What does the HDFC-HDFC Bank merger mean for shareholders?

The sudden announcement of the merger of HDFC and HDFC Bank surprised everyone. For its part, The Street supported the merger with the shares of both financial entities, which rose as much as 16% during the day yesterday.

The merger, if successful, would create the largest financial giant in India by market capitalization.

However, the key word here is ‘if’ the merge is done.

In an unexpected announcement on Monday, HDFC Bank said it would fully absorb its sister company HDFC in a stock swap deal.

The shareholders of HDFC Ltd will receive 42 shares of the Bank for the 25 shares held, thus the existing shareholders of HDFC Ltd will own 41 per cent of HDFC Bank.

The equity owned by the lender’s housing finance company will be amortized, making HDFC Bank a fully public company.

However, the merger will have to stand the test of regulators, particularly the Reserve Bank of India and the Insurance Regulatory Authority.

Back in 2020, the banking regulator did not single-handedly allow Axis Bank to own a large stake in the life insurance company. Analysts believe that this precedent may validate the merger of HDFC and HDFC Bank as well.

Currently, HDFC owns approximately 48% of the shares of HDFC Life. If the merging entity holds a larger stake, the merging entity may have to reduce its holding within the next 15-18 months.

Nowadays, banks can own more than 50% of the shares of an insurance company. But, they have to reduce the quota over a period of time. Moreover, the Reserve Bank of India was considering capping a bank’s ownership in an insurance company at 20%. Analysts say all of these regulatory requirements should be monitored.

Regardless, analysts say investors need to be vigilant regarding foreign investment inflows into the merged entity.

This is because, at the moment, domestic mutual funds can keep 10% of their total pools in one entity.

The third burden may be on finances. According to early estimates from global brokerage Macquarie, HDFC Bank will have a surplus SLR/CRR asset requirement of around Rs 70,000-80,000 crore and will need an additional agricultural portfolio of Rs 90,000 crore to meet the PSL standards.

The brokerage says that these low-return portfolios can be a drag on the combined entity’s profits and losses.

HDFC Ltd refinancing with low cost deposits will be another key factor to the success of the merger. Analysts fear HDFC Bank’s effective CASA will drop to 35% from 47% after the merger.

Therefore, investors must be patient in order to reap the benefits from the proposed merger.

From a valuation standpoint, analysts say HDFC Bank’s valuation could jump from less than 4x price to book to 5-6x price to book in 1-2 years.

Against this background, stock movement will once again be the main driver of the markets on Tuesday. Besides, stock actions and other global signals will guide the indicators.

The benchmark S&P BSE Sensex and Nifty50 indices finished above their key psychological levels at 60,000 and 18,000 yesterday, encouraging a consolidation.

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