HDFC Bank Merger: A detailed guide

HDFC Bank will be the world’s fourth largest from 1st July 2023.

Sounds like a proud moment as an Indian, right?

Look at the chart below of the top 15 market cap-wise banks (source: Statista). In December,2022 HDFC Bank was at the 11th place in the world with a market capitalisation of $127 billion.
Now, after the HDFC Ltd and HDFC Bank merger, the bank will jump to the fourth rank with a market capitalisation of over $170 billion.

In the race with the world’s top-notch banks like Morgan Stanley and Royal Bank of Canada, how will HDFC Bank outperform most of them? 

At Insider, we are bringing a deep analysis of this merger, which will include the following:

• The merger details
• Why is the merger happening?
• Changes in the bank’s fundamentals after the merger.

HDFC merger details

HDFC Ltd will be merged into HDFC Bank Ltd from July 1st, 2023, and on the same day, there will be only a single entity as HDFC Bank. The stocks of HDFC Ltd will be delisted from exchanges on July 13th, 2023.

After the merger, HDFC Ltd shareholders will receive 42 shares of HDFC Bank for every 25 shares held in HDFC Ltd.

When considering the shareholding pattern, it can be observed that HDFC Bank will be 100% owned by public shareholders. Furthermore, the current HDFC shareholders will retain approximately 41% ownership in the merged entity.

But…

Why is the merger happening?

Before talking about the reason behind the merger, let’s first talk about both entities one by one.

HDFC Ltd started in 1977 as a housing finance company. Back then, the housing demand was present, but people were very cautious about borrowing money. When globalisation started in the early 90s, people started taking individual and business loans, and demand for loan products had shot up.

The increased demand for loans prompted the establishment of HDFC Bank in 1994, and the bank started its operations as a scheduled commercial bank in January 1995.

Let’s talk about HDFC Ltd first.

In the early 90s, the mortgage penetration in India was just 1% of the GDP, which has reached around 10.5% today. When we compare this with different Western countries, the same number represents a ratio of around 40% to 50%. Even China has a mortgage penetration of over 20% of the GDP. This shows that we, as a country, have a lot to catch up to.

In India, the typical age for first-time home buyers is 37, and around 2/3rd of the population is under the age of 35. This shows a consistent and inherent rise in demand from millions of new home buyers annually, reflecting both organic and structural growth factors.

During an interview with BQ Prime, Mr Ketki Mistry, the Vice Chairman and CEO of HDFC Ltd, discussed their primary objectives for HDFC when it started.

1. To achieve a yearly increase of 1% in ROE: They had been successfully achieving this target until their Life and General Insurance and Banking businesses took off.
When the insurance business and banking business started to grow beyond a point, as a promoter, HDFC Ltd had to keep cash for many regulatory and risk management reasons, which then lowered the growth in ROE.

2. To maintain a cost-to-income ratio below 10%: This target has been achieved by very few financial institutions, not only in India but globally.

3. To maintain exceptional asset quality: Over the past four decades, the total individual loan losses accounted for a mere 0.04% of the total disbursals.

This was all about HDFC Ltd. Now, before talking about the reason behind the merger, let’s shift our focus to the bank for a bit.

When we examine SBI, the largest bank of India, based on the size of its balance sheet, we observe that its balance sheet has been expanding at a CAGR of approximately 11.25% from FY19, reaching around ₹60 lakh crores.

But…

If we talk about the balance sheet of HDFC Bank, the balance sheet size is around ₹35 lakhs crores, which is growing much faster than SBI at a CAGR of around 28% from FY19.

It seems, in a very brief moment, with this merger, HDFC Bank is set to overtake SBI.

As both HDFC and HDFC Bank experienced significant growth over time, it became inevitable for the merger to occur. Because HDFC was only providing housing loans, and the bank was providing everything else other than housing loans.

But how would this change the bank’s fundamentals?

Changes in HDFC Bank’s fundamentals after the merger

After the merger, HDFC Life and General Insurance, HDFC AMC, and HDFC Capital Advisers will become subsidiaries of HDFC Bank, while HDFC Bank and HDFC Ltd will combine to form a single entity.

This will lead to a significant rise in the total assets and deposits of the bank. The total loan disbursals will see a tremendous amount of rise because the housing loans of HDFC Ltd will come under the bank’s loan disbursals.

Because of the merger, cross-selling among the products will increase and then revenue will again shoot up for both the bank and its subsidiaries.

Currently, HDFC Bank has over 8 crore customers, out of which only 2 % took housing loans from HDFC Ltd, and 5% took them from other banks. The remaining 93% of customers have not taken any housing loan.

Now, with the merger, the bank can now offer housing loans to the remaining 93% of the customers more aggressively. Also, the number of HDFC Bank accounts of the customers of HDFC Ltd is very low, which will again go significantly up after the merger.

As a result of cross-selling opportunities within its subsidiaries, such as HDFC Life or HDFC AMC, the Bank is expected to witness a rise in the number of deposit accounts.

The Bottom Line

HDFC is easily one of the strongest financial institutes in the country, and this merger is only set to bolster its position. The merger will also give HDFC a stronger bargaining position as a financial service provider.

While this position of being a market leader is not something to be worried about, owing to the regulations in the banking industry, the investors in the bank are likely to benefit from the acquisition of this position.

*Disclaimer: The stocks and companies discussed above aren't a recommendation from Insider by Finology and shall not be construed as a replacement for professional advice. Consult a professional or conduct the necessary research before making investment decisions.