxy on the entire Indian economy. It has exposure across many corporate segments, and big retail ticket consumption (real estate mortgages, vehicle loans) as well as insurance and mutual funds. It also has a presence across all of India’s regions, including rural and semi-urban markets. The market has bid both entities’ shares up enthusiastically upon the announcement of the merger, pushing the combined market cap beyond the Rs 14-trillion mark. The combined entity would, by far, have the highest weighting in the Nifty 50 index because of its high free float. Index funds and exchange-traded funds will have to rebalance their stakes, which could drive the market valuations even higher.