Hesitancy, Exuberance, Realisation – CASINOIN -Sports betting at the casinoin betting company,casinoin online betting, casinoin bookmaker line, casinoin bookmaker bonuses, casinoin bookmaker, casinoin bookmaker, casinoin sports betting, casinoin bookmaker, casinoin bookmaker,

By V Thiagarajan

Most marriages in an Indian family or mergers in Indian corporate groups normally evolve in three phases — Early Hesitancy, Intermediate Exuberance and Final Realisation. The merger of HDFC-HDFC Bank, which hogged the headlines last week, has followed the script of the first two phases so far.

In the first Hesitancy Phase, both parties started saying — No, not now, it’s too early, let them be mature; and slowly evolved to —  Yes, it was always on the cards. Markets entered the Exuberant Phase and now we need to see what the future holds. As Indian markets walked into the first bank working day of the financial year with dreary eyes, the news broke of the much-discussed “transformational merger” of two equals.

The markets, which till then were bruised by March volatility, got something to cheer about to support their perennially optimistic mindset. In a classic spell of emotions of greed and hope, the buying frenzy took over. As the day wore on, reality started asserting and caution prevailed, and as the week progressed, the news had had minimal impact and the Realisation Phase had set in.

Markets are back to their business of watching the tape and still trying to figure out the moral of the story. It may probably be sheer coincidence that the all-pervasive regulator had a role to play in all three phases.

Hesitancy Phase 

Back in July 2014, the Reserve Bank of India (RBI) had issued a notification saying banks do not have to maintain cash reserve ratio or CRR (percentage of money, which a bank has to keep with the RBI in the form of cash) and statutory liquidity ratio or SLR (minimum percentage of deposits that a commercial bank has to maintain in the form of liquid cash, gold or other securities) for funds raised by issuing long-term bonds to fund infrastructure and affordable housing. The RBI also exempted them from meeting priority sector lending targets on such funds. The regulator may not have even expected this innocuous circular would have an unexpected impact in the board rooms.

Aditya Puri, then CEO of HDFC Bank — who had led famous mergers of Times Bank and Centurion Bank of Punjab with HDFC Bank — acknowledged that infrastructure bond issuance heightened the case for a merger with HDFC Ltd. He made a pertinent point when he said: “Both in the view of HDFC and HDFC Bank, the merger in the long-run makes sense… But there is no proposal on the table at the moment. We have been saying the same thing about the merger for the past 20 years.”

HDFC Chairman Deepak Parekh added that the boards of HDFC Bank and HDFC have not considered a merger, but they may look into it at an appropriate time “if it is necessary and beneficial to both entities”.

So, the Hesitancy Phase had been existing within the family for a long time although it was common knowledge that a day would come when the merger would eventually happen. The day indeed arrived on 4 April and thus began the Exuberance Phase

Early Exuberance

The markets could have taken this in stride in as much as the event was the most awaited one in the Indian markets next only to the much-awaited IPO of the largest life insurer of the country. However, the consensus saw the merger as a positive development for both HDFC and HDFC Bank and the markets greeted it with an impulsive rally in both stocks in this Exuberance Phase.

Post the merger, HDFC Bank will have the following advantages:

• It allows the bank to have a sizeable exposure towards mortgages while benefitting from lower cost of funds. The combined entity will be in a position to offer mortgage products seamlessly Vs the current assignment route.
• It strengthens the market share in advances of the bank by about 60 bps (basis points) at 14.7%. The bank would also be double the size of the second largest private sector bank, ICICI Bank, which has a market share of about 7%.
• The combined advances portfolio would improve the mortgages share meaningfully to nearly 30% of advances versus 6% pre-merger. Also, the share of unsecured portfolio will reduce from 16% to 11% post-merger.
• EPS (earnings per share) accretive from the beginning and will derive synergies from untapped HDFC Ltd customers. It is estimated that 70% of HDFC Ltd customers do not bank with HDFC Bank.
• It lowers the operating expenses for the combined entity due to superior operating ratios of HDFC Ltd.

And the advantages for HDFC Ltd post-merger are:

• Synergetic benefits arising out of operating under the ambit of the bank.
• Holding company discount is eliminated thus benefitting shareholders of HDFC Ltd.

Why the Merger

As any impulsive trader would do, the markets at the terminal moment of early exuberance started analysing the reasons for the announcement at this moment. Some of these include:

• The RBI has been tightening the regulatory framework for NBFCs, which has almost closed the regulatory arbitrage that they enjoyed vis-à-vis banks.
• The RBI last year came out with new scale-based regulations for the NBFC sector, which would be applicable from October this year. Under the new framework, the regulatory structure has four layers based on size, activity and perceived risk. HDFC Ltd as the largest NBFC was falling under the upper layer implying enhanced regulatory requirements
• NBFCs are required to maintain liquidity coverage ratio or LCR (high quality liquid assets as a percentage of liabilities) of 100% by Dec 2024. Banks at present comply with minimum LCR requirement of 100%.
• NBFC housing finance companies (HFCs) are required to maintain minimum capital adequacy ratio (the ratio of a bank’s capital to its risk that assesses the ability of banks to absorb losses) of 15%.
• Gross NPA (non-performing asset) norms have been aligned with banks with 90 days past due daily NPA recognition
• Foreign institutional investor (FII) holding in the merged entity would be approximately 67%, which would offer headroom of another 10.58% for further increase in FII stake. The stock price of both HDFC and HDFC Bank has remained stagnant. This merger provides strong sentimental support for the stock prices
• Housing finance is a price-sensitive sector, especially in an environment when the credit growth is anaemic across the industry in a low interest regime that has prevailed in the last two years. PSU banks in an unusually aggressive style have been gaining market share. On the corporate/developer loans, larger private equity players have been steadily flooding the market. Competing with banks on competitive home loan products and larger players like Brookfield on the developer loans is a key constraint of all NBFCs in housing finance. HDFC Ltd may not be an exception.

Realisation Phase, Challenges

Now that the Final Realisation Phase has kicked in, some of the challenges the merged entity would face include:

• Higher regulatory/compliance costs due to CRR/SLR and priority sector lending requirements.
• Back of the envelope calculations seem to suggest CRR/SLR investments of approximately Rs 70,000-90,000 crore and priority sector loans of Rs 1.5 lakh crore.
• HDFC Ltd has non-convertible bonds with seven-year maturity of Rs 80,000 crore which will qualify as infra bonds, which will not require CRR and SLR compliance.
• But overall, HDFC Bank’s NDTL (Demand deposit+time deposit) will grow on which it will have to provide CRR and SLR, which would increase its costs.
• However, it remains to be seen whether it will be given a treatment like IDBI Ltd or ICICI Bank.
• With interest rates currently at historic lows and the RBI continuing to be the sheet anchor for domestic liquidity, there is no better moment for the merger to happen. If the rates rise soon in keeping with the global normalisation cycle, there is a case for significant cost overrun.

Concentration Risk

More importantly, sectoral concentration risk matters very much. Concentration of bank assets is one of the most important factors contributing to systemic banking risk. According to a 2004 Basel Committee study, credit concentration in banks caused nine of the 13 major banking crises around the world in the 20th century.

It’s all not smooth sailing for the housing industry since the pandemic. The home loan portfolio is fraught with concentration risk, high litigation risk and with the real estate sector continuing to be in a struggle despite the low rates, the risk is even bigger. Unless home prices rise in keeping pace with annual interest, it may be tough to avoid slippages of significant proportion.

The loan mix of the combined entity would be 33%, 19%, 24%, 21% for mortgage, corporate, commercial & rural banking, retail vs the current mix of 11%, 26%, 35%, 28% for mortgage, corporate, commercial & rural banking, retail respectively. With mortgages forming ~33% of advances, there will likely be some pressure on yields due to a mix change.

The risk of the second largest bank in the country holding 33% of its assets in home loans may not be easily dismissed as temporary as it could have wider systemic ramifications. MSCI India Index would delete HDFC Limited and may not include the merged entity because FII headroom would only be limited at 10.58% as against the 15% required. In such an eventuality of MSCI India Index not including HDFC Bank, there is a case for FII overhang in the stock.

Regulatory concern about banks holding higher stakes in insurance companies is another key factor. Currently, the RBI allows banks to hold up to 50% in insurance subsidiaries but there have been indications (Axis-Max Life deal) where the RBI wanted to restrict the stake of banks in insurance companies to up to 20%. In the case of ICICI Bank, it was asked to bring down the shareholding to less than 30%. This could pose a risk of dilution in subsidiaries.

The ICICI Bank had undergone a similar merger in 2002. CASA (Current Account, Savings Account) of ICICI Bank declined from 26% in FY2001 to 9% in FY2003 and recovered back to the pre-merge levels only by FY2010. Although a similar drop may not be witnessed in HDFC Bank, there is a significant risk of CASA as a percentage of funding not being able to reach pre-merger levels for a longer time.

No doubt, the initial exuberance and excitement have waned and there is a sense of disappointment that this “transformational merger” may have to prove to the world that they have indeed thought through this realisation phase. Some other story would emerge soon and we would once more go through the three phases.

(The author is an Independent Market Expert) 


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