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HDFC Bank has announced a merger with HDFC Ltd, issuing 1.68 shares of HDFCB for every 1 share of HDFC Ltd (in line with last close). While the merger will increase the bank’s product portfolio and ability to cross-sell, we think there will also be a drag on its P&L due to PSL requirements and higher SLR/CRR requirements. RBI’s approval will also be a key monitorable, as the bank will end up owning large stakes in the life-insurance, general insurance and AMC businesses.

Regulatory nod a key monitorable

Merger creates behemoth: The merger will widen product coverage for HDFC Bank. As per mgmt., ~70% of HDFCB customers do not have mortgages from HDFC Ltd. We think the merger has direct implications for the sector, as it increases competitive intensity (as HDFCB’s capabilities will be enhanced). There is also a clear read-through that larger NBFCs will have to convert into banks to thrive.

Technical gains from FII headroom expansion may be limited

FII shareholding in HDFC Bank (post merger) will be ~66% vs the 74% cap. Hence, there is an enhanced gap of 7-8% vs ~4% currently for FIIs to hold the stock. However, we think inclusion of the merged HDFCB in the index may be difficult, as MSCI India requires a larger FII headroom (from cap) for inclusion.

Priority-sector requirements and SRR/CLR may be a drag on P&L

As per rough calculations, HDFCB will have an excess SLR/CRR asset requirement of ~Rs 700-800 bn and will also need an incremental ~ Rs 900 bn agriculture portfolio to meet PSL norms. These low-yielding portfolios could be a drag on the P&L.

RBI’s approvals a key monitorable

RBI’s approval will also be key monitorable, as the bank will end up owning 48% in the life, ~50% in general insurance and 69% in AMC entities of group. Very recently, RBI did not allow Axis Bank to directly own >10% in Max Life, and ICICI Bank was asked to bring down shareholding in ICICI Lombard to <30%.

Merger solves succession problem at HDFC Ltd

The merged entity will include all senior mgmt personnel of HDFC. Keki Mistry will be non-executive director on board, while Deepak Parekh will not serve due to age caps. We believe the merger solves the succession problem at HDFC Ltd to a great extent.

Lessons from ICICI group merger

ICICI had undergone a similar group merger in 2002. CASA for ICICI (as % of total funding) dropped from 26% (FY01) to 9% in FY03 and recovered to the 30% level only by FY10. Refinancing HDFC’s funding with low-cost deposits will be key for success of the merger, in our view. HDFC Bank’s effective CASA could go down to ~35% from ~47% post merger.

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Author: Howard Caldwell