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What the HDFC Bank merger really means for investors


The biggest merger in India in the last decade is now complete. As of 14th July 2023, HDFC shares will stop trading. What does this mean for investors?

Firstly, why bother merging? HDFC and HDFC Bank, the two giants of the Indian financial industry, are fusing into one. And creating a behemoth bank that will be India’s second-largest, even if it’s still going only to be half of the mammoth State Bank of India. The new HDFC Bank, after gobbling up its promoter, HDFC, will have ₹ 22 lakh crore in its mega balance sheet.

So we’re going to make our guesses about what the merger means for investors, and we warn you that they’re all very good guesses disguised as convincing data.


  • Forms the biggest private bank in India
  • Housing is a good addition but won’t immediately help as people think they’re the same thing
  • Why do banks love housing? A summary of how credit to housing is enormously subsidized by the risk weight

HDFC is a housing lender. It lends to you and me, traditionally called “retail”. This is about 77% of their loans. It also lends money to builders who get to build houses and other purposes such as Loans against property etc. Mortgages, which are about giving money to people who primarily use it to buy houses, have three characteristics: They are long in duration, up to 20 years, and they have a low-interest rate (typically 6.8% to 8%) and a generally low risk of default.

HDFC Bank, on the other hand, has a large number of personal loans (credit card outstandings, personal loans, loans against deposits etc.). It also has a large number of auto loans. Here, you can imagine that most loans are short in duration (even auto loans close in 7 years max), have a higher interest rate, and have a relatively larger risk of default. HDFC Bank doesn’t normally lend directly for home loans. It sells loans for HDFC and its parent and then repurchases some of the loans, which they use for priority sector lending.

When they merge, the whole thing becomes a larger entity with all this exposure added up. HDFC Bank has over 16.6 lakh cr. of lending, and HDFC has about 6.2 lakh cr.

What the HDFC Bank merger really means for investors

HDFC Bank is largely retail loans; their mortgages tend to be what they buy from HDFC itself. HDFC is mostly individual mortgages, but they have about 23%, over ₹ 140,000 cr. – of lending to corporates, builders, and commercial buildings.

HDFC has about 4,000 employees and uses distribution through HDFC Sales, its subsidiary, which has 11,000 employees. HDFC Bank, on the other hand, has 170,000 employees, and it’s the larger entity.

So the question that everyone seems to be asking is:

Is this merger going to change the world? Should I buy these stocks now or forever be cast as a loser who couldn’t see the opportunity?

The answers are no, and what are you smoking?

Potential synergies: Is there something awesome?

We really tried hard to find something incredible in this merger. For the sake of brevity, let’s say we failed. There are a lot of good things and bad things.

Good things:

HDFC Bank is now going to be able to lend for housing directly. Currently, it does something ridiculous, like it first sells housing loans of HDFC to its customers and earns a commission. It does not make any interest income from such loans. Then it goes back to HDFC and buys some of those loans, for which it might pay a slight premium. This merger allows them to directly sell customers home loans that they can earn interest income, fees (like processing charges), and potential other income such as insurance, etc.

The cost of funding will reduce somewhat. HDFC itself has a higher cost of borrowing, at 6.7%. HDFC Bank is at 4.2% because of all the money you good people leave in your bank accounts for (mostly) free and all those corporate accounts. Imagine that a merged entity will get loans at a lower rate, getting a higher “NIM” (Net interest margin). Note, however, there are other things to consider – that HDFC Bank has to keep part of the money raised through deposits in SLR and CRR which are very low yielding products. We’ll talk about this later, but the merged entity will have a lower cost of borrowing, closer to what HDFC Bank gets now.

All the subsidiaries of HDFC (such as the Mutual Fund AMC, the life insurance company, the general insurance company, and many others) will now be subsidiaries of HDFC Bank. This will probably require a go-ahead from various regulators, but it brings HDFC Bank in line with other large banks like ICICI, Axis, and SBI, which own such subsidiaries. Basically, if you go to a branch, the bankers sell you these products anyhow, but now the bank will make greater revenues as they will own a part of the subsidiaries’ profits. This may not be good for customers, but it’s positive for shareholders.

What the HDFC Bank merger really means for investors

What the HDFC Bank merger really means for investors


One small benefit is lower aggregate capital costs. Housing loans are a special beast, so they are priced low. Here’s a run-through:

  • Banks are limited in lending purely by capital. If they have ₹ 100 and they have to maintain a 15% capital adequacy ratio, they can lend only ₹ 650 or so. (15% of 650 is ₹ 100)
  • The ₹ 650 is “Risk-weighted assets”. If you lend ₹ 1000 to the government, it needs no capital (risk weight of zero), so any amount is fine. If you lend for a personal loan, the risk weight might be 100%. (so you can lend ₹ 650 to personal loans, max)
  • But if you lend to low-cost housing (less than ₹ 30 lakh loan amount), you have a risk weight of 35% to 50%. That means you could lend a higher amount (₹ 1300) to low-cost housing.
  • In fact, no matter how much the housing loan is if about 1/4th of the amount is paid by the borrower (loan to value of 75%), then the max-risk-weight is 50%.
  • This is a huge incentive for banks to lend to housing. If they earn a 2% net interest margin in housing, it’s equivalent to a 4% NIM in other loans (such as credit cards etc.)
  • This allows banks to lend at such a low rate to housing. (Versus credit cards where the risk weight is 125% and other retail loans where the risk weight is 75%)

HDFC has a similar risk weight structure (the lower risk weights are also translated to housing finance companies). Still, the merger will result in a bank that has 33% exposure to housing (versus 11% now). This means that the higher exposure to housing needs relatively lower capital overall from the bank. The merger will not benefit the capital ratios, but incremental new housing loans will need lower capital and provide higher income due to the risk weights.

Don’t let it startle you if you didn’t understand this whole thing. Lemme put it simply: RBI loves housing loans and gold and has allowed banks that lend to individuals who buy those things a much higher return on equity than people who might want to borrow to build a business. Therefore, HDFC Bank getting more mortgages will, hopefully, help it in the longer term. In the short term, it will not be helpful.

Bad things:

Regulatory load: HDFC is an NBFC. It doesn’t currently need SLR, CRR or such ratios – meaning, it needn’t have parked money in low-yielding government bonds or for no cost with the RBI. That allows it to borrow ₹ N and then lend out ₹ N. That’s not the same for a bank: borrow ₹ N and put 4.5% of that N in the RBI for no return (CRR). And another 18% in low-yielding government bonds (SLR). This means that post the merger, HDFC Bank will need an additional ₹ 100,000 cr. (around 22% of the 500,000 cr. they have lent) in these low-yielding avenues. HDFC Bank will, after the merger, have a lower “net interest margin” (NIM) because housing loans have very low yields, at around 6.8% to 7% anyhow. The current NIMs of 4.1%+ will flatten down to 3.5% or so. Lower NIMs mean lower margins. This is not good for shareholders, who will undoubtedly pay a lower price for such a margin compression.

Note: HDFC must have something called a Liquidity Coverage Ratio, which means they need to keep some portion of whatever debt maturing in the next 30 days in highly liquid instruments (govt bonds, etc.). That effectively reduces yield since something or the other will be maturing in the next 30 days, all the time, and so some portion of their borrowing cannot be used for lending. Note that the LCR for NBFCs is a concept that started in 2020 and slowly increases to the level that banks must keep.

Second, the loan durations go to 20 years for mortgage loans. These loans are currently linked to an RPLR (the lending rate of HDFC) which is 16% or so, and this will have to change to the MCLR/Base Rate/Floating rate loans.

Rate Flexibility Gone: Currently, when borrowing rates fall (repo etc.), then all banks must reduce their lending rates automatically, even to existing customers, typically with a short lag. However, HDFC isn’t a bank, so it doesn’t really have to reduce these rates. It maintains a high Retail Prime Lending Rate (RPLR) and offers NEW customers a higher discount to the RPLR while keeping existing customers at the same rate. This allows them to attract new customers at lower rates while retaining current customers at high rates.

If existing customers want to change rates to a lower one – because they say come on, why are you offering lower rates than mine to new customers – then there’s a fee for that change! HDFC has a page that says this:

HDFC Change loan rate

As a bank, it will no longer have this flexibility. Rate changes will apply at regular resets automatically. That is good for the customers but not so good for shareholders.

No major synergy: When you think of Kotak merging with ING Vysya, ING customers get to be sold the Kotak brand and other products that Kotak has, etc. When you think of HDFC merging with HDFC Bank, the customers are already getting sold each other’s products. The name is the same, and there’s no advantage to merging the brands (they are the same brand).

CASA changes: Most of HDFC’s borrowings are from the market (Commercial paper, Bonds, Masala bonds, etc.). This will need to be replaced slowly by the CASA of HDFC Bank, which can take a while. HDFC’s customers may not have HDFC Bank accounts today and will take years to be moved to a structure where they maintain their core accounts with the bank.

Comparing the merged bank to the rest

HDFC Bank, a pre-merger, is largely an auto and credit card lender. The merger will make it a mortgage-heavy lender.

It will also become the second-largest bank by lending size:

From a low-cost deposit perspective, HDFC’s been the best so far. That will change.

With the best-in-class ROE today, it will fall to a lower ROE (Return on Equity) after the merger.

Valuation wise: what happens?

HDFC Bank currently gets a price that is 3.8x book. HDFC itself gets a price that is less than 2.6x book. HDFC bank gets the higher price because of relatively higher growth in its business, the higher effective NIMs, etc.

What the HDFC Bank merger really means for investors

Valuing its Subsidiaries

You cannot simply value the subsidiaries at their face value. Take, for example, HDFC, which owns 52% of the listed HDFC AMC. As a mutual fund sponsor, HDFC must retain at least 40% ownership, but we can expect a minimum of 50% to remain owned. Therefore, the valuation can only be applied to the remaining 2%. This will not significantly alter a per-share valuation.

Along similar lines, HDFC needs to maintain its presence in the insurance business for a long duration. This sector will likely continue to require capital, so valuing the shareholding at market value isn’t feasible. However, since these subsidiaries are profitable, they will contribute to increasing the bank’s book value.

What next for HDFC Bank?

This merger is not going to change things overnight. It will take a few quarters to see some change:

  • Most synergies are already in place; no major changes are expected
  • No major impact on book value because of the addition of HDFC’s subsidiaries (AMC, Insurance, Broker, etc)
  • HDFC Bank can now directly lend for housing, thereby deriving various income streams like interest and fees
  • The increased focus on housing loans reduces capital requirements, thereby maximizing income
  • Regulatory requirements necessitate investment in low-yield avenues, reducing the net interest margin

The merger is more about succession and answering the question: Who after Keki Mistry and Deepak Parekh? The answer seems to be: Ask HDFC Bank, who will run the show after the merger.

It’s a good answer. It’s just not so juicy that the bank is any more attractive than now. Expect the price to book values to moderate, and that growth at this size will slow at some level.

What the HDFC Bank merger really means for investors

Disclosure: The author and Capitalmind Wealth PMS maintain positions in HDFC Bank and HDFC Ltd.


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