HDFC Bank Ltd, India’s most valuable lender, agreed to acquire its parent and the country’s largest mortgage lender for about $64 billion in an all-stock deal to create a $160 billion financial services behemoth that will be better positioned to tap soaring demand for home loans.
The merger, expected to close in 18 months, would significantly widen the bank’s lead over rival private sector peers ICICI Bank Ltd and Axis Bank Ltd in terms of total assets. Based on data as of 31 December, the merged HDFC Bank would have a loan book of ₹17.9 trillion, much ahead of ₹8.14 trillion of ICICI Bank and ₹6.65 trillion of Axis Bank. India’s largest lender State Bank of India (SBI), had total loans of ₹26.64 trillion at the end of December.
The merger of the two entities comes as the Reserve Bank of India (RBI) steadily tightens norms for non-bank lenders to bring them on par with banks, leaving little incentive for large shadow banks to operate independently. The combined entity will benefit from adding a large portfolio of mortgages amid a spike in demand for home loans.
“The merger makes the combined entity strong enough not only to counter competition but to make the mortgage offering even more competitive,” said Deepak Parekh, chairman of Housing Development Finance Corp. Ltd (HDFC).
While a deal of this nature has been speculated for several years, Parekh said the merger makes more sense now due to the changing regulatory landscape. The arbitrage enjoyed by non-bank lenders in terms of regulations has been diminishing as RBI looks to harmonize norms across categories of lenders. Experts said this could also send out a message to other large non-banks to look at converting into a bank.
Investors cheered the announcement, with HDFC and HDFC Bank shares surging 9.3% and 9.97%, respectively, at the end of trading on Monday, paring some of gains in intraday trading. The combined entity’s estimated ₹12.1 trillion market value would bring it within snapping distance of India’s second most valuable company, Tata Consultancy Services Ltd. Reliance Industries will remain India’s most valuable company.
According to the merger terms, shareholders of the mortgage lender will receive 42 equity shares of HDFC Bank for every 25 shares they hold. HDFC’s current stake of 21% in the bank will be extinguished, and HDFC Bank will be fully owned by public shareholders. Existing shareholders of the mortgage lender will own 41% of the bank after the merger.
Parekh, a veteran banker, would not be on the board of the consolidated entity owing to age-related restrictions. HDFC’s current chief executive Keki Mistry will be a director on the board but not a full-time executive.
Calling the deal a coming together of equals, Parekh said customers of both the mortgage lender and the bank will be the biggest beneficiaries. While HDFC’s customers will now have access to a wider gamut of products and services, the bank’s customers will have better access to home loans. Around 70% of HDFC customers do not have bank accounts with HDFC Bank, and about 80% of HDFC Bank customers do not have mortgages from the group.
The proposal will now require a string of approvals from RBI, the Securities and Exchange Board of India (Sebi), the Competition Commission of India (CCI), the National Housing Bank (NHB), the Insurance Regulatory and Development Authority of India (IRDAI), the Pension Fund Regulatory and Development Authority (PFRDA), shareholders and others.
The nod from RBI will be keenly watched by investors, given that the bank will now have sizeable stakes in insurance entities, something the regulator is known to be uncomfortable about.
“The bank will end up owning 48% in the life insurer, about 50% in the general insurance and 69% in the asset management company (AMC) entities of the group. Very recently, RBI did not allow Axis Bank to directly own over 10% in Max Life, and ICICI Bank was asked to bring down shareholding in ICICI Lombard to below 30%,” analysts at Macquarie said in a note on Monday.
Experts pointed out that while this deal would widen HDFC Bank’s suite of products and allow better cross-selling, it could impact the bank’s profitability. The regulatory capital buffer requirements—statutory liquidity ratio and cash reserve ratio—would increase. It is estimated that HDFC Bank will have an excess SLR/CRR asset requirement of ₹70,000-80,000 crore and will also need an incremental ₹90,000 crore agriculture portfolio to meet priority sector lending norms, according to Macquarie Research.
“If you look at the excess (capital buffer) we have, not just from a regulatory requirement perspective, but from the capital cushion point of view, the number probably is already there,” said Sashidhar Jagdishan, MD & CEO, HDFC Bank. Jagdishan will remain the chief executive of the merged entity.
Meanwhile, Parekh told reporters the lender had requested RBI to allow staggered compliance with the capital buffer requirements for existing assets over two-three years, although new loans will be compliant with SLR-CRR regulations. “These are open questions that depend on how RBI responds to our letter,” he said.