Post-merger bumps are not ruled out for HDFC Home Finance and HDFC Bank

Mergers in the past have been marked by retrenchments and only marginal improvements in efficiency and profitability. While the merger may have been inevitable in this case, the future is uncertain

Post-merger bumps are not ruled out for HDFC Home Finance and HDFC Bank

Furqan Qamar and Hassan Ahmad

Reverse mergers in India has so far been a rare occurrence. It, therefore, made a splash when the Housing Development Finance Corporation (HDFC) established in 1977 and known as a market leader in the housing finance sector was merged into the HDFC bank, established in 1994, as a subsidiary of HDFC itself.

Now the offspring has taken over the parent. Obviously, the subsidiary had become so big that the parent company probably felt compelled to lose its own identity.

Deepak Parekh, Chairman of HDFC, explaining the circumstances of the merger is quoted to have said that "as the son grows older, he acquires the father's business," and "This is a friendly merger. We won't be thrown out. After 45 years in housing finance, we have to find a home for ourselves, which we found in our own family company HDFC Bank".

On a more serious note, he clarified that ‘the resulting larger balance sheet would allow underwriting of large ticket infrastructure loans, accelerate the pace of credit growth in the economy, boost affordable housing and increase quantum of credit to priority sector lending including credit to agriculture sector’.

Mergers are usually a long drawn process requiring consent and approvals of the shareholders, the Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Competition Commission of India (CCI), and the Insurance Regulatory and Development Authority of India (IRDAI). This one is expected to take about 18 months to complete. Apprehensions are already being expressed that the mergers may hit regulatory roadblocks as it also involves mergers of many other subsidiaries.

Even otherwise, ‘merger between two large entities may have long-term implications not only for the entities under merger but also for the banking and the non-banking financial institutions as a whole.

Post-merger, the HDFC Bank is expected to become the largest and the biggest private sector bank in the country. Public and private sector banks taken together, the HDFC bank is probably the second largest bank in India, after the State Bank of India. They may be the biggest in India but still nowhere close to the biggest banks of the world. It may be hoped that they are now too big, by the Indian standards, to fail and that must reassure the market and and the investors.

Prior to the merger, HDFC Bank had total advances of Rs.12.7 Lakh crores whereas the parent HDFC had advances to the tune of Rs. 5.25 Lakh Crores only. Post-merger, the HDFC Bank is expected to have market capitalisation of Rs. 12.8 Lakh Crores as against the balance sheet value of Rs. 17.87 Lakh Crores. The merged entity would then be the top lender in the country in the individual as well as corporate lending segments.

The merged entity will have a Market capitalisation of ₹14 trillion rupees and will become India's second-largest company after Reliance Industries Limited (RIL). Post-merger, the HDFC Bank is likely to be reckoned amongst the the top 5 banks in the world by value.

Details of the mergers, including valuations of the two entities and other associated aspects, were worked out in complete secrecy and no one had any clue about it until it was officially announced on 4th April 2022, though people have been guessing for sometime that this was likely to come soon. Many had thought that it was not a question of ‘if’ but ‘when’ the two entities would merge. Guesses about the date and details of the merger notwithstanding, the market did not react kindly to the merger. Within 10 days of the merger, the share prices of the HDFC Bank declined by 12 percent.

In hindsight, it appears the merger was triggered more out of concern for meeting the tightened regulatory norms for the banking as well as the non-banking finance companies (NBFCs) by the Reserve Bank of India. Increased capital requirements, Non Performing Assets (NPAs) to be at par with the commercial banks, maintenance of liquidity coverage ratio were just a few that have been exerting pressure on the NBFCs. HDFC’s merger into the HDFC Bank could, thus, have been necessary for its survival and growth. HDFC Bank, on the other hand may have seized this opportunity to garner larger market share leading to economies of scale and lower borrowing costs.

Collapse of IL&FS in 2017 due to non availability of cheaper liquidity, may have also been weighing heavily in the mind of the management. Banks indeed have better access to cheaper funds as compared to the NBFCs and development banks.

As there are no free lunches and everything comes at a price HDFC Bank shall now have to be prepared to make way for the Priority Sector Lending requirements (PSL), expected to be about ₹900 billion, besides maintaining the Cash Reserve Ration (CRR) and Statutory Liquidity Ratio (SLR), which may further block an additional ₹800 billion, and may, prove to be a drag on the merged entity.

As an immediate reaction to the announcement of the merger, shares of both the HDFC and HDFC Banks had jumped by about 10 percent, but within four days recorded a fall of about 8 percent. It was a substantial loss to the HDFC shareholders as they had received 25 shares in the HDFC Bank for every 42 shares that they held in the HDFC.

Implication of this merger will also be felt by the portfolio investors, particularly the mutual funds, as some of them have had more than 10 percent ownership in the two entities. They may have to shed shed a part of their ownership stake and restructure their portfolio, because SEBI norms don't allow a mutual fund to hold more than 10 percent equity in a listed firm and 5 percent in non-listed firms.

As a consequence of the merger, the customer of the erstwhile HDFC would now be able to access all the products and services of the HDFC Bank like opening savings and current accounts, availing credit cards and many more. This will also reduce the cost of borrowings for the bank.

Similarly, the HDFC Bank customers will now have seamless access to the HDFC housing loan market. So far, the HDFC Bank was reluctant to offer housing loans to avoid competing with its parent. The merger is also expected to reduce the risk of HDFC Bank as mortgage loans are considered relatively less risky than the other forms of credits and lending.

If past experiences are any indication, the merger may, however, affect officers and employees of the two entities. When the State Bank of India subsumed five of its associates, and one more bank into its fold, the merged entity gained only on a few parameters of profitability, growth and efficiency but the decline in manpower and human resources were far more pronounced.

During a five year period, two prior to the merger and two after the merger and one in which the merger took place, the merged entity saw the number of employees decline by 13.7 percent (Qamar and Din, Consolidation of State Bank of India: Effects on Performance and Policy Implication, Nice Journal of Business, Vol 16 (1&2) January-December 2021, In Print). It may only be hoped that this would not happen in the case of this merger.

Besides retrenchment, an overnight changes in their role, responsibilities and change in the culture, are the biggest source of anxieties for the two organisations that seek to merge. Even though the employees and staff of the HDFC and the HDFC Bank have been under the same management, the role and responsibility of officers, staff and employees working in HDFC must have been quite different than their counterparts in the HDFC Bank.

It may take them a while to adjust to the changed work place environment and culture. Obviously, this entail an onerous responsibility on the management to keep the motivation and morale of their employees high. Apprehending such misgivings, the top management has already come out to assure the employees and staff of the two entities.

Mergers are never about two plus two being equal to four. They are all about the ability of the merged entity to capitalise on the synergy that arises on account the mergers. Mergers, in the banking sector, are generally expected to improve efficiency, enhance size and scale of operation and lead to improvements in profitability and other performance parameters. The existing research evidences are, however, still inconclusive and it cannot be said with a high degree of certainty that it would positively be to the advantage of the merged entity.

(The writers are independent commentators. Opinion is personal)

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